Key themes
Banking entities and effective dates
Proprietary trading
Covered funds
Compliance and reporting


On December 10 2013 the five agencies principally responsible for banking and financial market regulation in the United States(1) adopted their final rule implementing the so-called 'Volcker Rule'.(2) In doing so, the agencies closed an important Dodd-Frank chapter and set in motion the writing of a new and similarly important one: the contours of the final rule ensure that the rule's requirements will evolve in practice, and that the agencies will play a significant continuing role in determining the rule's practical meaning in the varied circumstances to which it will apply.

This update first provides an overview of several key themes associated with the final rule and then highlights a number of its most important elements. Following the overview and highlights, the update addresses in detail the highlighted subject matters.

Key themes

The agencies responded constructively to many (though not all) of the comments they received regarding their initial proposal.(3) Although the regulatory process may not have been all that some had hoped, the outcome was collaborative and, in many respects, the regulatory product was thoughtful.

Facing a subject matter of great complexity – proprietary trading and covered fund activities and investments – the agencies opted in important areas to define permitted activities in relatively broad, non-specific terms. For example, the hedging exemption to the prohibition on proprietary trading permits the hedging of 'aggregated positions' across various 'trading desks' as long as the hedging transactions address 'specific risks'. The final rule provides some content for these phrases, but it will likely take iterative experience (ie, banking entities working with their regulators) before the final rule's nuances are understood.

Perhaps because of terminology that is not overly specific, the final rule puts extraordinary emphasis on, and provides exceptionally prescriptive detail for, compliance programmes and reporting regimes, particularly for larger banking organisations. For example, the final rule addresses the oversight responsibilities of four different levels of management within a bank: boards of directors, chief executive officers (CEOs), members of senior management and line managers. The final rule also imposes an annual attestation requirement on CEOs.

This combination of permitted activity provisions that require both significant interpretation and very detailed compliance and reporting regimes points in at least one likely direction: the agencies intend to take an active role in moulding the application of the final rule to the discrete trading and covered fund activities of individual banking organisations. This approach will likely dovetail most readily with the supervisory mode in which prudential bank regulators traditionally operate. It is less clear how well it will mesh with the examination and enforcement mode to which non-bank regulators are accustomed.

Between the final rule (over 70 pages) and the supplementary information (nearly 900 pages),(4) market participants have a great deal to digest.

Banking entities and effective dates

'Banking entity' definition
The definition of 'banking entity' remains essentially unchanged from the proposed rule. The definition covers US banks, foreign banks and their affiliates. However, the definition has been narrowed slightly in certain circumstances under the final rule. For example, the final rule excludes from the definition of 'banking entity' covered funds that are not otherwise banking entities. By contrast, the proposed rule excluded only those covered funds organised, offered and held by a banking entity in connection with providing bona fide trust, fiduciary, investment advisory or commodity trading advisory services. In addition, the final rule excludes from the definition of a 'banking entity' any portfolio company held under merchant banking authority, provided that the portfolio company is not a banking entity. This will help to limit the downstream applicability of the final rule and related bank holding company restrictions on covered funds and other portfolio companies.

Effective date and conformance date
Although the final rule's effective date is April 1 2014, and the conformance period provided in the statute ends on July 21 2014, the board extended the conformance period until July 21 2015, subject to certain conditions.(5) In addition, there are important phase-in rules for banks that must satisfy the detailed reporting requirements associated with significant permissible trading activities.

Proprietary trading

The final rule broadens the scope of the definition of 'distribution' by eliminating any reference to the magnitude of the offering. Thus, offerings of all sizes including small offerings (involving less than 1% of an outstanding class) and private offerings fit within the definition of 'distribution'. Moreover, the final rule broadens the scope of permitted activities in connection with a distribution by eliminating the "solely in connection" requirement.

Market making
The definition of 'market making' in the final rule (ie, routinely standing ready to purchase and sell one or more types of financial instrument) modifies a more restrictive definition (ie, regularly and continuously holding oneself out as a market maker on a security-by-security basis), which had been modelled on a provision defining an 'equity market maker' in the Securities Exchange Act of 1934. The final definition provides additional flexibility for a broader range of asset classes, such as fixed income securities. In addition, the final rule eliminates a requirement in the proposed rule that the market-making activities of a trading desk be designed to generate revenues primarily from fees, commissions, bid/ask spreads or other income rather than the appreciation in the value of covered financial positions or the hedging of such positions.

The final rule allows hedging of aggregated positions (so-called 'portfolio hedging') but requires that all hedging "demonstrably reduce or otherwise significantly mitigate specific identifiable risks".

Non-US government securities
The final rule permits US operations of foreign banking entities, as well as foreign affiliates of US banking entities, to engage in proprietary trading in foreign government obligations, so long as certain requirements are met. The proposed rule did not contain a similar exemption.

Trading by foreign banking entities
The final rule more generally authorises a foreign banking entity, or its foreign affiliates, to engage in proprietary trading, so long as the banking entity:

  • is located outside the United States (as are any relevant personnel);
  • is organised under non-US law; and
  • meets certain other requirements.

In contrast to the proposed rule, which took a transaction-based approach, the final rule does not contain a blanket prohibition against transacting in US markets or transacting with parties residing in the United States. Instead, the rule focuses on whether the trading activity creates risks for US banking entities.

Compensation practice
The final rule generally prohibits compensation practices from being designed to reward or incentivise prohibited proprietary trading. This will likely entail a host of interpretive issues for banking entities engaged in permitted trading activities.

Related compliance and reporting requirements
As noted below, the final rule requires reporting across a broad set of trading metrics (though the number of metrics has been reduced), and sets forth extensive compliance procedures, internal controls and documentation requirements.

Covered funds

Definition of 'covered fund'
The final rule takes a fundamentally different approach to defining a 'covered fund' from the proposed rule. The proposed rule defined 'covered fund' broadly and then allowed for certain permitted covered fund activities. The final rule excludes entities engaging in certain activities from the definition of 'covered fund' (eg, wholly owned subsidiaries, joint ventures, loan securitisations and qualifying asset-backed commercial paper conduits) with the consequence that the related activities are removed from the scope of the Final Rule entirely. In addition, the final rule revises the references to commodity pools and foreign funds to include such entities in a more limited manner, which more closely aligns with the statutory goal of addressing bank activities and investments related to hedge funds and private equity funds and risks to US financial markets.

Definition of 'ownership interest'
The final rule provides additional clarification by defining 'other similar interests' which will be treated as ownership interests, though it does so in a potentially expansive way. The agencies clarified that substance, not form, will determine whether an investment constitutes an ownership interest, noting in particular that debt securities are not excluded from consideration if they have certain equity characteristics. In addition, the definition of a 'restricted profit interest' (referred to as 'carried interest' in the proposed rule), which is excluded from the definition of an 'ownership interest', was also broadened in response to industry comment.

Permitted risk mitigating hedge activity
The proposed rule would have permitted hedging activity that resulted in the holding of ownership interests in covered funds if the activity:

  • either arose out of a transaction conducted solely to accommodate a specific customer request with respect to the covered fund; or
  • was directly connected to the banking entity's compensation of an employee investment adviser for the covered fund.

The first of these exceptions is not included in the final rule, and thus only compensation-related hedging is permitted, which is quite narrow.

Super 23A
The Super 23A provision is largely unchanged in the final rule. However, its scope has been significantly curtailed significantly by changes to the definition of 'covered fund', which expanded the exclusions from the definition (eg, for loan securitisations, asset-backed commercial paper conduits and public welfare funds). In addition, the supplementary information clarifies that the Super 23A provision applies only to transactions with related covered funds. Section 23A's attribution rule does not apply to transactions such as loans to unaffiliated third parties that are secured by covered funds. The agencies declined, however, to extend any of the standard Section 23A exceptions, such as the exception for intra-day credits; this will continue to create challenges for banks that provide services, such as custody services, that may involve incidental extensions of credit to covered funds.


Loan securitisation exclusion
The revised definition of 'covered fund' excludes loan securitisations, which are generally characterised as issuing entities of asset-backed securities (defined under the Exchange Act) collateralised by loans (broadly defined to include leases and other receivables, but not securities or derivatives), servicing assets, interest rate and foreign exchange derivatives and special units of beneficial interest, and certain collateral certificates. Re-securitisation vehicles and other issuers that hold securities or derivatives more generally, and that rely exclusively on Section 3(c)(1) or 3(c)(7) of the Investment Company Act of 1940, will not qualify for the loan securitisation exclusion.

ABCP conduits
Many asset-backed commercial paper (ABCP) conduits will benefit from the new express exemptions outlined in the definition of covered fund under the final rule. In addition to providing more expansive relief for loan securitisations – which will be available to ABCP conduits that meet the related requirements the final rule provides specific relief for qualifying asset-backed commercial paper conduits. To the extent that ABCP conduits may have actively considered a conversion to Section 3(c)(5) or Rule 3a-7 programmes under the Investment Company Act, the focus will likely turn to complying with the asset restrictions and 100% liquidity support requirements under the final rule. For ABCP conduits not sponsored directly or indirectly by US banks, there is additional relief from the rule.

Covered bonds
The agencies have provided significant relief for covered bonds sold into the United States by non-US banks. Under the terms of the final rule, qualifying covered bonds are excluded from the definition of covered fund. In order to qualify for this protection, the assets that collateralised a banking entity's covered bonds must be loans, as required for loan securitisations under the final rule. The great majority of covered bonds sold in the United States by foreign banks already meet this requirement. The final rule does not address covered bonds that US banks may issue in the future, under pending legislation.

Compliance and reporting

Compliance requirements
The final rule uses measures of consolidated total assets to distinguish among those banking entities that:

  • may customise their compliance programmes;
  • are subject to specified compliance programme requirements; and
  • must meet additional enhanced requirements.

The latter in particular, which apply to the largest banking entities, may prove to be onerous and costly. The agencies also include an annual CEO attestation requirement.

Reporting requirements
Banking entities with significant trading assets and liabilities ($10 billion or greater) must track and report detailed information regarding their trading activities. For banking entities with the greatest trading assets and liabilities ($50 billion or greater), this reporting starts as of June 30 2014.

Foreign banking entities
For purposes of the final rule's compliance and reporting regime, a foreign banking entity will measure related thresholds against total assets or trading assets and the liabilities of the foreign banking entity's US operations (including all subsidiaries, affiliates, branches and agencies of the foreign banking entity operating, located or organised in the United States). This may create interpretive questions, given the generality of the regulatory text and the variety of US operations of foreign banking entities.

For further information on this topic please contact William S Eckland, David E Teitelbaum or James A Huizinga at Sidley Austin LLP by telephone (+1 202 736 8000), fax (+1 202 736 8711) or email (, or The Sidley website can be accessed at


(1) The agencies are the Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the Securities and Exchange Commission and the Commodity Futures Trading Commission (CFTC).

(2) 'Volcker Rule' is shorthand for Section 13 of the Bank Holding Company Act of 1956 (the BHC Act), which was added to the statute by Section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The final rule implements the statutory provision. The final rule is available here. The CFTC adopted a separate version of the final rule, and issued its own supplementary information, though both were substantively similar to those adopted and issued by the other agencies.

(3) The agencies (other than the CFTC) published for public comment the proposed rule in October 2011. The proposed rule and its related preamble are available here. The proposed rule was discussed in an update dated October 17 2011.

(4) The supplementary information is available here.

(5) The board's order stated: "During the conformance period, each banking entity is expected to engage in good-faith efforts, appropriate for its activities and investments, that will result in the conformance of all of its activities and investments to the requirements of section 619 and the implementing rules by no later than the end of the conformance period". See Order Approving Extension of Conformance Period (December 10 2013).