On December 10, 2013, the so-called “Volcker Rule” final regulations were approved (the “Rule”). In addition, the Federal Reserve Board extended the conformance period to be in compliance with the Rule until July 21, 2015. The Rule may be found at http://www.federalreserve.gov/aboutthefed/boardmeetings/20131210openmaterials.htm
For covered banking entities, the Rule imposes certain prohibitions and restrictions on proprietary trading and on ownership and sponsorship of “covered funds” pursuant to Section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.
This memorandum outlines the covered fund portion of the Rule, together with noting some of the significant changes between the proposed regulations and the Rule. We will be providing additional detailed guidance and analysis in subsequent releases.
General Prohibition. In general, the Rule prohibits a banking entity, as principal, directly or indirectly, from acquiring or retaining any ownership interest in or sponsoring a covered fund, subject to certain exceptions or exemptions. In this connection, with respect to the definition of banking entity, the Rule clarified that generally a bank holding company merchant banking portfolio company, as well as SBIC investment concerns, would not be considered banking entities.
Covered Fund Definition. A “covered fund” is any fund that would be an investment company, as defined in the Investment Company Act of 1940 (the “Act”), but for section 3(c)(1) or 3(c)(7) of the Act, or such “similar funds” as the appropriate banking regulator may determine. The proposed rule had designated as similar funds commodity pools and foreign issuers that would be covered funds under the rule if they were organized or offered under U.S. law. The Rule refined and limited the commodity pools and foreign funds that are considered “similar” covered funds subject to the Volcker Rule.
“As principal, directly or indirectly.” The Rule provides that a banking entity is not acting “as principal, directly or indirectly” in certain fiduciary, trust, agent, broker, or custodian capacities. The final Rule also specified that a banking entity may act as trustee for certain deferred compensation, stock-bonus, profitsharing, or pension plans for the benefit of banking entity employees.
Covered Fund Exceptions and Exemptions
Subject to certain requirements and limitations, the Rule provides for several exceptions to its general prohibitions. Notably, the final Rule added an exception that permits an insurance company or its affiliate to sponsor or own a covered fund for the general or separate account of a regulated insurance company. In addition, registered investment companies, business development companies, and funds that rely on Investment Company Act exclusions or exemptions other than 3(c)(1) or 3(c)(7) are not covered funds. Finally, subject to any specified requirements, conditions, or limits, the covered fund prohibition does not apply to banking entities investing in, or acting as a sponsor to, the following:
- Publicly offered foreign funds;
- Wholly-owned subsidiaries;
- Joint ventures;
- Acquisition vehicles;
- Foreign pension or retirement funds;
- Bank owned life insurance;
- Loan securitizations;
- Asset-backed commercial paper conduits;
- Qualifying covered bonds;
- SBIC and public welfare investments;
- Certain FDIC receivership issuers.
Other exemptions include:
- Certain banking entity sponsored, organized, and offered funds, subject to a defined ultimate 3% ownership limit and several other requirements;
- Underwriting and market making.
- Permitted risk-mitigating hedging activities.
- Foreign banking entities investing in, or acting as a sponsor to, a foreign covered fund. The “solely outside the United States” requirements and conditions for this exemption were clarified in the Rule to allow the exemption to be more readily used by foreign banks.
Super 23A and 23B and Prudential Limitations
The transactions with affiliates prohibitions and limitations between a banking entity and its affiliates and related funds, as well as the requirements for material conflicts of interest, remained generally as proposed.