The FDIC, OCC, Federal Reserve and SEC have jointly issued proposed regulations that would implement the so-called “Volcker Rule”—Section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). The proposal issued on October 11 clarifies the scope of the Volcker Rule’s restrictions on proprietary trading and other activities, and provides certain exemptions. The Volcker Rule generally prohibits “banking entities” from engaging in short-term proprietary trading of any security, derivative, and certain other financial instruments for a banking entity’s own account, subject to certain exemptions. It also prohibits banking entities from owning, sponsoring, or having certain other relationships with a hedge fund or private equity fund, subject to certain exemptions. For purposes of the Volcker Rule, the term “banking entity” includes insured depository institutions, bank holding companies, and their subsidiaries or affiliates. The proposed regulations would require banking entities that engage in activities covered by the law to establish an internal compliance program that is designed to ensure and monitor compliance with the Volcker Rule. The proposal would also require certain banking entities with significant trading operations to report to their primary federal regulator certain quantitative measurements of their trading activities. Comments on the proposed regulations are due by January 13, 2012.
Nutter Notes: Transactions in certain instruments, including obligations of the U.S. government or a U.S. government agency, government-sponsored enterprises, and state and local governments, are exempt from the Volcker Rule’s prohibitions on short-term proprietary trading. Exempt activities also include market making, underwriting, and risk-mitigating hedging. The proposed regulations would impose certain requirements that must be met in order for a banking entity to rely on a statutory exemption. For example, the exemption for risk-mitigating hedging would be available only if the transaction hedges or otherwise mitigates one or more specific risks, including market risk, counterparty or other credit risk, currency or foreign exchange risk, interest rate risk, basis risk, or similar risks, arising in connection with and related to individual or aggregated positions held by the banking entity. The banking entity also would be required to have written policies and procedures in place to comply with the requirements of the exemption that address techniques and strategies that may be used for hedging, internal controls and monitoring procedures, and independent testing. The proposed regulations include official commentary that provides guidance on distinguishing permitted market making and related activities from prohibited proprietary trading activities. The proposal also includes certain exemptions to reduce the regulatory burden on smaller, less complex banking entities. For example, proposed reporting and recordkeeping requirements would vary depending on the scope and size of covered trading activities, and would apply only if the banking entity has trading assets and liabilities greater than or equal to $1 billion.