The five US financial regulators1 yesterday approved the Volcker rule which is a key element of the US 2010 wide-ranging banking reform legislation known as Dodd-Frank. Paul Volcker (former Federal Reserve Chairman) first pushed for a ban on proprietary trading (whereby banks use their own funds for trading activities) in 2010. US President Barack Obama said of the regime, "The Volcker Rule will make it illegal for firms to use government-insured money to make speculative bets that threaten the entire financial system, and demand a new era of accountability from CEOs who must sign off on their firm's practices."
The Volcker rule had threatened to limit the operations of bank-owned asset managers in Europe. In addition to banning proprietary trading, the rule also imposes restrictions on how and when banks sponsor and invest in hedge funds, private equity, commodity pools and "covered funds". UCITS products were considered to fall within the definition of covered funds in earlier drafts of the rule. The inclusion of UCITS in the definition would have resulted in US banks facing an outright ban on acting as sponsors of or investing on a proprietary basis in UCITS products. Following extensive commentary and intensive lobbying by European governments, as well as those of Canada and Japan, the covered fund definition has been modified “to more effectively tailor the scope of foreign funds that would be covered funds under the rule". UCITS products will not be caught by the definition with the result that UCITS will be on a substantially similar footing as US mutual funds regulated under the 1940 US Investment Company Act. The rule goes into effect in April 2014 but banks effectively have until July 2015 to comply.
What does this mean for US Banks? The rule means that US banks and their foreign affiliates may continue to act as promoter/sponsor of US mutual funds and UCITS products and may carry on much of their traditional asset management businesses outside of the United States. In order to be avoid being considered a covered fund the UCITS will need to meet certain requirements applicable to non-US funds such as:
- be established outside of the United States,
- be authorised to be offered and sold to retail2 investors in its home jurisdiction,
- be sold predominantly through one or more public offerings3 outside4 the United States.
Moreover, where the UCITS is sponsored by a US bank, it must be sold predominantly to persons other than the sponsoring bank, affiliates of the issuer and the sponsoring bank, and their employees and directors. The Rule contains anti-avoidance provisions.