The US federal banking agencies with responsibility for enforcing the Volcker Rule have issued temporary one year no-action relief with respect to certain private non-US investment funds that are not “covered funds” for purposes of the Volcker Rule, but that could be treated as “banking entities” for purposes of the Volcker Rule due to a foreign bank’s investment in or governance arrangements with the fund.[1] Such funds are referred to as “qualifying foreign excluded funds.” The relief generally provides that the US banking agencies will not take action against a foreign bank or treat a qualifying foreign excluded fund as a banking entity based on the foreign bank’s acquisition or retention of an ownership interest in, or sponsorship of, the qualifying foreign excluded fund.

The no-action relief is significant because being treated as a banking entity would cause the non-US fund itself to be subject to the Volcker Rule’s limitations on proprietary trading and other restrictions. Such limitations and restrictions could significantly impair the operations of a fund whose purpose is to engage in making proprietary investments for clients in the same manner as a covered fund.

What is the problem? The need for relief generally arises because such funds are non-US funds that do not have US investors and therefore the funds are not covered funds under the Volcker Rule. Accordingly, although the Volcker Rule does not restrict a foreign bank’s investment in or sponsorship of such a fund, the fund itself could be a banking entity under the rule by virtue of being “controlled” by the foreign bank within the meaning of the Bank Holding Company Act. In contrast, funds that are covered funds are not banking entities, and although a banking entity’s investment in and relationships with covered funds are generally limited, a covered fund itself is generally not subject to the Volcker Rule’s limitations and restrictions with respect to its investment activities. The disparity in treatment between covered funds and similar foreign private funds that would be considered banking entities but not covered funds, i.e., qualifying foreign excluded funds, is generally viewed as an unintended consquence of the Volcker Rule.

What are the conditions for relief? The no-action relief is generally conditioned on a foreign bank’s investment in or relationship with the qualifying foreign excluded fund meeting the requirements of the Volcker Rule’s exemption for permitted covered fund activities conducted solely outside the United States, i.e., the so-called SOTUS exemption, as if the qualifying foreign excluded fund were a covered fund. The relief also requires, among other things, that the qualifying foreign excluded fund:

  • must be organized or established outside the United States and the ownership interests must be offered and sold solely outside the United States;
  • would be a covered fund were it organized or established in the United States, or is, or holds itself out as being, an entity or arrangement that raises money from investors primarily for the purpose of investing in or trading financial instruments;
  • would not otherwise be a banking entity except by virtue of the foreign bank’s acquisition or retention of an ownership interest in, or sponsorship of, the fund;
  • must be established and operated as part of a bona fide asset management business; and
  • is not operated in a manner that enables the foreign bank to evade the requirements of the Volcker Rule.

What is the holding period requirement? This no-action relief is not restricted to investments or arrangements with qualifying foreign excluded funds in place prior to any specific date. The no-action relief is for a one year period ending July 21, 2018.

What other relief is on the horizon? The no-action relief was issued in connection with an announcement that the five federal financial regulatory agencies responsible for implementing the Volcker Rule are coordinating their respective reviews of the treatment of foreign excluded funds under the Volcker Rule.[2] Specifically, the agencies are considering concerns that have been raised about the unintended consequences and extraterritorial impact of the Volcker Rule on foreign excluded funds, and to what extent these issues can be addressed by amendments to the implementing regulation, which could be done by the five agencies working together, and to what extent addressing the issues would require Congressional action.