On November 6 the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation and the Board of Governors of the Federal Reserve System (collectively, the 'banking agencies') issued interagency guidance clarifying the relationship between their regulatory capital rule and the capital treatment of certain private funds, known as covered funds, under the Volcker Rule.(1) The guidance ensures that covered fund investments by banking entities that result in capital deductions pursuant to the Volcker Rule will not be double-counted if deductions for the same investment would also be required pursuant to the banking agencies' capital rule. The guidance includes a step-by-step deduction methodology, as well as information about how banking organisations should report capital deductions taken pursuant to the Volcker Rule.

Capital deduction

Under the Volcker Rule, for the purposes of compliance with applicable regulatory capital requirements a banking entity must generally deduct from its Tier 1 capital the greater of the fair market value or historical cost (plus any earnings received) of its investments in covered funds, including any amounts paid to obtain a restricted profit interest in the covered fund. Although it is not entirely clear from the text of the final rule, this deduction is generally understood to apply only to those investments in covered funds held pursuant to an exemption under Section _.11 of the final rule, which includes the exemptions for organising and offering a covered fund in connection with an asset management business or a securitisation, and the exemptions for underwriting and market making in covered funds. The Volcker Rule capital deduction took effect on July 21 2015. For certain legacy covered funds that were in place before December 31 2013, the agencies intend to delay implementation of the capital deduction until July 21 2017.

The text of the final rule did not address how the Volcker Rule capital deduction interacts with other regulatory capital requirements that apply to banking organisations. However, the commentary acknowledged that the capital deduction required for investments in covered funds does not perfectly align with the deduction and risk-weighting requirements imposed by the banking agencies' regulatory capital rule. It went on to state that the banking agencies expected to propose steps to reconcile the two rules.(2) The interagency guidance appears to be the banking agencies' approach to accomplishing this reconciliation.

Deduction methodology in interagency guidance

Under the regulatory capital rule, a banking organisation's investment in the capital of an unconsolidated financial institution (UFI) may be subject to a deduction from Tier 1 capital. If a banking organisation holds such an investment and it is also an investment in a covered fund for purposes of the Volcker Rule, there appears to be overlapping capital requirements for the investment that could require the investment to be deducted from Tier 1 capital under each rule, resulting in double counting. The interagency guidance clarifies that such investments should be deducted only once from the banking organisation's Tier 1 capital.

The banking agencies included a specific methodology to ensure that banking organisations take the appropriate deductions under each rule. In effect, the methodology gives a banking organisation credit toward the required Volcker Rule capital deduction for any deduction taken from common equity Tier 1 capital or additional Tier 1 capital under the regulatory capital rule with respect to an investment that is an investment in both a UFI and a covered fund. Any remaining investments in covered funds that would be required to be deducted pursuant to the Volcker Rule capital deduction must still be deducted accordingly. The methodology also clarifies that deductions taken pursuant to this part of the capital rule and the Volcker Rule are excluded not only from the numerator, but also from the denominator of the relevant capital ratios.

Reporting and compliance

The interagency guidance reiterates that a banking organisation should be able to demonstrate to its primary federal regulatory agency that it is in compliance with the Volcker Rule and that all covered fund investment amounts have been deducted from Tier 1 capital. To that end, the guidance indicates the particular regulatory reports and line items in which banking organisations should report the capital deductions of investments made in covered funds. These reports and line items vary depending on the type and size of the banking organisation in question and are listed in more detail in the interagency guidance.

For further information on this topic please contact William S Eckland or Michael D Lewis at Sidley Austin LLP's Washington DC office by telephone (+1 202 736 8000) or email ([email protected] or [email protected]). Alternatively, contact William Shirley at Sidley Austin LLP's New York office by telephone (+1 212 839 5300) or email ([email protected]). The Sidley Austin LLP website can be accessed at


(1) The full text of the interagency guidance can be found here.

(2) The commentary to the final rule also clarifies that the Volcker Rule does not require a non-US banking entity that invests in a covered fund to deduct the value of its investment from Tier 1 capital calculated under applicable home country capital standards. Any US subsidiary of such a banking entity that is separately required to calculate and report Tier 1 capital under US capital rules would still be subject to the deduction for its own investments in covered funds.

This article was first published by the International Law Office, a premium online legal update service for major companies and law firms worldwide. Register for a free subscription.