On December 6, 2013, five federal financial regulatory agencies – Board of Governors of the Federal Reserve System (FRB); Office of the Comptroller of the Currency (OCC); Federal Deposit Insurance Corporation (FDIC); Securities and Exchange Commission (SEC); and Commodity Futures Trading Commission (CFTC) (collectively the “Agencies”) – each approved their own final regulations implementing section 619 of the Dodd-Frank Act (Regulations), which is known as the Volcker Rule.
The Volcker Rule seeks to limit certain risks that Congress believed insured depository institutions and certain foreign banking organizations with U.S. operations and their respective affiliates (banking entities) might be exposed to in connection with short-term proprietary trading and investments in and certain relationships with private equity funds and hedge funds (covered funds). The principles set forth in the Volcker Rule are implemented by the Regulations.
The FRB has extended the period for banking entities to conform with the Regulations until July 21, 2015. During that period, each banking entity is expected to engage in good faith efforts that will result in conformance with the Regulations for all of its activities and investments.
Since the adoption of the Regulations there have been a number of developments regarding the obligations imposed on banking entities.
Grandfathering Certain CDOs
Under the original Regulations, many mid-sized and community banks that invested in issuances of trust preferred securities and subordinated debt securities (TruPS CDOs) were concerned they would be unintentionally deemed to hold prohibited ownership interests in a covered fund. On December 24, 2013, the American Bankers Association filed suit seeking an injunction against this application of the Regulations. On January 14, 2014, the Agencies issued an interim final rule grandfathering certain qualifying TruPS CDOs.
Extended CLO Conformance Period
In April, the FRB announced plans to give banking entities two additional one-year conformance period extensions for certain collateralized loan obligations (CLOs). The FRB noted CLOs that hold some non-conforming non-loan assets may be a covered fund under the Regulations, which could require divestiture of ownership interests in such CLOs.
Banking entities now have until July 21, 2017, to conform their ownership interest in and sponsorship of CLOs that were in place as of December 31, 2013, and do not qualify for loan securitization exclusion. During the conformance period, a banking entity will not be required to include ownership interests in CLOs in determining compliance with the limitations on investment in certain covered funds and is not required to deduct its CLO investments from its Tier 1 capital as otherwise provided in the Regulations.
In June, the Agencies released an initial set of responses to frequently asked questions regarding the Volcker Rule and the Regulations.
- A trading desk may span multiple affiliated banking entities, but must report quantitative measurements to each of the Agencies with jurisdiction under the Volcker Rule over any of the entities.
- Another question addressed whether a banking entity must deduct its investment in a covered fund from its Tier 1 capital prior to the end of the conformance period. A banking entity would not be required to deduct its permitted investments in covered funds from Tier 1 capital until the end of the conformance period on July 21, 2015.
- An entity formed and operated under a written plan to become a qualifying foreign public fund may be excluded from the definition of a covered fund as is a company operating under a written plan to become a registered investment company or a business development company, in the opinion of Agency staffs.
- Certain permissible covered funds may not share a name or a variation of the same name with the applicable banking entity or an affiliate thereof. This includes use of the same root word, initials or a logo, trademark, or other corporate symbol that is also used by, or that clearly references a connection with, the banking entity, including any affiliate of the banking entity. The name of the covered fund must be sufficiently distinct from the name of the banking entity so that it would not likely lead to customer confusion regarding the relationship between the banking entity and the covered fund.
OCC Interim Examination Procedures
In June, the OCC issued interim procedures for examiners to assess the progress of banks and federal savings institutions in complying with the Regulations (Procedures). Examiners will look at an institution’s progress in, among other things, identifying relevant banking entities engaged in activities subject to the Regulations; identifying its proprietary trading and trading desks; and identifying its ownership interests in covered funds and sponsorship of covered funds. Examiners will also assess an institution’s progress in establishing a compliance program and its plan for avoiding material conflicts of interest and material exposures to high-risk assets and high-risk trading strategies. The Procedures provide detailed guidance on how examiners are to review institution compliance efforts regarding proprietary trading and covered fund activities.
Banking entities generally now have less than a year to achieve compliance. They should remain alert to additional guidance that the Agencies may provide regarding compliance expectations.
Published September 15, 2014.