Regulators Amend Volcker Rule for Investments in Hedge Funds

On June 25, 2020, five agencies, including the OCC, Board, FDIC, SEC, and CFTC, adopted amendments to Section 13 of the BHC Act, also known as the Volcker Rule.

  • OCC here refers to Department of Treasury, Office of the Comptroller of the Currency
  • Board refers to the Federal Reserve System
  • FDIC refers to the Federal Deposit Insurance Corporation
  • CFTC refers to Commodity Futures Trading Commission
  • SEC refers to the Securities And Exchange Commission
  • BHC Act refers to the Bank Holding Company Act

Volcker Rule restricts banks or nonbank financial companies from engaging in proprietary trading or having relationships with hedge funds or private equity funds (covered funds). The purpose of this rule was to discourage banks from taking too much risk and avoid conflict of interest with their customers; however, certain exemptions include:

  • Underwriting,
  • Risk-mitigation,
  • Activities on behalf of customers,
  • Activities for the general account of insurance companies,
  • Trading and covered fund activities and investments by non-U.S. banking entities
  • solely outside the United States

The provisions to the 2013 amendments became effective in January 2020, and the compliance date is January 1, 2021. The agencies received mixed reviews on the 2020 proposal. While banking entities and trade groups supported the amendments, several organizations and individuals stood in opposition.

Final Rule:

The final rule clarifies and simplifies regulations, refines the application of section 13 of the BHC Act outside the USA, and permits additional fund activities while safeguarding interests that section 13 intends to address. The modifications include:

  • Streamlining the covered funds’ portion of rule:
    • There is an exemption for covered funds that extend credit to permit the same credit-related activities that banking entities can directly engage in
    • Exclusions also include Venture Capital Funds, so banking entities can indirectly facilitate development and investment activity
    • Exemptions also include Family wealth management and customer facilitation vehicles so that banking entities can provide advisory and other traditional banking services to customers through a fund structure.
  • Addressing the extraterritorial treatment of certain foreign funds: Specifically, it contains modifications to the proposed exemption, the anti-evasion provision and compliance program requirements including:
    • Revision in restrictions in the foreign public funds’ exclusion to align them with the exclusion for similarly situated the U.S. registered investment companies.
    • Loan securitizations inclusion in the covered fund to permit small debt securities. Existing staff-level guidance regarding this exclusion is also systematically listed in the final rules.
    • Small business investment companies will not be required to account for their life cycle. Also, there is clarity in exemptions, defined for public welfare and other investments to include rural business investment companies and qualified opportunity funds.
    • Now there is a clarity in the calculation of ownership interests in covered funds attributed to a banking entity.

    “Qualifying foreign excluded fund” refers to an entity that:

        • Is organized or established outside the United States and the ownership interests of which are offered and sold solely outside the United States,
        • Would be a covered fund were the entity 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 to invest in financial instruments for resale or other disposition or otherwise trade in financial instruments.
      • Permitting banking entities to offer financial services and engage in other activities that do not raise concerns that the Volcker rule was intended to address:
        • The final law allows limited low-risk transactions between a banking entity and a related fund, rights
        • Finally, some revisions clarify a banking entity’s permissible investments in the same investments as a covered fund organized or offered by such a banking entity.
        • Including riskless principal transactions. It also allows a banking entity to engage in payment, clearing, and settlement activities with a related fund
        • Senior loans and senior debt will have a provision for “Safe Harbor” including clarity on the types of creditor

    To read amendments in further detail, click here.

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