Henry M. Fields, Julian E. Hammar, Oliver I. Ireland, Jiang Liu, and Mark R. Sobin
Banking + Financial Services, Financial Institutions + Financial Services, and Financial Services
On August 20, 2019, the Office of the Comptroller of the Currency (“OCC”) and the Federal Deposit Insurance Corporation (“FDIC”) approved a final rule (the “2019 Final Rule”) to amend the rules implementing Section 13 of the Bank Holding Company Act of 1956 (the “Volcker Rule”). It is expected that the other three federal agencies responsible for implementing the Volcker Rule (together with the OCC and FDIC, the “Agencies”) will approve the 2019 Final Rule in the coming days.
The 2019 Final Rule will be effective on January 1, 2020. However, banking entities will not be required to comply with the 2019 Final Rule until January 1, 2021 (the “Compliance Date”). Prior to the Compliance Date, banking entities may voluntarily comply, in whole or in part, with the 2019 Final Rule.
The Volcker Rule generally prohibits banking entities from engaging in proprietary trading or from investing in, sponsoring, or having certain relationships with hedge funds and private equity funds (“covered funds”). In 2013, the Agencies adopted regulations to implement the Volcker Rule (the “2013 Rule”). With more than five years of experience living under the 2013 Rule, banking entities generally have found certain of the 2013 Rule’s restrictions unduly complex and compliance burdensome. On their part, the Agencies have acknowledged that certain aspects of the 2013 Rule have been difficult to implement in practice and have identified opportunities for improvement consistent with the statute.
Recent legislative and regulatory initiatives have focused on reducing the burden of the Volcker Rule and tailoring its application. On May 24, 2018, the President signed into law the Economic Growth, Regulatory Relief, and Consumer Protection Act (“EGRRCPA”), which made certain statutory changes to the Volcker Rule.The changes include an exemption from the Volcker Rule for any insured depository institution (“IDI”) that does not have (and is not controlled by a company that has): (i) more than $10 billion in total consolidated assets; or (ii) total trading assets and trading liabilities that are more than 5% of total consolidated assets. This legislation also permits certain banking entities to share the same name as a covered fund they sponsor or advise and still rely on the asset management exemption. On July 22, 2019, the Agencies amended the 2013 Rule to conform the regulations implementing the Volcker Rule to the statutory changes affecting the Volcker Rule made by EGRRCPA.
In addition, on July 17, 2018, the Agencies published a proposed rule to implement more comprehensive changes to the Volcker Rule (the “2018 Proposed Rule”). The 2019 Final Rule adopts the 2018 Proposed Rule largely as proposed, although with a number of important modifications reflecting concerns expressed by commenters. In general, consistent with the 2018 Proposed Rule, the 2019 Final Rule provides regulatory relief to banking entities subject to the Volcker Rule by tailoring its application, simplifying certain standards and requirements, and reducing compliance burden. The 2019 Final Rule also codifies certain guidance previously published in the form of Frequently Asked Questions (“FAQs”).
As discussed below, the Agencies also plan to propose further amendments to certain fund-related provisions of the Volcker Rule in a separate rulemaking.
The Volcker Rule regulations are complex. In the pages that follow, this Client Alert aims to summarize the most significant changes brought about by the 2019 Final Rule.
TAILORING THE APPLICATION OF THE VOLCKER RULE
The 2019 Final Rule adopts the 2018 Proposed Rule’s tailored approach to compliance obligations, but with several important changes. As in the 2018 Proposed Rule, the 2019 Final Rule segments banking entities based on their level of trading assets and liabilities into three categories and subjects banking entities with higher levels of trading assets and liabilities to more stringent requirements. Banking entities with the lowest level of trading assets and liabilities (i.e., those with “Limited Trading Assets and Liabilities”) are presumed to be compliant with the Volcker Rule and will not have an obligation to demonstrate compliance on an ongoing basis (unless compliance with requirements applicable to other banking entities is required by an applicable Agency). This will provide substantial relief to banking entities with less trading activities. It should be emphasized, however, that the lack of an obligation to demonstrate compliance does not relieve a banking entity from compliance with the Volcker Rule’s restrictions.
In sum, the Final Rule establishes the following three categories:
In an important change from the 2018 Proposed Rule, the 2019 Final Rule raises the threshold for determining classification in the highest tier (Significant Trading Assets and Liabilities) to trading assets and liabilities equal to or greater than $20 billion. The 2018 Proposed Rule set the threshold at $10 billion. The Agencies agreed with commenters to the 2018 Proposed Rule who argued that raising the threshold to $20 billion would provide additional certainty to banking entities without significantly reducing the number of banking entities that will be categorized in the highest tier.
In addition, the 2019 Final Rule excludes from the calculation of trading assets and liabilities all financial instruments that are obligations of, or guaranteed by, the United States, or that are obligations, participations, or other instruments of, or guaranteed by, an agency of the United States or a government sponsored enterprise, as described in the regulations. In the 2018 Proposed Rule, a similar but narrower exclusion was provided.
In the preamble to the 2019 Final Rule (the “Preamble”), the Agencies note that they “support banking entities relying on current regulatory reporting forms to the extent possible to determine compliance obligations.” This should leave banking entities in a better position to leverage current regulatory reporting requirements, for example, reports made on Form Y9-C and the Call Report.
For U.S. banking entities, consistent with the 2018 Proposed Rule, trading assets and liabilities are measured on a worldwide consolidated basis for purposes of the 2019 Final Rule. However, the 2019 Final Rule adopts a significant change for foreign banking entities with respect to the calculation of trading assets and liabilities.
Under the 2018 Proposed Rule, banking entities that are foreign banking organizations (“FBOs”), and subsidiaries of FBOs, were required to use different standards for determining their classification. With respect to the “Limited Trading Assets and Liabilities” classification, FBOs and their subsidiaries would have been required to calculate trading assets and liabilities on a worldwide consolidated basis. For the “Significant Trading Assets and Liabilities” calculation, FBOs and their subsidiaries would have been required to calculate trading assets and liabilities using only the combined U.S. operations (including all U.S. subsidiaries, affiliates, branches, and agencies) of the top-tier FBO. Instead, the 2019 Final Rule adopts a single, consistent standard for each classification, enabling FBOs and their subsidiaries to calculate trading assets and liabilities as the trading assets and liabilities of the combined U.S. operations of the top-tier FBO for all classification purposes. This will extend the relief available to less active U.S. banking entities to those FBOs and their subsidiaries that have active trading activities outside the United States, but less active trading activities in the United States.
IMPLICATIONS OF THE TAILORED APPROACH
The revised approach to tailoring is most relevant for application of the compliance program requirements. However, it also has implications for the exemptions from the prohibition on proprietary trading for underwriting, market making, and hedging.
The following chart shows how the 2019 Final Rule amends the 2013 Rule’s tailored approach through a comparison of the treatment of banking entities that fall within the two highest tiers based on their trading activity. The chart shows certain provisions of the 2013 Rule that (i) apply to banking entities with significant trading assets and liabilities; (ii) apply to banking entities with moderate trading assets and liabilities; and (iii) have been removed from regulations altogether.
Requirement from 2013 Rule
Tailored Approach in 2019 Final Rule Based on
Level of Trading Assets and Liabilities
Volcker Rule Compliance Program Requirements
Banking entity must develop and provide for the continued administration of a compliance program reasonably designed to ensure and monitor compliance with the Volcker Rule.
Volcker Rule compliance program must include, at a minimum: (i) written policies and procedures; (ii) internal controls; (iii) management framework; (iv) independent testing and audit; (v) training; and (vi) recordkeeping.
Compliance program requirement may be satisfied by including appropriate references to the Volcker Rule’s requirements in existing compliance policies and procedures.
Enhanced compliance program for large and active banking entities.
Not applicable (requirement dropped).
CEO attestation that banking entity has processes in place reasonably designed to achieve compliance.
Metrics reporting for certain active banking entities.
Applicable (as amended).
Not applicable (unless notified in writing).
Covered funds documentation requirements.
Proprietary Trading – Underwriting Exemption
Banking entity must maintain a specified compliance program.
Applicable (as amended).
Proprietary Trading – Market-Making Exemption
Banking entity must maintain a specified compliance program.
Applicable (as amended).
Proprietary Trading – Risk-Mitigating Hedging Exemption
Banking entity must maintain a specified compliance program.
Hedging activity must be conducted in accordance with required written policies, procedures, and internal controls.
At inception, hedging must be designed to mitigate specific, identifiable risks.
Risk-mitigating hedging activity demonstrably reduces or otherwise significantly mitigates specific risks.
Not applicable (requirement dropped).
Hedging must be subject to continuing review, monitoring, and management.
Hedging must be subject to ongoing recalibration to ensure the activity satisfies the requirements of the exemption and is not prohibited proprietary trading.
Enhanced documentation requirements for certain hedging activity.
Applicable, but an exemption from required documentation is available for hedging of pre-approved, commonly used financial instruments that complies with certain hedging limits.
Not applicable (requirement dropped).
Compensation arrangements of persons performing risk-mitigating hedging activities are designed not to reward or incentivize prohibited proprietary trading.
PROPOSED CHANGES WITH RESPECT TO PROVISIONS OF GENERAL APPLICABILITY
“Banking Entity” Definition
As described above, the Volcker Rule generally prohibits “banking entities” from engaging in proprietary trading or from investing in, sponsoring, or having certain relationships with covered funds. The 2019 Final Rule does not change the definition of “banking entity.” However, the Preamble discusses (but does not resolve) an issue presented by the definition of “banking entity.” A “banking entity” does not by definition include a “covered fund” that is not itself an IDI (or company controlling an IDI), or a foreign bank regulated as a bank holding company. As a result, funds that are not “covered funds” under the Volcker Rule and that are affiliated with U.S. or foreign banking entities are themselves “banking entities.” Such funds could include registered investment companies, foreign public funds, and, with respect to foreign banking entities, certain foreign funds offered and sold outside the United States (“foreign excluded funds”). The result is that these funds are subject to the Volcker Rule’s prohibitions that apply to banking entities, including certain compliance obligations and restrictions on proprietary trading. The Preamble acknowledges that the Agencies have these issues under consideration and intend to address them in a separate rulemaking. To provide additional time for this rulemaking, the Agencies have extended their no-action position on foreign excluded funds. This extension is discussed below.
“Trading Account” Definition
Proprietary trading is defined in the 2013 Rule and the 2019 Final Rule as “engaging as principal for the trading account of the banking entity in any purchase or sale of one or more financial instruments.”
Under the 2013 Rule, a banking entity is deemed to be trading for its own trading account if:
(i) the trade is for a certain purpose (the “Purpose Test”);
(ii) the banking entity is subject to the U.S. market risk capital rules and the account is used to trade financial instruments that are both market risk capital rule covered positions and trading positions or hedges of other market risk capital rule covered positions (the “Market Risk Capital Rule Test”); or
(iii) the trade is by a securities dealer or other specified entity (the “Status Test”).
In addition, under the 2013 Rule, a trade is presumed (subject to rebuttal) to be for the trading account if the banking entity holds the financial instrument (or the risk of the trade) for fewer than 60 days. 
Proposed Accounting Test Abandoned; Purpose Test Reinstated for Certain Banking Entities
In the 2013 Rule, a trade is deemed to be for a trading account under the Purpose Test if the purpose of the trade is for:
(i) short-term resale;
(ii) benefitting from actual or expected short-term price movements;
(iii) realizing short-term arbitrage profits; or
(iv) hedging a trade that was made for one of the aforementioned purposes.
Banking entities have found it difficult to determine the purpose of trades under the Purpose Test. As a result, the determination of whether a trade is in the trading account often reverts to the rebuttable presumption described above, which may be difficult to rebut.
To address these issues, the 2018 Proposed Rule would have eliminated the Purpose Test and replaced it with an Accounting Test. Under the “Accounting Test,” an account used to effect trades would be for the banking entity’s trading account if the trade were “with respect to a financial instrument that is recorded at fair value on a recurring basis under applicable accounting standards.” This would have included financial instruments such as derivatives, trading securities, and available-for-sale securities. In the Preamble, the Agencies acknowledged that the proposed “Accounting Test” would have inappropriately included many financial instruments and activities that the Volcker rule was not intended to capture. Accordingly, the 2019 Final Rule abandons the Accounting Test and reinstates the original Purpose Test with two important changes.
Market Risk Capital Rule Test
Under the 2019 Final Rule, the Market Risk Capital Rule Test is retained with some refinements. It applies if the banking entity, or any affiliate with which the banking entity is consolidated for regulatory reporting purposes, calculates risk-based capital ratios under the market risk capital rule. U.S. banks and bank holding companies are subject to the market risk capital rule if aggregate trading assets and trading liabilities equal (i) 10% or more of total assets or (ii) $1 billion or more. A banking entity not subject to the market risk capital rule may elect (subject to certain conditions) to calculate risk-based capital ratios under the market risk capital rule and subject itself to the Market Risk Capital Rule Test.
As explained above, if a banking entity is subject to the Market Risk Capital Rule Test, it is not subject to the Purpose Test.
The 2018 Proposed Rule would have extended the Market Risk Capital Rule Test to those FBOs “that are subject to capital requirements under a market risk framework established by the home-country supervisor that is consistent with the market risk framework published by the Basel Committee on Banking Supervision.” That proposal has been abandoned.
For a banking entity subject to the Market Risk Capital Rule Test, a “trading account” includes any account used by a banking entity to purchase or sell one or more financial instruments that are both market risk capital rule “covered positions” and “trading positions” (or hedges of other market risk capital rule covered positions). In general, a position is a “covered position” if it is a trading asset or trading liability (whether on- or off-balance sheet) as reported on Call Report Schedule RC-D, or, for bank holding companies, on Schedule HC-D of the FR Y-9C Report Form. A “trading position” is a position held for the purpose of short-term resale or with the intent of benefitting from actual or expected short-term price movements, or to lock in arbitrage profits. It follows that if a financial instrument is not a trading asset or trading liability, it is not subject to the Market Risk Capital Rule Test.
The 2019 Final Rule retains the Status Test without any change of substance. The Preamble contains some helpful commentary on issues raised under the Status Test.
CEO Certification for Prime Brokerage Exemption to Super 23A Provisions
Subject to exceptions, relationships between a banking entity and certain covered funds with which the banking entity has specified relationships are subject to so-called Super 23A prohibitions under the 2013 Rule. One such exception permits banking entities to enter into prime brokerage transactions with a covered fund in which an applicable covered fund that is managed, sponsored, or advised by the banking entity or its affiliate has acquired an ownership interest, subject to certain conditions. Reliance on the prime brokerage exemption under the 2013 Rule requires the CEO of a banking entity to provide a certification that the banking entity does not guarantee, assume, or otherwise insure the obligations or performance of the covered fund or of any covered fund in which the covered fund invests. The 2019 Final Rule incorporates clarifications provided by the FAQs with respect to the CEO certification requirement. Consistent with the FAQs, such certification is required annually no later than March 31 of each year, and the CEO is required to update the certification with respect to any material changes.
PROPRIETARY TRADING EXCLUSIONS
Expansion of Liquidity Management Plan Exclusion
The 2013 Rule excludes from the definition of proprietary trading the purchase or sale of a security for liquidity management purposes in accordance with a documented liquidity management plan that meets certain requirements. The 2018 Proposed Rule would have expanded the financial instruments for which the liquidity management exception applies to the trading of foreign exchange forwards, foreign exchange swaps, and physically settled cross-currency swaps pursuant to a liquidity management plan. The 2019 Final Rule adopts the 2018 Proposed Rule in this regard and adds to this list non-deliverable cross-currency swaps.
The 2019 Final Rule excludes from the definition of proprietary trading any trades made in error in the course of conducting a permitted or excluded activity, as well as any subsequent transaction to correct the error. The availability of the exclusion will depend on the facts and circumstances of any given transaction. In a departure from the 2018 Proposed Rule, the 2019 Final Rule does not require that an erroneous trade be transferred to a separately managed trade error account for disposition.
The 2018 Proposed Rule requested comment on whether loan-related swaps between a banking entity and a borrower from a banking entity should not be treated as prohibited proprietary trading. Comment was further requested on whether other types of swaps, such as end-user swaps used by a customer to hedge commercial risk, should be treated the same way as loan-related swaps. Most commenters supported the exclusion of such transactions from the proprietary trading prohibition. In particular, the lack of a clear exemption for loan-related swaps was seen by some as having a potential chilling effect on prudent lending practices. Accordingly, the 2019 Final Rule excludes from the definition of proprietary trading the entering into a customer‑driven swap or a customer-driven security-based swap and a matched swap or security-based swap if (i) the transactions are entered into contemporaneously; (ii) the banking entity retains no more than minimal price risk; and (iii) the banking entity is not a registered dealer, swap dealer, or security-based swap dealer. The Agencies explain in the Preamble that this exclusion is expected to reduce costs for non-dealer banking entities and avoid disrupting a common and traditional banking service provided to small and medium-sized businesses.
Hedges of Mortgage Servicing Rights or Assets
The 2019 Final Rule excludes from the definition of proprietary trading the purchase and sale of financial instruments for the hedging of mortgage servicing rights or mortgage servicing assets in accordance with a documented hedging strategy.Such transactions would not be captured by the Market Risk Capital Rule Test and likely would not be captured under the Purpose Test because the principal purpose of the transactions would be to hedge risk and not for short-term resale or profit. However, given the uncertainty that attends the application of the Purpose Test, the creation of an explicit exclusion for the purchase and sale of financial instruments for such hedging purposes was deemed to be appropriate, in particular for those banking entities relying on the Purpose Test.
Financial Instruments That Are Not Trading Assets or Trading Liabilities
As explained above under the discussion of the Market Risk Capital Rule Test, if a financial instrument is not a trading asset or trading liability, it is generally not subject to that Test and thereby the trading of such assets or liabilities would not be in a trading account under the Market Risk Capital Rule Test. However, no such explicit exclusion for the trading of such assets and liabilities exists under the Purpose Test. To address this situation, and for avoidance of doubt, the 2019 Final Rule excludes the purchase and sale of financial instruments that are not trading assets or trading liabilities from the definition of proprietary trading.
PERMITTED UNDERWRITING, MARKET MAKING, AND HEDGING ACTIVITIES
Reasonably Expected Near Term Demand (RENT-D)
The Volcker Rule permits certain underwriting and market-making activity to the extent such activities are designed not to exceed the reasonably expected near term demands (“RENT-D”) of clients, customers, or counterparties. The 2013 Rule set forth conditions to be met and standards to be used by a banking entity to determine whether activities meet the RENT-D requirement. The Agencies acknowledge that the approach taken in the 2013 Rule may have been “overly broad and complex, and also may inhibit otherwise permissible” underwriting and market-making activity.
Consistent with the 2018 Proposed Rule, the 2019 Final Rule creates a presumption of compliance with the RENT-D requirements for both the underwriting and market-making exemptions. To satisfy the presumption, banking entities are required to establish internal risk limits for each trading desk designed not to exceed the RENT-D of clients, customers, or counterparties, based on the nature and amount of the trading desk’s underwriting or market-making activities, as applicable.
With respect to underwriting activities, to satisfy the presumption, internal risk limits must be placed on: (i) the amount, types, and risk of the trading desk’s underwriting position; (ii) the level of exposures to relevant risk factors arising from its underwriting position; and (iii) the period of time a security may be held. With respect to market-making activities, internal risk limits would be placed on: (i) the amount, types, and risks of its market maker positions; (ii) the amount, types, and risks of the products, instruments, and exposures the trading desk may use for risk management purposes; (iii) the level of exposures to relevant risk factors arising from its financial exposure; and (iv) the period of time a financial instrument may be held. The risk limits are subject to supervisory review and oversight by the appropriate Agency on an ongoing basis.
Unlike the 2018 Proposed Rule, the 2019 Final Rule does not require notice to the appropriate Agency if: (i) a trading desk exceeds or increases its internal risk limits; or (ii) the banking entity temporarily or permanently increases internal risk limits. The Agencies acknowledged comments that pointed out that, if limits are appropriately set, they may be breached with some frequency and the burden of reporting such breaches may not outweigh the potential benefits. Instead, under the 2019 Final Rule, banking entities are required to maintain and make available to the applicable Agency records regarding any limit that was exceeded and any temporary or permanent increase to any limit. However, there is no affirmative reporting obligation. The 2019 Final Rule provides that, in the event a limit is breached, the presumption of compliance will continue to apply if certain specified actions are promptly taken by the banking entity.
Underwriting and Market Making of Ownership Interests in Covered Funds
The Volcker Rule exempts the underwriting and market making of ownership interests of covered funds conducted in accordance with specific exemptions from the prohibition on proprietary trading. Under the 2013 Rule, the exempt activity is subject to: (i) a per-fund limitation on the percentage ownership of each fund in which a banking entity holds investments; and (ii) a limitation on the value of ownership interests so acquired based on the banking entity’s capital. In this last regard, the aggregate value of a banking entity’s and its affiliates’ ownership interests in covered funds cannot exceed 3% of the banking entity’s tier 1 capital. In addition, for purposes of calculating regulatory capital requirements, a banking entity is generally required to make certain deductions from its tier 1 capital related to the value of, or amount paid for, its ownership interests in covered funds.
Consistent with the 2018 Proposed Rule, under the 2019 Final Rule, the aggregate limitation on ownership interests in covered funds does not apply with respect to ownership interests in covered funds held pursuant to the underwriting and market-making exemptions. In addition, no capital deduction will be required with respect to such ownership interests held pursuant to the underwriting and market-making exemptions.
Extension of Covered Funds Exemption for Risk-Mitigating Hedging
Under the 2013 Rule, risk-mitigating hedging activities with respect to ownership interests in a covered fund are permissible only if they meet certain conditions and are “designed to demonstrably reduce or otherwise significantly mitigate the specific, identifiable risks to the banking entity in connection with a compensation arrangement with an employee of the banking entity or an affiliate thereof that directly provides investment advisory, commodity trading advisory or other services to the covered fund.”
Consistent with the 2018 Proposed Rule, the 2019 Final Rule also permits risk-mitigating hedging activities with respect to ownership interests in a covered fund in connection with “[a] position taken by the banking entity when acting as intermediary on behalf of a customer that is not itself a banking entity to facilitate the exposure by the customer to the profits and losses of the covered fund.” The 2019 Final Rule also makes certain changes to align the exemption with the new modifications to the underwriting and market making exemptions from the prohibition on proprietary trading.
CHANGES AFFECTING FOREIGN BANKING ENTITIES
The 2019 Final Rule makes several important revisions concerning the application of the Volcker Rule to foreign banking entities, i.e., banking entities located outside the United States.
Trading and Covered Funds Activities Outside the United States
The Volcker Rule contains exemptions for activities conducted by foreign banking entities solely outside the United States. The 2019 Final Rule removes some of the conditions for these exemptions in a manner designed to increase the ability of foreign banking entities to qualify for the exemptions. The changes focus principally on whether the risk inherent in the activity is located or held outside of the United States.
Exemption for Trading Outside the United States
The 2013 Rule provides an exemption from the proprietary trading restrictions for trading by a foreign banking entity outside the United States (the so-called “TOTUS exemption”). To rely on the TOTUS exemption, the 2013 Rule requires, among other conditions, that trades not be conducted with or through a U.S. entity (subject to certain exceptions). This has required foreign banking entities to verify whether counterparties are U.S. entities (or qualify for exceptions). A significant feature of the 2019 Final Rule is that it eliminates this requirement. In other words, a foreign banking entity can now conduct trades with U.S. counterparties, and still rely on the TOTUS exemption, as long as it complies with other TOTUS exemption requirements.
The TOTUS exemption requirements have been relaxed in other respects. The 2013 Rule requires, among other things, that any employees of the foreign banking entity or its affiliate that arrange, negotiate, or execute the trade outside the United States, not be located in the United States. The 2019 Final Rule relaxes this condition by prohibiting only those involved in the decision to make the trade from being located in the United States. The 2019 Final Rule also eliminates the 2013 Rule’s requirement that no financing for the purchase, sale, or investment be provided by any branch or affiliate of the foreign banking entity located in the United States.
Exemption for Covered Funds Solely Outside the United States
Under the 2013 Rule, certain covered fund activity involving a foreign banking entity is permissible if it meets the requirements of the exemption for covered fund activity that occurs solely outside the United States (the so-called “SOTUS covered fund exemption”). The 2019 Final Rule eliminates one such requirement – i.e., that no financing for the ownership or sponsorship of the covered fund be provided by a branch or affiliate of the foreign banking entity located or organized under the laws of the United States.
The SOTUS covered fund exemption now requires that “no ownership interest in the covered fund may be offered for sale or sold to a resident of the United States.” Consistent with clarification provided in FAQ No. 13, the 2019 Final Rule enables foreign banking entities to rely on the SOTUS covered fund exemption for foreign funds that are marketed to residents of the United States, if the foreign banking entity does not participate in the marketing. Again, consistent with FAQ No. 13, a foreign banking entity will be deemed to participate in the offering or marketing of ownership interests in covered funds to U.S. residents if the foreign banking entity or its affiliate serves as the covered fund’s sponsor, investment manager, investment adviser, commodity pool operator, or commodity trading adviser.
Extension of No-Action Relief for Foreign Excluded Funds
A “foreign excluded fund” is generally understood to be a fund:
(i) in which a foreign banking entity invests or that it sponsors;
(ii) that is organized under the laws of a foreign jurisdiction;
(iii) the ownership interests of which are offered and sold solely outside the United States; and
(iv) that is, or holds itself out as being, an entity or arrangement that raises money from investors primarily for the purpose of investing in financial instruments for resale or other disposition or otherwise trading in financial instruments.
Foreign excluded funds are not “covered funds” under the 2013 Rule.
Under the 2013 Rule, the definition of a “banking entity” includes any affiliate of a banking entity but excludes “covered funds.” Covered funds controlled by a banking entity, even though they are affiliates of the banking entity, are not themselves banking entities by virtue of the exclusion. However, since foreign excluded funds are not covered funds, they cannot avail themselves of the exclusion from the definition of banking entity. Therefore, if a foreign excluded fund is affiliated with a banking entity (through sponsorship or other means), then it will be deemed to be a banking entity and subject to the prohibitions of the Volcker Rule.
On July 21, 2017, the Federal Reserve, OCC and FDIC (the “Banking Agencies”) announced that they would not enforce the prohibitions and restrictions of the Volcker Rule with respect to the activities of certain “qualifying foreign excluded funds” controlled by “foreign banking entities” (the “No-action Relief”). This No-action Relief was initially set to expire on July 21, 2018 but, in connection with consideration and adoption of the 2019 Final Rule, has been extended, first, until July 21, 2019 and, then again, until July 21, 2021, to provide the Agencies time to issue a separate proposed rule to address this issue, among other things.
The No-action Relief provides that, as long as certain conditions are met, the Banking Agencies would not propose to take action against a foreign banking entity based on attribution of the activities and investments of a “qualifying foreign excluded fund” to the foreign banking entity, or against the qualifying foreign excluded fund as a banking entity in each case where the foreign banking entity’s acquisition or retention of any ownership interest in, or sponsorship of, the qualifying foreign excluded fund would meet the requirements for the SOTUS covered fund exemption.
A “qualifying foreign excluded fund” generally means a foreign excluded fund that is:
(i) affiliated with a foreign banking entity;
(ii) established and operated as part of the bona fide asset management business of the foreign banking entity; and
(iii) not operated in a manner that enables the foreign banking entity to evade the requirements of the Volcker Rule.
 The 2019 Final Rule has not yet been published in the Federal Register. Citations to the preamble to the 2019 Final Rule (the “Preamble”) are to the 2019 Final Rule as released by the FDIC, available at: https://www.fdic.gov/news/board/2019/2019-08-20-notice-dis-a-fr.pdf.
 The Agencies responsible for issuing rules to implement the Volcker Rule are the OCC, the FDIC, the Board of Governors of the Federal Reserve System (“Federal Reserve”), the U.S. Securities and Exchange Commission, and the U.S. Commodity Futures Trading Commission.
 A banking entity includes (subject to exceptions) the following: (i) any insured depository institution; (ii) any company that controls an insured depository institution; (iii) any company that is treated as a bank holding company for purposes of section 8 of the International Banking Act of 1978; and (iv) any affiliate or subsidiary of a banking entity. §__.2(c).
 The Agencies will need to complete certain technological programming to accept metrics compliant with the 2019 Final Rule, which they anticipate will take place during the period ending on the Compliance Date. Banking entities seeking to switch over to revised metrics before the Compliance Date will need to coordinate with their regulators.
 For more information regarding the statutory changes made to the Volcker Rule by S. 2155, as well as the other reforms enacted by S. 2155, please see our Client Alert, available at: https://www.mofo.com/resources/publications/180522-financial-regulatory-reform.html.
 84 Fed. Reg. 35008, available at: https://www.govinfo.gov/content/pkg/FR-2019-07-22/pdf/2019-15019.pdf. For more information regarding the final rule adopting conforming changes to S. 2155, please see our Client Alert, available at: https://www.mofo.com/resources/publications/190724-agencies-conforming-volcker-rule-regulations.html.
 83 Fed. Reg. 33432, available at: https://www.govinfo.gov/content/pkg/FR-2018-07-17/pdf/2018-13502.pdf. For our client alert discussing the 2018 Proposed Rule, please see: https://www.mofo.com/resources/publications/180619-volcker-rule.html.
 Volcker Rule: FAQs, available at: https://www.federalreserve.gov/bankinforeg/volcker-rule/faq.htm.
 Preamble at 20, 25.
 §__.20(g). Under the Final Rule, the Agencies must go through certain required notice and response procedures in order to make such a determination. §__.20(g)(2).
 2013 Rule at §__.20(c).
 §__.20(d)(1)(i); see also Appendix to Part__ - Reporting and Recordkeeping Requirements for Covered Trading Activities.
 The Final Rule contains various amendments to the metrics reporting requirements that are not detailed in this Client Alert.
 See §__.20(d)(1)(ii).
 The Final Rule would make additional changes to the underwriting exemption from the prohibition on proprietary trading that apply to all banking entities regardless of their level of trading assets and liabilities. Certain of these changes are detailed elsewhere in this Client Alert.
 The Final Rule would make additional changes to the market-making exemption from the prohibition on proprietary trading that apply to all banking entities regardless of their level of trading assets and liabilities. Certain of these changes are detailed elsewhere in this Client Alert.
 §__.5(b)(1)(ii)(B); §__.5(b)(2)(i).
 2013 Rule at §__.5(b)(2)(iv)(B).
 §__.5(b)(1)(ii)(D)(3); §__.5(b)(2)(ii).
 2013 Rule at §__.5(b)(1)(iii).
 See note 3 supra.
 §__.3(a) (emphasis added).
 Changes to the Market Risk Capital Rule Test with respect to FBOs are detailed elsewhere in this Client Alert.
 2013 Rule at §__.3(b)(2).
 2013 Rule at §__.3(b)(i).
 2018 Proposed Rule at §_.3(b)(3).
 Preamble to the 2018 Proposed Rule, 83 Fed. Reg. 33438.
 Under the 2018 Proposed Rule, if the activities of a trading desk were deemed to be proprietary trading under the Accounting Test, a trading desk would have been presumed to be in compliance with the prohibition on proprietary trading if it engaged in only de minimis activities, as defined. Since the Accounting Test was dropped in the 2019 Final Rule, and in light of changes made to the Purpose Test, the Agencies determined not to carry forward this presumption to the 2019 Final Rule.
 2013 Rule at §__.3(b)(2).
 The requirement that an affiliate be consolidated for regulatory reporting purposes with the banking entity is a change from the 2013 Rule. See Preamble at n. 220.
 12 C.F.R. § 217.201(b); 12 C.F.R. § 3.201(b); 12 C.F.R. § 324.201(b).
 2018 Proposed Rule at §_.3(b)(1)(ii).
 12 C.F.R. § 217.202(b); 12 C.F.R. 3.202(b); 12 C.F.R. 324.202(b).
 Please refer to the discussion below about the exclusion of transactions involving financial instruments that are not trading assets or trading liabilities from the definition of proprietary trading.
 Subject to exemptions, §__.14(a) prohibits banking entities that: (i) advise or sponsor a covered fund; (ii) organize and offer a customer fund or an issuer of asset-backed securities (“ABS”); or (iii) hold an interest in an ABS issuer, and any of the banking entity’s affiliates, from entering into covered transactions, as defined in Section 23A of the Federal Reserve Act, with such funds. This is referred to as the “Super 23A” restrictions because, unlike Section 23A itself, which allows affiliated transactions within limits, the prohibitions here are absolute.
 See FAQ No. 18.
 Preamble at p. 82.
 Preamble to the 2018 Proposed Rule, 83 Fed. Reg. 33455, 33459.
 2013 Rule at §__.11(c)(3); §__.12(a)(2)(iii).
 2013 Rule at §__.11(c)(2); §__.12(c)(3); §__.12(d).
 Under the 2019 Final Rule, the per-fund and aggregate limitations, as well as the capital deduction requirement, still apply with respect to ownership interests held in covered funds pursuant to two other exemptions: (i) an exemption for organizing and offering covered funds for the purpose of providing bona fide trust, fiduciary, investment advisory, or commodity trading advisory services and (ii) an exemption for organizing and offering an issuing entity of asset-backed securities. §__.11(c)(2). Such limitations do not apply, however, with respect to banking entities that, directly or indirectly, guarantee, assume, or otherwise insure the obligations or performance of a covered fund or of any covered fund in which such fund invests. Id.
 2013 Rule at §__.13(a)(1).
 12 C.F.R. 248.13(b)(1)(iii).
 For more information regarding this no-action relief, please see our Client Alert, available at: https://www.mofo.com/resources/publications/170724-federal-agencies-foreign-funds-volcker.html.
 See Board of Governors of the Federal Reserve System; Federal Deposit Insurance Corporation; Office of the Comptroller of the Currency, Statement regarding Treatment of Certain Foreign Funds under the Rules Implementing Section 13 of the Bank Holding Company Act (July 17, 2019), available at: https://www.federalreserve.gov/newsevents/pressreleases/files/bcreg20190717a1.pdf.
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