Charles M. Horn
Oliver Ireland
November 21, 2011
DC-648839
© 2010 Morrison & Foerster LLP | All Rights Reserved | mofo.com
The Volcker Rule: The Agencies’
Proposed Rules
The Volcker Rule: The Agencies’ Proposed
Rules
Basics and Some History
Compliance and Reporting Requirements
Proprietary Trading
Private Equity Funds and Hedge Funds
Restrictions and Limitations on Permitted Activities
Impact Issues
This is MoFo.
2
Basics and Some History
This is MoFo.
3
Basics
The statutory Volcker Rule (Dodd-Frank Act section 619)
contains two broad prohibitions for banking entities
No proprietary trading
No ownership interest in or sponsorship of a private equity or
hedge fund
The statutory Volcker Rule contains other requirements
Transactions prohibited that would result in material conflicts of
interest, material exposure to high-risk assets or activities, threaten
the safety or soundness of the banking entity, or pose a threat to
U.S. financial stability
Certain financial relationships with covered funds are prohibited
Nonbank financial firms may be subject to activities
restrictions/capital charges
Agencies must issue rules covering internal controls and
recordkeeping to insure compliance with statute
This is MoFo.
4
Basics
For nonbanking entities:
Statutory prohibitions on proprietary trading and private equity
fund/hedge fund ownership or sponsorship do not apply
A nonbanking financial company that is systemically important will
be subject to additional capital requirements and quantitative limits
on proprietary trading and ownership in or sponsorship of a private
equity or hedge fund
Prohibited proprietary trading and private fund activities
contain several important conditional exceptions
Proprietary trading exceptions for trading in exempted instruments,
underwriting and market-making activities, hedging/risk-mitigation
activities, and customer activities
Private fund prohibition exceptions for owned/offered funds
This is MoFo.
5
History
Volcker Rule “embraces the spirit of the Glass-Steagall
Act’s separation of ‘commercial’ from ‘investment’
banking by restoring a protective barrier around our
critical financial infrastructure.”
Cong. Merkley (D-MA)
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6
History
Rule is intended to “prohibit or restrict certain types of
financial activity … that are high-risk or which create
significant conflicts of interest”
Intent of prohibition is to:
Limit threats to safety and soundness
Limit threats to financial stability
Eliminate any economic subsidy to high-risk activities that is
provided by access to lower-cost capital because of participation
in the regulatory safety net
Senate Banking Committee
(April 2010)
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Chronology–History
January 2009: Group of 30 Report
Proprietary trading a major reason for the financial crisis
Recommends prohibition on proprietary trading by systemically important
institutions
June 2009: Administration proposals; no Volcker-type provisions
December 2009: H.R. 4173 passed; no Volcker-type provisions
January 2010: Obama Administration announces support for Rule
April 2010: Merkley-Levin Amendment
May 2010: S. 3217, passed, with amendment
July 2010: Conference committee adds “de minimis” exception to
private equity/hedge fund prohibition
July 21, 2010: Dodd-Frank Act signed into law
This is MoFo.
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Chronology–Post-Enactment
November 2010: FRB proposes rule on conformance periods
Jan. 2011: FSOC publishes required study
Feb. 2011: FRB releases final rule on conformance periods
October 2011: Proposed interagency regulations for
implementation of Volcker Rule (excluding CFTC)
Still to come:
1st or 2nd Quarter 2012: Final regulations on Volcker Rule.
July 21, 2012: Volcker Rule to take effect—with 2-year
conformance period.
July 21, 2014: Across-the-board conformance period ends, but
extensions are available
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Summary of the Proposed Rules
76 Fed. Reg. 68846 (Nov. 7, 2011)
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Summary of the Proposed Rules
Issuing Agencies
Compliance and Reporting Requirements
Required compliance program that is “reasonably designed” to
ensure and monitor” compliance, and that is appropriate for the
“size, scope and complexities” of the banking entity’s activities and
business structure
Reporting and recordkeeping requirements
Key Definitions
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Summary of the Proposed Rules
Proprietary Trading Prohibitions and Exceptions
Definition of “proprietary trading”
Implementation of major proprietary trading exceptions:
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Underwriting
Market-making
Risk-mitigating hedging activities
Trading “on behalf of” customers
Trading in permitted instruments
Trading by regulated insurance companies
Trading outside of the United States
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Summary of the Proposed Rules
Covered Fund Prohibitions and Exceptions
Definition of “covered fund”
Implementation of restrictions on owning/sponsoring covered
funds
Implementation of major covered fund exceptions:
“Organizing and offering” a covered fund
Investments in covered funds
Permitted covered fund activities and investments
Limits on certain relationships with covered funds
Prudential Limits on Permitted Trading and Fund Activities
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Summary of the Proposed Rules
Termination of Activities or Investments; Penalties
Conformance Period Provisions
General carryover of existing conformance rules
Treatment of Nonbank Financial Institutions
No specific rules proposed at this time
This is MoFo.
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Issuing Agencies
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Issuing Agencies
Banking agencies
Federal Reserve Board
Office of the Comptroller of the Currency
Federal Deposit Insurance Corporation
Securities and Exchange Commission
The SEC has joined with the banking agencies on the substantive
common rule proposals but separately is seeking comments on
certain aspects of the proposed rules
Commodity Futures Trading Commission – Not yet
The CFTC is one of the agencies that is directed to issue rules,
but it has not proposed rules as of now
Speculation over reasons for CFTC inaction to date
This is MoFo.
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Compliance and Reporting Requirements
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Compliance and Reporting Requirements
Structure of Required Compliance Program
The proposed rules would create compliance and reporting
requirements to assure that (i) covered banking entities comply
with the substantive requirements of the Volcker Rule and
implementing regulations, and (ii) the financial regulatory agencies
can monitor and supervise such compliance
These requirements broadly include:
This is MoFo.
A compliance program that is reasonably designed to assure and
monitor compliance with proprietary trading and covered fund
activities and investments
Reporting and recordkeeping requirements for covered trading
and covered fund activities
18
Compliance and Reporting Requirements
Structure of Required Compliance Program
Certain banking entities that are actively and substantially
engaged in trading activities would be subject to more stringent
and detailed compliance and reporting requirements that are
imposed on a tiered basis, depending on the quantitative level of
these activities
All of these requirements, by all accounts, will be costly and
burdensome for many banking entities to implement
This is MoFo.
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Compliance and Reporting Requirements
Compliance Program – Required Minimum Elements for
all Banking Entities (Section 20)
Internal written policies and procedures
System of internal controls
Management framework that clearly delineates responsibility and
accountability for Volcker Rule compliance
Independent testing of compliance program effectiveness
Training for trading personnel/managers and other appropriate
personnel
Making/keeping records sufficient to demonstrate compliance,
which must be provided to a banking entity’s regulatory agency on
request and maintain for a period of not less than 5 years
This is MoFo.
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Compliance and Reporting Requirements
Compliance Program – Enhanced Requirements for
Certain Banking Entities (Section 20 and Appendix C)
Affected banking entities (“Appendix C banking entities”) are:
This is MoFo.
Those that engage in proprietary trading and have total
worldwide trading assets and liabilities of either (i) equal or
greater than $1 billion, or (ii) 10% or more of total assets,
measured on a average gross sum basis as determined on the
last day of each of the four prior calendar quarters.
Those that invest in or have relationships with covered funds
where (i) aggregate investments in covered funds, or (ii) average
total assets of covered funds sponsored or advised by the
banking entity, are equal or greater than $1 billion, measured as
of the last day of each of the four prior calendar quarters
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Compliance and Reporting Requirements
Enhanced Requirements for Appendix C Banking Entities
Significantly more detailed requirements for covered trading
activities, covered fund activities or investments
Program requirements
Internal policies and procedures
Internal controls
Accountability requirements
Independent testing
Training
Recordkeeping
These requirements are similar but not identical for proprietary
trading and covered fund activities (and therefore are discussed
separately below)
This is MoFo.
22
Compliance and Reporting Requirements
Compliance Program – Conditional Exclusion
Conditional exclusion for banking entities “to the extent” not
engaged in “activities or investments prohibited or restricted” by
the proprietary trading or covered fund rules
Existing compliance policies and procedures must be designed
to prevent the banking entity from engaging in covered activities,
and require a banking entity to develop the required compliance
program before engaging in covered activities
Some questions regarding the practical impact and utility of this
conditional exclusion
This is MoFo.
Trading in exempted instruments
Investment portfolio purchases
Impact of high risk activities/systemic risk requirements
23
Key Global Definitions
This is MoFo.
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Key Global Definitions
“Banking Entity”
Generally tracks statutory definition, including fiduciary exclusion
Excludes “organized/offered funds” and entities they control
“Covered Banking Entity”
Separately defined by each proposing agency generally to include
banking entities under each agency’s respective regulatory and
supervisory jurisdiction
“Resident of the United States”
Broadly tracks parallel definition in SEC Regulation S, but is not
altogether identical to Regulation S definition
This is MoFo.
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Key Global Definitions
“Derivative”
Includes swaps and security-based swaps as defined in
Commodity Exchange Act and Securities Exchange Act,
respectively, as further defined by CFTC and SEC under DoddFrank Act section 712
“Loan”
Loan
Lease
Extension of credit
Secured/unsecured receivable
This is MoFo.
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Proprietary Trading
This is MoFo.
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Proprietary Trading–Statute
Statutory Definitions
“Proprietary trading” is defined as
engaging as principal for the trading account of the banking
entity or nonbank financial company (NBFC)
in any transaction to purchase or sell, or otherwise acquire or
dispose of, any security, any derivative, any contract of sale of a
commodity for future delivery, any option on any such security,
derivative, or contract, or “any other security or financial
instrument” that the appropriate federal agencies may determine
“Trading account” is defined as:
This is MoFo.
any account used for acquiring or taking positions principally for
the purpose of selling in the near term (or otherwise with the
intent to resell in order to profit from short-term price
movements), or
any such other accounts specified by rule
28
Proprietary Trading–Implementation Rules
The agencies’ proprietary trading rules consist of several
key elements
•
•
•
•
Key definitions
Application and elaboration of statutory prohibition
Application and elaboration of statutory exceptions
Detailed and elaborate compliance management, governance and
reporting requirements for banking entities that engage in
proprietary trading
This is MoFo.
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Proprietary Trading Rules–Core Provisions
Key Rule Definitions
•
“Proprietary trading”: Engaging as principal for a trading account in
purchase/sale of covered financial positions
•
•
Agency activities and transactions for unaffiliated third parties
are excluded from the definition
Covered financial position”:
•
•
This is MoFo.
Long, short, synthetic “or other” positions on: (i)
securities/options on securities; (ii) derivatives/options on
derivatives; (iii) commodity futures
Excludes: (i) loans, (ii) commodities, (iii) foreign exchange or
currencies
30
Proprietary Trading Rules–Core Provisions
Key Rule Definitions
•
“Trading Account”: An account that acquires or takes a covered
financial position:
•
•
•
This is MoFo.
for (i) short-tem resale, (ii) price movement benefits, (iii)
arbitrage, or (iv) hedging of (i), (ii) or (iii).
That is a market risk capital rule covered position, excluding
positions in foreign exchange derivatives and commodity
derivatives/futures, if the banking entity calculates such riskbased capital ratios
For any purpose if account holder is a regulated
securities/commodities firm
31
Proprietary Trading Rules–Core Provisions
Key Rule Definitions
•
•
Rebuttable trading account presumption: an account used to
acquire a covered financial position for 60 days or less, excluding
covered positions acquired as market risk capital rule positions or
acquired by regulated commodities/securities professionals (see
below), is presumed to be a trading account, but that presumption
is rebuttable based on the particular facts/circumstances
Other trading account exceptions
•
•
•
•
This is MoFo.
Covered positions arising under qualified repo transactions
Covered positions arising under qualified securities lending and
borrowing transactions
Bona fide, documented liquidity management activities
Clearing activities of registered securities clearing firms or
derivatives clearing organizations
32
Proprietary Trading Rules–Exceptions
Underwriting Activities and Requirements
Required compliance and reporting program
Limited to “securities”
Must occur “solely” in connection with a “distribution”
Limited to registered/exempt/qualified dealers
Activities not to exceed customers’ “reasonable short term
demands”
Activities must be designed to generate fee-based revenue not
based on price movements or hedging activities
Compensation system cannot reward proprietary trading
Key definitions: “underwriting” and “distribution”
This is MoFo.
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Proprietary Trading Rules–Exceptions
Market-Making Activities and Requirements
Required compliance and reporting program
Trading desk/unit must hold itself out as engaged in market-making
activities
Exception is limited to registered/exempt/qualified/dealers
Market-making activities are not to exceed customers’ “reasonable
short term demands”
Activities must be designed to generate fee-based revenue not
based on price movements or hedging activities
Compensation system cannot reward proprietary trading
Hedging of permitted market-making positions is allowed
See, Appendix B commentary on identification of permitted marketmaking activities
This is MoFo.
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Proprietary Trading Rules–Exceptions
Market-Making Activities and Requirements
Appendix B commentary on market-making activities
Elements of permitted market-making activities
Primary purpose: financial intermediation
Fee/commission spread revenues – not price movements
Customer-facing and customer-related activity
Absence of compensation incentives
Distinguishing permitted and prohibited activities
This is MoFo.
Risk retention profile and management
Revenue sources
Revenues relative to risk
Customer-facing activity
Fees, commissions and spreads
Compensation incentives
35
Proprietary Trading Rules–Exceptions
Hedging Activities and Requirements
Required compliance and reporting program
Must hedge “specific risks” in connection with covered positions
Must be reasonably correlated to underlying position risk based on
“facts and circumstances”
Hedging position cannot create significant new financial exposures
not already present at outset of transaction
Continuing review, monitoring and management of hedging
positions to assure (i) compliance with policies, (ii) maintenance of
reasonable correlation and (iii) risk exposure mitigation
Compensation system cannot reward proprietary trading
Hedging positions must be documented: purposes, risks hedged,
and level of organization establishing the hedge
This is MoFo.
36
Proprietary Trading Rules–Exceptions
Customer Transactions and Requirements
Banking entity must be acting as investment adviser, commodity
trading advisor, trustee or other fiduciary capacity
Transactions must be for accounts of customers
Customer(s) must have sole beneficial ownership of covered
positions
Others types of transactions allowed:
This is MoFo.
Riskless principal transactions
Separate account transactions by regulated insurance companies;
must relate to insurance policies issued and comply with applicable
state insurance laws
General account transactions by regulated insurance companies;
must comply with applicable state insurance laws
37
Proprietary Trading Rules–Exceptions
Permitted Instruments and Requirements
U.S. and agency obligations
Ginnie, Fannie, Freddie, FHLB, Farmer Mac and Farm Credit Bank
obligations
State and local government obligations
General and limited obligations, including revenue bonds, are
permitted
This is MoFo.
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Proprietary Trading Rules–Exceptions
Non-U.S. Transactions and Requirements
Eligibility limited to banking entities that are FBOs as defined under
the IBA and Regulation K, and other qualified foreign banking
entities
Transaction must be conducted pursuant to BHCA section 4(c)(9)
or 4(c)(13)
For FBOs this means compliance with Regulation K, Subpart B
Asset/revenue/net income tests for other foreign banking entities
Transaction must take place “solely” outside the U.S.
This is MoFo.
Banking entity effecting transaction cannot be a U.S. entity
No U.S. resident may be a party to the transaction
No banking entity personnel “directly” involved in transaction may
be “physically located” in the U.S.
Execution must occur “wholly outside” of the U.S.
39
Proprietary Trading–Compliance and
Reporting Requirements
Specific Requirements for Certain Banking Entities
(“Appendix A Banking Entities”)
All banking entities that have consolidated worldwide trading
assets and liabilities equal to or greater than $1 billion, measured
on an average gross sum basis as determined on the last day of
each of the four prior calendar quarters, will be subject to detailed
and extensive reporting and recordkeeping requirements for those
trading activities (Section 7 and Appendix A requirements),
depending on the nature and level of trading activity
This is MoFo.
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Proprietary Trading Rules–Compliance and
Reporting Requirements
Specific Requirements for Appendix A Banking Entities
These reporting and recordkeeping requirements are tiered as
follows:
Banking entities that have consolidated worldwide trading assets
and liabilities equal to or greater than $1 billion but less than $5
billion will be required to maintain records and report on their
market-making related activities
Banking entities that have consolidated worldwide trading assets
and liabilities equal to or greater than $5 billion, however, will be
required to maintain records and report on all covered trading
activity
This information is required for each “trading unit” of the reporting
banking entity
This is MoFo.
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Proprietary Trading Rules–Compliance and
Reporting Requirements
Specific Requirements for Appendix A Banking Entities
Scope of reporting
$1-$5 billion banking entities: 8 data points for market making
activities
$5+ banking entities: 17 data points for market-making
activities, 5 data points for other permitted trading
Frequency of calculation and reporting
This is MoFo.
Calculation: every trading day
Reporting: monthly -- reports due 30 days after calendar month’s
end or as other requested by supervisory agency
42
Proprietary Trading Rules–Compliance and
Reporting Requirements
Specific Requirements for Appendix A Banking Entities
Quantitative reporting and recordkeeping requirements
Risk management measurements
Source-of-revenue measurements
Revenue-relative-to-risk measurements
Customer-facing activity measurements
Payment of fees, commissions and spreads measurements
Further, all Appendix A banking entities are Appendix C banking
entities (although not necessarily vice-versa), and therefore are
subject to compliance management requirements specifically
impacting their trading activities
This is MoFo.
43
Proprietary Trading–Compliance and Reporting
Requirements
Appendix C Trading Compliance Program Requirements
Internal policies and procedures
Identification of trading accounts
Identification of trading units and organizational structure
Description of missions and strategies
Trader mandates
Description of risks and risk management processes
Hedging policies and procedures
Explanation of compliance
Remediation of violations
Written internal controls
This is MoFo.
Assure consistency with mission, strategy and risk mitigation
Must address, at a minimum, (i) authorized risks, instruments
and products, (ii) risk limits, (iii) robust analysis and quantitative
measurements, and (iv) surveillance of program effectiveness
44
Proprietary Trading–Compliance and Reporting
Requirements
Appendix C Trading Compliance Program Requirements
Responsibility/accountability
Independent testing
Corporate governance
Trader mandates
Management procedures
Business line managers
Senior management responsibilities
Board of directors/CEO responsibilities
Not less than annually
Evaluation of program adequacy/effectiveness, written policies
and procedures, internal controls and management procedures
Training
Recordkeeping
This is MoFo.
45
Private Equity Funds and Hedge Funds
(Covered Funds)
This is MoFo.
46
Covered Funds–Statute
Volcker Rule prohibits acquisitions of ownership interests
in, and sponsorship of, private/hedge funds
“Private equity funds” and “hedge funds” are those funds
exempt from the Investment Company Act of 1940
under ICA sections 3(c)(1) or 3(c)(7)
Regulatory agencies have authority to extend the private/hedge
fund limitations to other types of funds
Permissible fund-related activities:
Organizing/offering covered funds as part of a bona fide trust or
advisory business, and related de minimis investments
Prime brokerage services
Investments in SBICs and similar funds
The statutory limitations on high-risk positions and
activities for proprietary trading also apply to
permissible private/hedge fund activities
This is MoFo.
47
Covered Fund Rules–Core Provisions
Rules state that a banking entity may not, as principal,
directly or indirectly acquire or retain any ownership
interest or sponsor a covered fund
Key Definitions
“Covered fund”
Funds exempt under ICA section 3(c)(1) or 3(c)(7)
Commodity pool as defined in CEA section 1a(10)
A non-US issuer that would be a covered fund were it organized
or offered under U.S. or state law or offered to U.S. residents
“Any similar fund” as agencies may determine by rule
“Ownership interest”
This is MoFo.
Any equity, partnership or similar interest in a covered fund
Excludes qualifying carried interests
48
Covered Fund Rules–Core Provisions
Key Definitions
“Prime brokerage”
“Sponsor”
One or more products or services provided by a banking entity to
a fund such as: custody; clearance; securities borrowing or
lending; trade execution; or financing, data, operational or
portfolio management support
Serve as GP, managing member/trustee/CPO of covered fund
Ability to select/control directors/similar officials of covered fund
Share a name/name variation with a covered fund
“Trustee”
This is MoFo.
Excludes nondiscretionary trustees and directed trustees as
defined in ERISA
Includes persons with investment discretion controlling a
nondiscretionary/directed trustee
49
Covered Funds–Exceptions
Bona Fide Fiduciary Services – Organize/Offer
A banking entity that provides bona fide trust, fiduciary, or
investment advisory services may organize and offer a covered
fund, if the banking entity:
Offers interests in covered fund only in connection with providing bona fide
trust or related services to customers
Retains only a de minimis investment in fund
Observes “super 23A” and section 23B restrictions on transactions with fund
Does not, directly or indirectly, support fund obligations or performance
Does not share a name (or derivation) with fund, and fund does not use the
word “bank” in its name
Does not permit any director or employee of the banking entity to have an
economic interest in fund, except persons “directly engaged” in providing
investment advisory services to fund
Discloses to investors that fund losses are not borne by the banking entity
This is MoFo.
50
Covered Funds–Exceptions
Organize/Offer Exception – De Minimis Investments
A banking entity that “organizes and offers” a covered fund as part
its trust, fiduciary, or investment advisory services, may invest in
the fund under three broad conditions:
The banking entity seeks unaffiliated investors
The start-up investment in a fund is unrestricted but within one year
of the start date, the banking entity’s investments shall not exceed
more than 3% of the total ownership interests in the fund
The aggregate of investments in all such funds does not exceed 3%
of the banking entity’s Tier 1 capital
This is MoFo.
51
Covered Funds–Exceptions
Organize/Offer Exception – De Minimis Investments
Attribution rules
Controlled investments – full attribution
Non-controlled investments – pro rata attribution
Calculation of capital/investment ceilings:
Single fund rule -- greater of % equity value of investment or %
ownership interest
Certain parallel investments must be included
Calculations must be consistent with methodology of each
investment fund
Aggregate investments -- sum of values of each investment
Rules require deductions of qualifying investments from the
banking entity’s primary (Tier 1) capital
This is MoFo.
52
Funds–Compliance and Reporting
Requirements
Specific covered fund requirements apply to banking
entities that are subject to enhanced compliance
program requirements (Appendix C requirements)
Internal policies and procedures
Identification of covered funds
Identification of asset management units/organization
Description of sponsorship activities
Description of investment activities
Remediation of violations
Written internal controls
This is MoFo.
Investment monitoring
Relationship monitoring
Surveillance of program effectiveness
53
Funds–Compliance and Reporting
Requirements
Appendix C compliance program requirements
Responsibility/accountability
Independent testing
Corporate governance
Management procedures
Business line managers
Senior management responsibilities
Board of directors/CEO responsibilities
Not less than annually
Evaluation of program adequacy/effectiveness, written policies
and procedures, internal controls and management procedures
Training
Recordkeeping
This is MoFo.
54
Funds–Other Permissible Activities
Investments in SBICs and related investments
Related investments include funds designed primarily to promote
public welfare, or qualified IRC section 47/state historic tax credit
investments
Risk-mitigating hedging activities
Investments made in connection with obligations/liabilities of the
banking entity (i) taken when acting for a customer to facilitate
customer exposure to profits/losses of covered fund, or (ii) directly
connected to compensation of employee directly provided advisory
services to a covered fund
Such investments are designed to reduce specific risks to the
banking entity related to such obligations/liabilities
This is MoFo.
55
Funds–Other Permissible Activities
Foreign investments/sponsorship
Investment in or sponsorship of a covered fund by a banking entity
solely outside of the United States if:
• Banking entity not directly/indirectly controlled by U.S. banking
entity
• Activity is conducted pursuant to BHCA Section 4(c)(9) or 4(c)(13)
• Interests in the fund are not offered or sold to a U.S. resident
• Activity occurs solely outside of the U.S.
•
BHCA Section 4(c)(9) or 4(c)(13) activity
Same criteria as those used for permitted non-U.S. proprietary
trading
Solely outside the U.S.
No U.S. entity, U.S. legal/physical presence, or offer/sale to U.S.
resident
This is MoFo.
56
Funds–Other Permissible Activities
Loan Securitizations
Allows owner/sponsorship of covered fund that is an issuer of
asset-backed securities, assets of which are solely comprised of:
Loans
Directly related contractual rights or assets
Interest rate and foreign exchange derivatives that materially relate
to terms of underlying loans/contractual rights or assets and are
used for hedging purposes with respect to issuer
Bank-owned life insurance (BOLI) separate accounts
This is MoFo.
57
Funds–Other Permissible Activities
Other Permitted Covered Funds/Activities
Joint ventures/operating company investments
Acquisition vehicles
“Securitizer” and “originator” credit risk retentions of asset-backed
securities issuers under Securities Exchange Act section 15G
Liquidity management subsidiaries
Qualified ABS issuers
Covered fund ownership interests acquired DPC, subject to
compliance with agency disposition periods
Covered fund ownership interests acquired/held in compliance with
Federal Reserve Board’s Volcker Rule conformance periods
This is MoFo.
58
Covered Funds–Limits on Banking Entity
Relationships
Absolute prohibition on banking entity Section 23A
covered transactions with covered funds
“Super 23A” prohibition applies to any covered fund to which a
banking entity acts as investment manager, investment adviser, or
sponsor
Super 23A does not prohibit otherwise-permitted acquisitions or
retentions of covered fund ownership interests under the
organize/offer or other covered fund exceptions
Prime brokerage transactions with covered funds are conditionally
exempted
This is MoFo.
But, limited to covered funds in which a covered fund managed,
sponsored or advised by the banking entity has taken an
ownership interest
59
Covered Funds–Limits on Banking Entity
Relationships
Application of Federal Reserve Act Section 23B to banking
entity relationships with covered funds
Applies to any covered fund to which a banking entity acts as
investment manager, investment adviser, or sponsor
Banking entity and its affiliates are treated as a “member bank” for
Section 23B purposes
Permitted prime brokerage transactions are subject to Section 23B
limitations
This is MoFo.
60
Covered Activities – Prudential Limitations
This is MoFo.
61
Covered Activities–Prudential Limitations
Otherwise permissible proprietary trading or fund
ownership/sponsorship activity is forbidden if it would:
Result in a material conflict of interest between the banking
entity and its clients
Result, directly or indirectly, in a material exposure for the
banking entity to high-risk assets or high-risk trading
strategies
Pose a threat to the safety and soundness of the banking
entity
Pose a threat to the financial stability of the U.S.
This is MoFo.
62
Covered Activities–Prudential Limitations
Material Conflicts of Interest:
Activities or transactions that would involve or result in the banking
entity’s interests being “materially adverse” to client, customer or
counterparty interests, unless:
This is MoFo.
Banking entity makes “clear, timely and effective disclosure” of
conflict and
Disclosure is made “explicitly and effectively” in a manner that
allows client/customer/counterparty to “negate or substantially
negate” any materially adverse effect
or
Banking entity has information barriers that are reduced to writing in
specified written policies and procedures. Compliant information
barriers, however, do not permit transactions creating conflicts that
have materially adverse effect on client/customer/counterparty
63
Covered Activities–Prudential Limitations
High-Risk Asset: Asset or group of related assets that if
held by banking entity would significantly increase the
likelihood that the banking entity would incur a
substantial financial loss or would fail
High-Risk Trading Strategy: Trading strategy that if
conducted by banking entity would significantly
increase the likelihood that the banking entity would
incur a substantial financial loss or would fail
Threat to the safety and soundness of the banking entity
Threat to the financial stability of the U.S.
This is MoFo.
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Covered Activities–Prudential Limitations
Financial agencies may require banking entities that
violate or seek to evade requirements of Volcker Rule
or implementing regulations to restrict, limit or
terminate activity or dispose of investment
Such action may be taken upon finding of “reasonable cause”
upon notice and opportunity for a hearing
Enforcement powers and remedies of FDI Act section 8
(12 USC 1818) presumably are available to the
banking agencies
Ditto for SEC under the Securities Exchange Act?
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Effective Dates and Conformance Periods
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66
Effective Dates and Conformance Periods
Volcker Rule regulations will take effect not later than July 21,
2012
FRB’s prior rule on conformance deadlines would be relocated
without material changes into the general regulations; changes to
harmonize conformance rule definitions with general regulations
will be made
Banking entities will have until July 21, 2014, to bring existing
activities into compliance
Three one-year extensions are available if FRB determines that
extension is consistent with purposes of the Volcker Rule and
would not be detrimental to the public interest.
FRB may grant single five-year extension for illiquid funds owned
as of May 1, 2010.
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67
Impact Issues
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68
Impact Issues
Asset-liability management activities
Investment portfolio management
Hedging activities: identification and correlation issues
Investment banking activities
Public distributions
Private placements
Corporate finance and advisory activities
Market-making and dealing activities
Private fund activities
Fund-of-fund activities
Non-U.S. funds
Provision of fund services and financial support
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Impact Issues
Foreign banking entities
Differentiating U.S. and non-U.S. activities
Derivatives activities
Compliance infrastructure requirements and demands
Senior management and board responsibilities
Accountability
Level of detail
IT/systems requirements
Integration with existing compliance systems
Human resources needed to implement
Non-bank financial institutions
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Contact Information
Charles M. Horn
(202) 887-1555
charleshorn@mofo.com
Oliver I. Ireland
(202) 877-1614
oireland@mofo.com
Dwight C. Smith
(202) 887-1562
Barbara R. Mendelson
(212) 468-8118
dsmith@mofo.com
bmendelson@mofo.com
David H. Kaufman
(212) 468-8237
dkaufman@mofo.com
Anna T. Pinedo
(212) 468-8179
apinedo@mofo.com
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