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Volcker Rule January 27, 2014 Volcker Rule U.S. Agencies Approve Final Volcker Rule, Detailing Prohibitions and Compliance Regimes Applicable to Banking Entities Worldwide EXECUTIVE SUMMARY On December 10, 2013, the Board of Governors of the Federal Reserve System (the “Federal Reserve”), the Office of the Comptroller of the Currency (the “OCC”), the Federal Deposit Insurance Corporation (the “FDIC”), the Securities and Exchange Commission (the “SEC”) and the Commodity Futures Trading Commission (the “CFTC” and, together, the “Agencies”) approved a final rule (the “Final Rule”) implementing Section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), commonly referred to as the “Volcker Rule.” The Volcker Rule—one of the centerpieces of the Dodd-Frank Act—imposes broad prohibitions and restrictions on proprietary trading and investing in or sponsoring hedge funds or private equity funds by banking organizations and their affiliates. As originally released (prior to publication in the Federal Register), the Final Rule and the detailed “Supplementary Information,” which is critical to understanding and interpreting the Final Rule, were more than 950 pages in total and included more than 2,800 footnotes. In general, although many of the most unclear or troublesome provisions of the Agencies’ proposed rule (the “Proposed Rule”) have been addressed, there remain numerous interpretive issues and implementation challenges. The Final Rule is a sweeping regulation, with broad extraterritorial application, that will fundamentally shape how banking organizations do business. Although the Volcker Rule was principally directed at restricting the activities of certain large banking organizations, its restrictions apply to all banking organizations regardless of size, with limited accommodations for smaller banking organizations in the form of a simplified compliance program. Many of the Final Rule’s effects may New York Washington, D.C. Los Angeles Palo Alto London Paris Frankfurt Tokyo Hong Kong Beijing Melbourne Sydney www.sullcrom.com become apparent only over several years as the Agencies exercise their substantial discretion to interpret and administer the Volcker Rule in practice. In connection with the Final Rule, the Federal Reserve exercised its independent authority to grant a blanket one-year extension of the Volcker Rule conformance period for all banking organizations. As a result, banking organizations will have until July 21, 2015 to comply fully with most requirements of the Final Rule. An important exception applies for banking organizations with significant trading activities, which will be required to report quantitative metrics on their trading activities beginning as soon as July 2014. The extension order also requires banking organizations to use good faith efforts during the conformance period to conform to the Final Rule (and promptly terminate or divest any “stand-alone” proprietary trading operations). This memorandum summarizes the requirements of the Final Rule and the related guidance in the Supplementary Information.1 1 Please see our Memorandum to Clients, dated December 13, 2013, “Agencies Approve Long-Awaited Final Rule; Most Requirements to Take Effect on July 21, 2015,” for an initial overview of certain key requirements of the Final Rule and comparisons to the corresponding provisions of the Proposed Rule. TABLE OF CONTENTS 1. Background .................................................................................................................... 1 1.A. History of Rulemaking ............................................................................................................ 2 1.B. Statutory Effective Dates and Past Guidance on Conformance ................................................ 4 2. Coverage of the Volcker Rule and Regulatory Coordination........................................ 6 2.A. Coverage of the Volcker Rule ................................................................................................. 6 2.B. Thresholds for Compliance Programs and Reporting .............................................................. 9 Fig. 2.B: Criteria for Compliance Programs ........................................................... 10 2.B.1. Measurement of “Trading Assets and Liabilities”........................................................ 11 2.C. Key Compliance Dates and Further Extensions of the Conformance Period .......................... 12 Fig. 2.C: Certain Key Compliance and Application Dates ....................................... 14 2.D. Conduct During the Conformance Period ............................................................................. 15 2.E. Regulatory Authority and Coordination ................................................................................. 16 3. Proprietary Trading – Prohibition and Key Definitions............................................... 19 3.A. “Financial Instruments” Subject to the Proprietary Trading Restrictions ................................. 20 3.A.1. The Definition of “Loan” under the Volcker Rule ........................................................ 23 3.B. Transactions Subject to the Proprietary Trading Restrictions ................................................. 25 3.C. Activities Excluded from the Definition of “Proprietary Trading”.............................................. 29 3.C.1. The “Liquidity Management” Exclusion and Asset–Liability Management Activities under the Volcker Rule .............................................................................. 33 3.D. Definition of “Trading Desk” .................................................................................................. 35 4. Permitted Proprietary Trading Activities ..................................................................... 37 4.A. Underwriting Activities.......................................................................................................... 37 Selected Guidance on the Underwriting Activity Exemption .................................... 39 4.B. Market Making-Related Activities ......................................................................................... 40 Selected Guidance on the Market Making-Related Activity Exemption .................... 43 4.C. Risk-Mitigating Hedging Activities ......................................................................................... 44 Selected Guidance on the Risk-Mitigating Hedging Activity Exemption ................... 46 4.C.1. Market Making-Related Hedging ............................................................................... 48 4.D. Trading in Domestic Government Obligations ....................................................................... 48 4.E. Trading in Foreign Government Obligations .......................................................................... 50 4.F. Trading on Behalf of Customers ........................................................................................... 53 4.G. Trading by a Regulated Insurance Company ........................................................................ 54 4.H. Trading Activities of Foreign Banking Entities ...................................................................... 55 -i- Volcker Rule January 27, 2014 5. “Covered Fund” Activities and Investments – Prohibition and Key Definitions ............................................................................................................. 60 5.A. Definition of “Covered Fund” ................................................................................................ 62 5.A.1. Commodity Pools Included in the Definition of “Covered Fund” .................................. 65 Fig. 5.A.1: Comparison of “Exempt Pool” Requirements and Alternative Definition of “Similar Pool” ........................................... 66 5.B. Entities Excluded from the Definition of “Covered Fund” ....................................................... 67 5.B.1. The Exclusion for “Loan Securitizations” ................................................................... 77 5.B.2. Entities Expressly Not Excluded and Potential Alternatives ........................................ 80 Selected Guidance on Entities Expressly Not Excluded .......................................... 80 5.C. Definition of “Ownership Interest” ......................................................................................... 82 5.C.1 Agency Relief for Certain TruPS-Backed CDOs ......................................................... 85 5.D. Definition of “Sponsor” ......................................................................................................... 87 Guidance on Application of the Definition of “Sponsor” to Trustees ......................... 89 6. Permitted Organizing and Offering of a Covered Fund .............................................. 91 6.A. General Requirements for Organizing and Offering ............................................................... 92 6.B. Limitations on, and Capital Deduction for, Permitted Investments in Covered Funds ................................................................................................................ 95 Fig. 6.B.1: Calculation of Ownership Limits and Capital Deduction ........................ 97 Fig. 6.B.2: Calculation of Per-Fund Attributed Interests and Total Attributed Interests ...................................................................... 98 Fig. 6.B.3: Calculation of Notional Tier 1 Capital for Aggregate Funds Limitation
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