Foreign Bank Cross-Border Trading under the Volcker Rule: the “Trading Outside the United States” Exemption’s Incongruous Consequences

At its core, the Volcker Rule is designed to prevent excessive risk-taking by banks, which was seen by the U.S. Congress and financial regulators as a contributor to the 2008 financial crisis. With its focus on the stability of the U.S. financial system, the Volcker Rule is meant to have only a limited reach to activities of foreign banks outside the United States. Although the scope of banks and bank affiliates subject to the Volcker Rule is very broad, the statutory language of the Volcker Rule exempts from the proprietary trading prohibition foreign bank trading activity that occurs solely outside the United States.

In implementing this statutory provision, the Volcker Rule regulators provide further that some foreign bank trading activity that occurs “with or through” a U.S. entity is also permitted under this exemption. However, the requirements of this “trading outside the United States” or “TOTUS” exemption for such cross-border transactions are, in some common cases, very different from, and at times inconsistent with, regulatory requirements under pre-existing U.S. law. Thus, the TOTUS exemption will, at the very least, require restructuring of some common types of foreign bank trading activities in circumstances that do not seem to implicate the systemic risk reduction concerns that are the focus of the Volcker Rule. This result also seems at odds with the purpose of the TOTUS exemption to “recognize rules of international regulatory comity” and “mitigat[e] the concern that an overly narrow approach to the exemption (e.g., prohibiting trading with any US counterparty) may cause market bifurcation, reduce the efficiency and liquidity of the markets and harm US market participants” while “promot[ing] and protect[ing] the safety and soundness of banking entities and U.S. financial stability.”[1]

Following a brief description of the scope of the Volcker Rule proprietary trading provisions and the TOTUS exemption, this article briefly discusses two common examples of foreign bank trading activity and their incongruous treatment under the TOTUS exemption.

The Volcker Rule applies to all foreign banks with U.S. banking operations and their affiliates.

The Volcker Rule’s proprietary trading provisions prohibit any foreign bank with U.S. banking operations and all of the foreign bank’s affiliates from engaging in proprietary trading, unless that trading is permitted under an exclusion or exemption under the Rule. By its terms, the extraterritorial reach of the Volcker Rule’s proprietary trading prohibition is very broad – it applies not only to a foreign bank’s trading activities that are conducted in the United States and that cause it to be subject to supervision and regulation by U.S. financial regulators, but it also extends to the worldwide trading activities of the foreign bank and its affiliates, even those conducted entirely outside the United States. Thus, once a foreign bank becomes subject to the Volcker Rule because of its U.S. banking operations, the foreign bank and each of its affiliates are subject to the Volcker Rule, including its proprietary trading restriction, to the same extent as the foreign bank’s U.S. operations—regardless of the entity’s location, the location of its operations, or its place of incorporation.

The TOTUS exemption is available for some non-U.S. and cross-border trading activities.

To limit the otherwise significant extraterritorial reach of the Volcker Rule proprietary trading prohibition, the Volcker Rule contains an exemption that permits some of a non-U.S. banking entity’s trading activities that have only a limited U.S. nexus. Under this TOTUS exemption, a non-U.S. bank may engage in otherwise prohibited proprietary trading so long as the trading activity is generally conducted outside the United States, as specified in the detailed conditions of the exemption. The TOTUS exemption also is available for some types of cross-border transactions involving U.S. infrastructure or U.S. counterparties. More specifically, the TOTUS exemption includes provisions that allow a foreign banking entity to engage in transactions that are “with or through a U.S. entity,” subject to detailed conditions that apply to transactions conducted under the exemption.

The Volcker Rule and the TOTUS exemption, because they apply to trading activities in which banks have long engaged, impose additional layers of regulation on activities that were already subject to substantive regulation, indeed by the same regulators that adopted the Volcker Rule. The requirements that apply to a foreign bank’s trading activities under these pre-existing laws are, in some cases, very different from the conditions for meeting the TOTUS exemption—sometimes more restrictive, other times less restrictive, and often simply different. Particularly where the TOTUS exemption’s conditions are different from those under existing applicable law, or where those conditions do not reflect existing market structure, the exemption increases the regulatory complexity for foreign banks in structuring their trading activities. Indeed, in some cases, foreign banks will find the conditions of the TOTUS exemption to be inconsistent or impractical, given other U.S. law requirements and U.S. market structure, such that they will not or cannot rely on the TOTUS exemption.

Two Illustrative TOTUS Inconsistencies.

Two common types of securities transactions serve to illustrate the impracticalities of the TOTUS exemption.

Trading on U.S. Securities Exchanges. Generally, foreign banks that engage in sizable levels of securities trading in the United States do so through affiliated broker dealers. However, under the TOTUS exemption, any transaction “with or through a U.S. entity,” such as through a U.S. securities exchange or with a U.S. counterparty on that exchange, will need to be conducted by the foreign bank with or through an “unaffiliated market intermediary” (among other conditions). Thus, to engage in a transaction on a U.S. securities exchange in accordance with the TOTUS exemption, a foreign bank would need to transact through an unaffiliated broker-dealer. This could include, somewhat strangely, a broker-dealer affiliate of another foreign bank or a broker-dealer affiliate of a U.S. bank. It is not clear how this result furthers the policy goals of the TOTUS exemption. Whether or not a foreign bank’s broker is an affiliate, the principal risk of the securities transactions, under other requirements of the TOTUS exemption, would ultimately reside with the foreign bank outside the United States—not the broker-dealer through which the foreign bank accesses the exchange. Moreover, either an affiliated or unaffiliated broker-dealer would be engaging in the same types of activities, when acting as the foreign bank’s agent and broker in the transaction on the U.S. exchange. Thus, the requirement to transact through an unaffiliated market intermediary seems to neither reduce U.S. risk nor restrict U.S.-based conduct with regard to the transactions.

Internalized Transactions. Internalization is a common off-exchange manner in which broker-dealers execute customer securities transactions. It involves a broker-dealer filling a customer order for the purchase or sale of securities from the broker-dealer’s own inventory of securities; the broker-dealer acts as the counterparty to the customer rather than seeking a counterparty on an exchange. In 2010, the SEC estimated that broker-dealer internalization represented approximately 17.5% of share volume in NMS stocks, which generally include all stocks listed on national securities exchanges such as NASDAQ, the New York Stock Exchange, and the BATS Exchanges, among others.[2] Under the TOTUS exemption, a foreign bank could not engage in an internalized transaction with a U.S. broker dealer,[3] because the transaction would not be cleared through a clearing agency, another requirement of the exemption. As there is no clearing requirement under U.S. securities laws for securities transactions, the TOTUS clearing requirement instead seems to have some basis in the Dodd-Frank Act clearing mandate for derivatives transactions. However, the requirement is ill-fitting in the context of securities transactions, which give rise to very different risks than derivatives transactions, for which mandatory central clearing has been a policy objective under the Dodd-Frank Act.

Under these circumstances, a foreign bank may need to modify how its transactions are conducted, seek to trade in accordance with another Volcker Rule exemption, or, because either of these approaches would increase costs or entail significantly more restrictions on the bank, the bank may curtail some of its trading activity involving U.S. counterparties or infrastructure. Absent a reduction in U.S. conduct or risk, this result seems inconsistent with the objectives of the TOTUS exemption. To the extent that the Volcker Rule regulators revisit the TOTUS exemption through guidance or otherwise, they could seek to better align its technical requirements to avoid rendering the exemption too restrictive and, as a practical matter, largely unusable by foreign banks even for the types of cross-border trading that seems to be contemplated by the exemption.


[1] 156 Cong. Rec. S5897 (daily ed. July 15, 2010) (discussing the Volcker Rule, Senator Jeff Merkley explained that Section 619 acknowledges “rules of international regulatory comity by permitting foreign banks, regulated and backed by foreign taxpayers, in the course of operating outside of the United States to engage in activities permitted under relevant foreign law.”); Volcker Rule Regulations, 79 Fed. Reg. 5536, 5654.

[2] SEC, Concept Release on Equity Market Structure, 75 Fed. Reg. 3594, 3597 at FN 20 (Jan. 14, 2010), available at

[3] The transaction would be permitted if it involved only the foreign operations of the U.S. broker dealer, under another part of the TOTUS cross-border provisions. However, the transaction could not involve any U.S. personnel or activities of the U.S. broker-dealer.

The preceding post comes to us from Jai Massari, Associate in the Financial Institutions Group of Davis Polk & Wardwell. The post is based on her recent article, which is entitled “Foreign Bank Cross-Border Trading under the Volcker Rule: the ‘Trading Outside the United States’ Exemption’s Incongruous Consequences” and available here.

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