Sullivan & Cromwell Discusses Amendments to Volcker Rule Regulations

On July 9, 2019, 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 collectively, the “Agencies”) released final rules adopting their previously proposed amendments to the regulations implementing Section 13 of the Bank Holding Company Act of 1956 (the “BHC Act”),[1] known as the “Volcker Rule.”

The amendments modify the implementing regulations in a manner consistent with Sections 203 and 204 of the Economic Growth, Regulatory Relief, and Consumer Protection Act the (the “EGRRCPA”).[2]  Under Section 203 of the EGRRCPA, institutions that have total consolidated assets equal to $10 billion or less and total trading assets and liabilities equal to five percent or less of total consolidated assets were excluded from the definition of “insured depository institution,” and therefore generally were excluded from the scope of “banking entities” that are subject to the Volcker Rule’s restrictions and compliance program requirements.  Section 204 of the EGRRCPA modified the restrictions on the sharing of a name (or variation of the same name) between a banking entity and a hedge fund or private equity fund so as to permit a banking entity that serves as an investment adviser for a fund to share a name with that fund, subject to certain conditions.  The Agencies’ release accompanying the amendments (the “Adopting Release”) confirmed that Sections 203 and 204 of the EGRRCPA became effective upon enactment of the statute on May 24, 2018.

Discussion

The amendments adopted by the Agencies are unchanged from those that the Agencies proposed in their notice of proposed rulemaking in February 2019.[3] Appendix A to this Memorandum provides a comparison of the text of the provisions of the 2013 Rule (as defined below) that were affected by the amendments against the text of such provisions that will become effective on the first day following publication in the Federal Register.

The Volcker Rule, as implemented by the regulations adopted by the Agencies in December 2013 (the “2013 Rule”), imposes broad prohibitions on banking entities from engaging in proprietary trading and investing in and sponsoring private equity funds, hedge funds and certain other investment vehicles—referred to as “covered funds” in the 2013 Rule—and includes requirements to establish an internal compliance program that is reasonably designed to ensure and monitor compliance with the Volcker Rule.[4]  The 2013 Rule is currently the subject of an rulemaking process, separate from the rulemaking that concluded with the adoption of the amendments described here, that commenced with a notice of proposed rulemaking issued by the Agencies during the summer of 2018 and remains ongoing.

Exclusion from Definition of “insured depository institution”

The amendments modify the definition of “insured depository institution” in the 2013 Rule by excluding any institution that satisfies two conditions, consistent with Section 203 of the EGRRCPA.  First, the institution, and every entity that controls it, must have total consolidated assets equal to or less than $10 billion.  Second, total consolidated trading assets and liabilities of the institution, and every entity that controls it, must be equal to or less than five percent of its total consolidated assets.  Any insured depository institution that meets both of these conditions (as well as any subsidiary or affiliate of such an institution) generally would not be a “banking entity” and therefore would not be subject to the Volcker Rule or the 2013 Rule, unless it is a banking entity by virtue of being affiliated with another insured depository institution that does not qualify for the exclusion or with a company that is treated as a bank holding company for purposes of Section 8 of the International Banking Act of 1978.[5]

In the Adopting Release, the Agencies confirmed that a bank or savings association seeking to determine its eligibility for the exclusion may use its most recent quarterly Consolidated Report of Condition and Income (commonly referred to as a “call report”) as the source of data for its consolidated assets and its total trading assets and liabilities at the bank or savings association level.[6] Similarly, a banking organization may use the most recent filing of Form FR Y-9C by its holding company as the source of data about the consolidated assets and total trading assets and liabilities of the companies controlling the bank or savings association.  The Agencies instructed that institutions should classify assets and liabilities consistent with the instructions to the relevant report in consultation with appropriate supervisors, as necessary.[7]

In the Adopting Release, the Agencies rejected the suggestion made by certain commenters that the exclusion provided by Section 203 of the EGRRCPA extended to firms with either $10 billion or less in total consolidated assets or trading assets and liabilities equal to five percent or less of total consolidated assets.[8] The Agencies called these arguments unpersuasive, stating that the requirement that both criteria be satisfied to qualify for the exclusion “is most consistent with the statutory language of EGRRCPA, the congressional intent behind the statute, and the structure of the statute as a whole.”[9]

Exemption from Restriction on name-sharing between banking entity and covered funds

The amendments also provide an exemption from the restriction on a banking entity (or an affiliate of the banking entity) sharing the same name or a variation of the same name with a covered fund.[10]  Under the Volcker Rule and the 2013 Rule, banking entities are generally prohibited from serving as the “sponsor” to a covered fund, absent an exemption or exclusion.  The definition of “sponsor” for this purpose includes a banking entity that shares the same name or a variation of the same name with a fund for corporate, marketing, promotional, or other purposes.[11]  Name-sharing is also prohibited with respect to a covered fund that a banking entity permissibly sponsors under the so-called “organizing and offering exemption.”[12]

As amended, the regulations will permit a covered fund to share the same name or a variation of the same name with a banking entity (or an affiliate of the banking entity) that is an investment adviser to the fund, subject to two conditions.  First, the investment adviser is not, and does not share the same name (or a variation of the same name) as, an insured depository institution, a company that controls an insured depository institution, or a company that is treated as a bank holding company for purposes of Section 8 of the International Bank Act of 1978.[13] Second, the investment adviser’s name does not contain the word “bank.”[14]

The amendments also modify the definition of “sponsor” in the 2013 Rule to conform to Section 204 of the EGRRCPA.[15]  As amended, the definition of “sponsor” for purposes of the 2013 Rule will not include name-sharing that is permitted in accordance with the conditions described above, but will otherwise continue to include sharing the same name or a variation of the same name with a fund for corporate, marketing, promotional, or other purposes.

ENDNOTES

[1]   12 U.S.C. § 1851.

[2]   EGRRCPA, Pub. L. 115-174 (May 24, 2018).  The Adopting Release confirms that Sections 203 and 204 of the EGRRCPA were effective upon the statute’s enactment.  Adopting Release at 4 n.6.

[3]   Proposed Revisions to Prohibitions and Restrictions on Proprietary Trading and Certain Interests in, and Relationships With, Hedge Funds and Private Equity Funds, 84 Fed. Reg. 2778 (Feb. 8, 2019).

[4]   For a discussion of the requirements of the 2013 Rule, please see our Client Memorandum, Volcker Rule: U.S. Agencies Approve Final Volcker Rule, Detailing Prohibitions and Compliance Regimes Applicable to Banking Entities Worldwide, dated January 27, 2014, available at https://www.sullcrom.com/Volcker-Rule-01-27-2014.  During the summer of 2018, the Agencies approved a notice of proposed rulemaking to amend the 2013 Rule, including changes to the proprietary trading and compliance program provisions of the 2013 Rule and, to a lesser extent, the covered funds provisions.  The rulemaking process initiated by this notice remains ongoing.  For a discussion of this notice of proposed rulemaking, please see our Client Memorandum, Federal Banking Agencies and CFTC Approve Notice of Proposed Rulemaking to Amend Volcker Rule Regulations; SEC Expected to Follow, dated June 5, 2019, available at https://www.sullcrom.com/siteFiles/Publications/SC_Publication_Volcker_Rule_06_05_18.pdf.

[5]   Adopting Release at 5 n.9.  See also 12 U.S.C. § 1851(h)(1); 2013 Rule § _.2(c)(1).

[6]   Adopting Release at 9.

[7]   Id. at 10.

[8]   Id. at 7.

[9]   Id. at 8.

[10] 2013 Rule § _.11(a)(6).

[11] 12 U.S.C. § 1851(h)(5); 2013 Rule § _.10(d)(9).

[12] 2013 Rule § _.11(a)(6).

[13] 12 U.S.C. §§ 1851(d)(1)(G)(vi)(I); 12 U.S.C. 1851(d)(1)(G)(vi)(II).

[14] 12 U.S.C. § 1851(d)(1)(G)(vi)(III); 2013 Rule § _.10(d)(9).  Section 204 of the EGRRCPA included the additional condition that the name of the fund may not contain the word “bank” in order to qualify for the exemption, but because this condition is already included in the 2013 Rule’s organizing and offering exemption (2013 Rule § _.11(a)(6)(ii)), the Agencies did not make any additional modifications to the rule to reflect this condition.

[15] 12 U.S.C. § 1851(h)(5); 2013 Rule § _.10(d)(9).

This post comes to us from Sullivan & Cromwell LLP. It is based on the firm’s memorandum, “Volcker Rule,” dated July 10, 2019, and available here.