On January 30, 2020, the Federal Reserve Board, FDIC, OCC, SEC, and CFTC issued a notice of proposed rulemaking to amend the definition of "covered funds" under the Volcker Rule. The proposal is intended to "improve and streamline" the Volcker Rule’s treatment of covered funds, and to permit banking entities to offer products and services that do not present the sorts of regulatory concerns intended to be addressed by the Volcker Rule. The agencies’ proposal is similar to their 2018 efforts to clarify the portions of the Volcker Rule governing prohibitions on proprietary trading activities, which became effective in January 2020.
The proposed rule represents a significant opportunity for banks and their affiliates to shape and define new exclusions and exemptions from the Volcker Rule’s prohibitions. Similarly, certain funds, such as venture capital funds or SBICs, which may seek investment from banking entities should also see this as an opportunity to expand their investor base by supporting the expanded set of exclusions. This opportunity has, for the most part, been rare and relatively limited in scope.
Comments on the proposed rule are due April 1, 2020.
In relevant part, the Volcker Rule imposes restrictions on the manner in which banks and certain of their affiliates (referred to as banking entities) can sponsor, advise, or have ownership interests in private equity or hedge funds (referred to as covered funds). The proposed rule represents an effort by the agencies to offer several points of amendment, clarification and expansion of the exclusions to this general prohibition on a banking entity’s interactions with and ownership of covered funds.
The proposed rule would first modify several current exclusions from the covered fund provisions in an effort to simplify and clarify the relevant requirements for these exclusions. First, the restrictions for the foreign public funds exclusion will be tailored to match the exclusion for similarly situated U.S. registered investment companies. Second, the loan securitization exclusion would be revised to permit, among other things, the loan securitizations to hold a small amount of non-loan assets and still qualify for the exclusion. Third, the small business investment company (SBIC) exclusion would be amended to account for the typical life cycle of SBICs. The proposal also requests comments on clarifications to rural business investment companies and qualified opportunity zone funds.
The proposed rule also includes several new exclusions for permissible fund structures through which a banking entity can provide traditional financial services. First, an exclusion would be created for an entity created and used "to facilitate a customer’s exposures to a transaction, investment strategy, or other service". Second, wealth management vehicles used for family investment portfolio and used by the banking entity to provide integrated private wealth management would also be excluded. Third, funds "that make loans, invest in debt, or otherwise extend the type of credit that banking entities may provide directly under applicable banking law" – so called credit funds – are proposed to be excluded from the definition of a covered fund. Finally, the proposal would exclude "venture capital funds" meeting the definition contained in the SEC’s rule at 17 C.F.R. § 275.203(l)-1 and certain other criteria regarding, among other things, the permissibility of the investment under other applicable laws.
The proposed rule includes an effort to "better limit the extraterritorial impact" of the Volcker Rule by exempting certain funds organized outside the US and offered to foreign investors, but which are controlled by foreign banking entities and thus are treated as banking entities. In such instances, the foreign fund could be subject to compliance obligations that are more stringent than those imposed on similarly situated covered funds, even though the foreign funds have limited connection to the United States.
The proposal would clarify aspects of the definition of ownership interest. As proposed, certain bona fide senior loans or senior debt instruments made by a banking entity to a covered fund would be included in a safe harbor to make clear such credit amounts are not an "ownership interest" in the covered fund. The proposed rule would also expand the scope of covered transactions that a banking entity may conduct with a covered fund that it sponsors, advises, or has other relationships. This proposal is designed to permit banking entities to provide certain traditional banking services to covered funds, such as standard payment, clearing, and settlement services, to related covered funds. Finally, the proposed rule provides additional clean up and clarification to existing issues in the Volcker Rule’s implementing regulations, including addressing the manner in which a banking entity’s ownership interests in covered funds is calculated and the way in which a banking entity would calculate aggregate fund limits in its side-by-side or parallel investments with a covered fund.
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