According to a joint statement, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, the SEC, and the CFTC (collectively, the “agencies”) will undertake a coordinated review of how the Volcker Rule (codified at BHCA Section 13) applies to certain foreign funds that are excluded from the definition of “covered funds.” The purpose of the review is to examine “possible unintended consequences” and impacts of the Volcker Rule.
The agencies stated that market participants are concerned about potential competitive disadvantages that could arise as a result of certain foreign funds being subjected to the Volcker Rule’s requirements due to their affiliations with a foreign banking entity, while other foreign funds remain exempt from the Volcker Rule’s requirements because they are not affiliated with a banking entity. Such foreign funds often fall outside (or are excluded from) the Volcker Rule’s definition of “covered fund,” and thus foreign banking organizations are free to invest in or sponsor such funds without violating the Volcker Rule. Nonetheless, the act of sponsoring or investing in the so-called “foreign excluded funds” can create certain problems for the funds themselves.
A foreign banking entity’s investment in or sponsorship of such a foreign excluded fund can cause the fund to be viewed as “affiliated” with the foreign banking entity. If deemed to be affiliated, foreign excluded funds are themselves “banking entities” and the funds themselves must comply with the Volcker Rule’s requirements – in particular, such funds are prohibited from engaging in proprietary trading or investing in other covered funds, absent an exception in the Volcker Rule. In addition, such funds must maintain a Volcker compliance program.
In this regard, the agencies noted that the Volcker Rule incorporates the BHCA’s existing concept of “affiliation.” For example, a foreign excluded fund would be “affiliated” with a foreign banking entity if the foreign banking entity were the general partner of the foreign excluded fund, or if the foreign banking entity were to own more than 25% of the voting shares of the fund.
The agencies also are not willing to simply exempt all foreign excluded funds from the scope of the Volcker Rule. There is no clear definition of what is a “foreign excluded fund” – other than an entity that isn’t a Volcker Rule regulated “covered fund.” The agencies expressed concern that exempting all foreign excluded funds from the “banking entity” definition could enable foreign banking organizations to use structures self-described as foreign excluded funds to engage in proprietary trading or covered fund investing in a manner that the foreign banking organization could not do so directly.
The agencies stated that until July 21, 2018, the agencies will not treat as a “banking entity” any foreign excluded fund that meets the agencies’ definition of a “qualified foreign excluded fund.” A “qualified foreign excluded fund” is defined as an entity that:
(1) Is organized or established outside the United States and the ownership interests of which are offered and sold solely outside the United States;
(2) Would be a covered fund were the entity organized or established in the United States, or is, or holds itself out as being, an entity or arrangement that raises money from investors primarily for the purpose of investing in financial instruments for resale or other disposition or otherwise trading in financial instruments;
(3) Would not otherwise be a banking entity except by virtue of the foreign banking entity’s acquisition or retention of an ownership interest in, or sponsorship of, the entity;
(4) Is established and operated as part of a bona fide asset management business; and
(5) Is not operated in a manner that enables the foreign banking entity to evade the requirements of the Volcker Rule or its implementing regulations.
The agencies further noted that ultimately any relief may require Congressional action to amend the Volcker Rule itself.