Federal Reserve Introduces Volcker Rule

by Glen Shapiro, LawAndTax-News.com, New York

15 February 2011

The United States Federal Reserve Board (the Board) has announced its approval of a final rule to implement the provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act) that give banking firms a period of time to conform their activities and investments to the prohibitions and restrictions of the so-called Volcker Rule.

The Volcker Rule generally prohibits banking entities from engaging in proprietary trading in securities, derivatives, or certain other financial instruments and from investing in, sponsoring, or having certain relationships with a hedge fund or private equity fund.

It is required, in the Dodd-Frank Act, that the Board should issue the rules implementing a conformance period of two years, during which those banking entities and nonbank financial companies supervised by the Board must bring their activities and investments into compliance.

The Volcker Rule also allows the Board to extend this two-year period by up to three, one-year periods. In addition, there is a special five-year extended transition period available for certain qualifying investments in hedge funds and private equity funds that are ‘illiquid funds.’ In order to grant any extension, the Board must determine that the extension is consistent with the purposes of the Volcker Rule and would not be detrimental to the public interest.

A public consultation on the Board’s proposal closed on January 10, 2011. A majority of the comments focused on the five-year extended transition period available to banking entities to the extent necessary to take or retain an interest in a hedge fund or private equity fund that qualifies as an illiquid fund.

For example, some comments requested that the Board lower the proposed rule’s requirement that at least 75% of a fund’s assets be invested in ‘illiquid assets’ in order for the fund to qualify for the extended transition period. While that request could not be accepted by the Board, it has expanded the conditions under which an asset may be considered an ‘illiquid asset’ to include situations where an asset is subject to a contractual restriction on sale or redemption for a period of three years or more.

Additionally, comments addressed the procedural aspects of the proposed rule governing the receipt and review of applications for an extension of the conformance period. For example, some requested that the rule permit the Board to grant all possible extensions to a banking entity at a single time. However, that has been rejected by the Board as the Dodd-Frank Act specifically provides that any extension may be granted “for not more than one year at a time.”

In developing the rule, the Board has consulted with the Department of the Treasury, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the Securities and Exchange Commission and the Commodity Futures Trading Commission. The final rule is effective from April 1, 2011.

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