US Regulators Issue Proposed Volcker Rule

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

14 October 2011

Developed together with the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, the Securities and Exchange Commission, and the Commodity Futures Trading Commission, the Federal Reserve Board of the United States has requested public comment on a proposed regulation implementing the so-called "Volcker Rule" requirements of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act).

The Dodd-Frank Act introduced two prohibitions on depository financial institutions, bank holding companies, and their subsidiaries or affiliates (banking entities) - from engaging in short-term proprietary trading of any security, derivative, and certain other financial instruments for a banking entity's own account, and the owning, sponsoring, or having certain relationships with, a hedge fund or private equity fund, subject to certain exemptions.

The proposed rule adopts the 3% limit on the amount by which a banking entity may invest in such funds organized and offered by it or by an affiliate or subsidiary. For any particular fund, a banking entity may not own directly, and/or indirectly, more than 3% of the value or ownership interests of that fund.

In addition, a banking entity’s aggregate direct and/or indirect ownership in all such funds may not exceed 3% of the banking entity’s Tier 1 capital; and any ownership interest in a fund that is held by a banking entity must be deducted from the banking entity’s Tier 1 capital, including the ownership amounts that fall within the above limitations.

The proposal is said to clarify the scope of the Dodd-Frank Act's prohibitions and, consistent with statutory authority, provides certain exemptions to these prohibitions. For example, transactions in certain instruments, including obligations of the US government or a US government agency, government-sponsored enterprises, and state and local governments, are exempt from the statute's prohibitions. Other activities are also exempted, such as market making, underwriting, and risk-mitigating hedging.

The proposed rule would require banking entities that engage in these activities to establish an internal compliance programme that is designed to ensure and monitor compliance with the statute's prohibitions and restrictions, and implementing regulations. The proposed rule provides commentary intended to assist banking entities in distinguishing permitted market making-related activities from prohibited proprietary trading activities.

The rule prohibits banking entities from engaging in an exempted transaction or activity if it would involve or result in a material conflict of interest between the banking entity and its clients, customers, or counterparties, or that would result in a material exposure to high-risk assets or trading strategies, in each case as defined by the proposed rule.

The proposal also requires banking entities with significant trading operations to report to the appropriate federal supervisory agency certain quantitative measurements designed to assist the federal supervisory agencies and banking entities in identifying prohibited proprietary trading in the context of certain exempt activities, and identifying high-risk assets or trading strategies.

It also includes a number of elements intended to reduce the burden of the proposal on smaller, less-complex banking entities. For example, the proposal limits the extent to which smaller banking entities are required to report quantitative measurements.

Comments on the proposed rule are to be received on or before January 13, 2012.

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