Volcker Rule Changes Provide Stimulus Effect With Banks and Investment Funds

Financial Services Law

On June 25, 2020, federal banking and securities regulators issued new regulations that will ease burdens on banks that involve themselves with certain types of investment funds. By creating new exclusions from the definition of a “covered fund” under the so-called Volcker Rule, simplifying some requirements and clarifying others, the regulators have enhanced the certainty with which banking entities can approach participation in these transactions.

What happened

The Volcker Rule became law in 2010 under the Dodd-Frank Wall Street Reform and Consumer Protection Act. It generally restricts proprietary trading by banking entities and prohibits them from investing in or sponsoring “covered funds.” Regulations implementing the statute, adopted in 2013, are lengthy and detailed. Since passage seven years ago, regulatory agencies have simplified and, in some cases, relaxed the burdens posed by the rule, particularly as regards smaller financial institutions, without undercutting the intended purposes of the law.

The Federal Reserve, OCC, FDIC, SEC and CFTC (agencies that share jurisdiction over the Volcker Rule regulations) have modified those regulations, effective October 1, 2020.

New exclusions

Among other things, the modifications add new exclusions from the “covered fund” definition for:

  • Credit funds, which invest primarily in loans and debt instruments that the banking entity would be permitted to own directly, and certain related assets such as servicing rights and derivatives
  • Venture capital funds, as defined in Section 275.203(l)-1 of the SEC’s regulations under the Investment Advisers Act of 1940 (IA Act), provided that (1) the fund does not itself engage in activities that would be considered proprietary trading if done by a banking entity and (2) the fund adheres to specified disclosure and business practices laid out in the new regulations
  • Qualified opportunity funds, as defined in Section 1400Z-2(d) of the Internal Revenue Code
  • Family wealth management vehicles, as defined in the regulations (generally, for fiduciary and similar relationships)
  • Customer facilitation vehicles, as defined in the regulations (generally, entities used to enable existing customers to gain exposure to investment strategies of desired types)
  • Funds that make investments that qualify for consideration under regulations implementing the Community Reinvestment Act (CRA)
  • Rural business investment companies, as defined in the SEC’s regulations under the IA Act, with certain limitations
  • Co-investments alongside covered investments, by banking entities or their directors or employees, with specified conditions

Modifications to prior rules

Other changes made in the new regulations include:

  • Simplification and expansion of the exclusion for foreign private funds
  • Expansion of the existing exclusion for certain securitizations, allowing up to 5% of the assets to be debt securities
  • Clarification of the existing exclusion for SBICs to include an SBIC’s wind-down period
  • Simplification of the existing exclusion of a debt investment from consideration as an “ownership interest” in a covered fund with respect to the powers that a debt instrument holder might have to participate in the removal and replacement of a manager for “cause”
  • Easing of existing restrictions on transactions with affiliates (sometimes called “Super 23A”)

Why it matters

Banks that in the past may have shied away from involvement with investment funds they thought might be constrained by the Volcker Rule can now reconsider. For venture capital funds, qualified opportunity funds and foreign funds, these changes couldn’t have come at a better time.

This summary can only touch on the subjects covered in the 430-page Final Rule. On the whole, the changes represent a meaningful improvement in the certainty that banking entities can have when approaching (or revisiting) potential transactions involving investment funds.

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