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"There you go again": The Obama administration sends proposed text of Volcker Rule to Congress


05 March 2010

On 3 March 2010, President Obama sent to Congress the Administration's proposed text for the so-called "Volcker Rule".  

If enacted into law, this would both limit the size of U.S. banks and require both U.S. and non-U.S. banks to choose between engaging in commercial banking, on the one hand, or principal activities not related to serving customers, on the other.

For details of the Volcker Rule as initially proposed on January 21 and questions about what it would mean for U.S. and non-U.S. banks, please see our e-Alerts Obama proposal for new restrictions on size and scope of U.S. financial institutions. 

The Administration's proposed text (the Proposed Rule) brings to light a few more details of the Volcker Rule. We are gratified that the Proposed Rule answers some of the questions we previously posed. However, the five page legislative proposal still leaves many issues unaddressed and will present significant issues to U.S. and non-U.S. banks.

We summarize key aspects of the Proposed Rule below.

Structure of the Proposed Rule

The Proposed Rule would add a new chapter 13 to the Bank Holding Company Act of 1956 (BHCA) and would, in application, amend, delete or reverse provisions of the Gramm-Leach-Bliley Act of 1999 (GLBA).

Definition of proprietary trading

Section 13(f)(1) of the Proposed Rule attempts, for the first time, to define what would be prohibited as proprietary trading. The proposed definition is extremely broad, covering any purchase and sale of any "stocks, bonds, options, commodities, derivatives, or other financial instruments" for an institution's own trading book and not on the account of a customer or as part of market-making activities. Hedging activities and any activity in facilitation of customer relationships will be permitted.

An exception to the prohibition is made for trading in the obligations of government or government-sponsored enterprise (GSE), and certain investments designed to promote the public welfare. Existing permitted proprietary activities not so excepted are presumably prohibited, including such traditional bank investments as currencies and bullion, and the eligible principle investments under various State and federal laws such as 12 U.S.C. § 1 and Section 4 of the BHCA.

Prohibition on proprietary trading

The Proposed Rule would prohibit proprietary trading by insured depository institutions, companies that control insured depository institutions and any other companies treated as bank holding companies for the purposes of the BHCA. This prohibition would then apply to all U.S. banks that accept insured deposits, the few foreign bank branches that accept insured deposits, all entities that own or control U.S. banks (bank holding companies) or (BHCs) and foreign banks with branches or agencies in the U.S. (or that are otherwise treated as BHCs) (collectively, Covered Entities). Although the sparse language of the proposed Section 13(a) does not include the customary "direct or indirect" language, we presume that the prohibition would apply to subsidiaries of each of these entities as well.

In essence, a Covered Entity will be required to choose between engaging in the U.S. in proprietary trading (as defined above) or in commercial banking.

Definition of "hedge fund," "private equity fund" and "sponsoring"

Section 13(f)(2) of the Proposed Rule defines as a hedge fund or a private equity fund any entity exempt from registration as an investment company pursuant to section 3(c)(1) or 3(c)(7) of the Investment Company Act (ICA), or such similar funds as determined by the federal regulators. This definition is stunningly broad in scope, and appears to be missing several important words and concepts that would narrow its scope to entities pooling funds for purposes of investment appreciation so as to make them eligible for registration under the ICA. Instead, the definition covers any entity that is not required to register as an investment fund.

Section 13(f)(3) defines "sponsoring" a fund to mean serving as the general partner, managing member or trustee of a fund, controlling a majority of the directors, trustees or management of a fund, or sharing the same or similar name of a fund.

Prohibition on sponsoring or investing in, or providing services to, hedge funds and private equity funds

The Proposed Rule would prohibit Covered Entities from sponsoring and investing in hedge funds and private equity funds. Exceptions are made for investments in small business investment companies and investments designed primarily to promote the public welfare.

Section 13(b)(2) of the Proposed Rule would limit the ability of Covered Entities that serve, directly or indirectly, as an investment manager or investment advisor to a hedge fund or a private equity fund to lend or acquire assets from such entities, or to provide prime brokerage services to them. Specifically, a Covered Entity could not provide custody, securities lending and other prime brokerage services to such funds. The Proposed Rule would bar a Covered Entity from engaging in any "covered transaction," as such term is defined in Section 23A of the Federal Reserve Act (Section 23A) with such a fund. Section 23A generally includes as a covered transaction when a bank lends to, buys assets from, or provides guarantees to or on behalf of, an affiliated entity. The Proposed Rule would also apply to transactions between such funds and a Covered Entity under Section 23B of the Federal Reserve Act, which requires most every service or activity between such entities to be on market terms.

The Proposed Rule materially extends application of Section 23A in two significant ways. First, it applies the provision to non-banks that control banks (such as a BHC). Second, it applies the provision to entities that are unaffiliated currently under Section 23A.

Capital requirements for nonbank financial companies

Section 13(e) of the Proposed Rule directs the Board of Governors of the Federal Reserve (Federal Reserve Board) to impose additional capital requirements and additional quantitative limitations on non-bank financial companies that are under its supervision and that engage in proprietary trading not excepted or sponsored or invested in hedge funds and private equity funds. The Proposed Rule does not provide guidance on how the Federal Reserve Board should determine what capital should be imposed on what entities for what activities, or whether the Federal Reserve Board should seek to align itself with international standards such as the proposed Basel revisions on trading book capital.

Concentration limits on large financial firms

The Proposed Rule prohibits Covered Entities as well as non-bank financial companies supervised by the Federal Reserve Board (collectively, Financial Companies) from merging with, acquiring the assets of or otherwise acquiring control of another company, if doing so would cause the Financial Company's total consolidated liabilities to exceed ten percent of the aggregate consolidated liabilities of all Financial Companies as of the end of the prior calendar year. This prohibition would be in addition to the ten percent deposit cap presently in place for insured depository institutions.

The Proposed Rule defines "liabilities" to include a Financial Company's total risk-weighted assets (after deductions from regulatory capital) less the company's total regulatory capital. For non-U.S. Financial Companies, liabilities will equal only the total risk-weighted assets of its U.S. operations.

The concentration prohibition may be waived with Federal Reserve Board approval, however, for acquisitions of banks in default or danger of default, acquisitions of banks to which the Federal Deposit Insurance Company has provided emergency assistance or acquisitions that would result in only a de minimis increase in the Financial Company's liabilities.


The Proposed Rule allows two years for Covered Entities to reform their activities to come into compliance with its terms. Covered Entities may apply to their appropriate federal bank regulator for one-year extensions of the two-year period for up to three additional years.


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