Skip to content

Volcker Rule Update: Non-U.S. banks may invest in third-party covered funds under the SOTUS exemption

On February 27, 2015, the federal regulators charged with implementing section 13 of the Bank Holding Company Act of 1956, as amended, commonly known as the "Volcker Rule," added new guidance to those federal regulators' list of Frequently Asked Questions (FAQs) that should permit most non-U.S. banks to invest in "covered funds" that are sponsored, managed, and marketed by third parties.1 The new guidance clarifies the availability of the so-called "SOTUS" exemption so as to allow many non-U.S. banking entities to acquire and retain ownership interests in third-party funds with U.S. investors, including hedge funds, private equity funds, real estate funds and securitization vehicles.

We discussed elsewhere2 that non-U.S. banking entities, unlike U.S. banking entities, are free under the Volcker Rule to invest in non-U.S. investment vehicles that are not offered to U.S. persons, as these vehicles do not rely on Section 3(c)(1) or 3(c)(7) of the Investment Company Act of 1940 to be exempt from registration as investment companies, pursuant to Securities and Exchange Commission staff interpretations of Section 7(d) under the Investment Company Act of 1940.3
The conclusion that these vehicles should not be treated as covered funds under the Volcker Rule is unchanged.

A private fund that offers or sells its interests to U.S. persons, however, is generally a covered fund and we had previously advised that non-U.S. banking entities must exercise caution when seeking to invest in such funds (Covered Funds); absent such a fund meeting a specific exemption from the definition of covered fund. That analysis was based on the express language of the exemption for investments made "solely outside of the United States" (the SOTUS Exemption) that prohibited reliance on the exemption for a non-U.S. banking entity investing in the ownership interests of a Covered Fund that were "offered for sale or sold to a resident of the United States."

The FAQ clarifies that the restriction on the offering and sale to residents in the United States applies only to the marketing activities and participation of the non-U.S. banking entity seeking to rely on the SOTUS Exemption and not to the third party manager or sponsor offering and selling interests to U.S. investors. In other words, a non-U.S. banking entity's acquisition and retention of an ownership interest in any investment vehicle that is a Covered Fund and that is sponsored, managed and marketed by a third party unaffiliated with the non-U.S. banking entity should not be prohibited by the Volcker Rule; provided that the non-U.S. banking entity can otherwise meet the other conditions of the SOTUS Exemption summarized further below, and does not participate in the marketing of the fund to U.S. persons. We note that several large U.S. law firms issued a consensus interpretation of the Volcker Rule that advocated for the use of parallel fund structures to accommodate non-U.S. banking entity investments; such parallel fund structures may no longer be necessary.4

The SOTUS Exemption would generally not be available for a non-U.S. banking entity seeking to sponsor a Covered Fund that will offer interests to U.S. investors. The FAQ notes that when a non-U.S. banking entity acts as sponsor or serves, directly or indirectly, as the investment manager, investment advisor, commodity pool operator or commodity trading advisor to a Covered Fund, the non-U.S. banking entity automatically will be deemed to be participating in the marketing of the fund's ownership interests as contemplated by the SOTUS Exemption. In addition to refraining from participating in the marketing of a Covered Fund to U.S. investors, a non-U.S. banking entity must generally meet each of the following conditions to avail itself of the SOTUS Exemption for investments in Covered Funds:

  • The banking entity is not organized, or directly or indirectly controlled by a banking entity that is organized, under the laws of the United States or of one or more states.
  • The banking entity either:
  • meets the qualifying foreign banking organization requirements of Section 211.23(a), (c) or (e) of Regulation K; or
  • satisfies at least two of the following:
  • its total assets held outside the United States exceed those held in the United States,
  • its total revenues from its non-U.S. business exceed those from its U.S. business,
  • its total net income from its non-U.S. business exceed that from its U.S. business.
  • The banking entity (including relevant personnel) that has decision-making authority over the investment is not organized or located in the United States.
  • The investment is not accounted for as principal, directly or indirectly, on a consolidated basis by a branch or affiliate organized or located in the United States.
  • No financing for the investment is provided, directly or indirectly, by a branch or affiliate organized or located in the United States.


1. See Federal Reserve, Volcker Rule, Frequently Asked Questions (February 27, 2015):
2. Asset Managers – The Volcker Rule's Relevance (See:'s-Relevance.aspx).
3. Non-3. U.S. Banks Under the Volcker Rule: A Framework for Analyzing Covered Fund Status (See: U.S. Volcker Rule – Covered Funds: FAQs for European structured finance transactions (See:
4. Assuming that the investment vehicle does not otherwise meet the definition of covered fund as a commodity pool.
5. See: "Consensus Interpretation of the Implementation of Parallel Fund Structures under the Volcker Rule" (May 1, 2014).

Legal and Regulatory Risk Note
United States