Key highlights of the Volcker Rule proposal has been saved
Key highlights of the Volcker Rule proposal
On May 30, 2018, the Federal Reserve Board approved a 373 page notice of proposed rulemaking (the “proposal”) to amend the regulations implementing the Volcker Rule (the Rule), a centerpiece of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”).
June 6, 2018 | Financial services
The proposal aims to simplify and tailor the compliance requirements of the Rule, which was finalized back in December 2013 to prevent banks from engaging in proprietary trading and from owning hedge funds or private equity funds. The proposed changes were jointly developed and approved by the Federal Reserve Board (FRB), the Federal Deposit Insurance Corporation (FDIC), the Office of the Comptroller of the Currency (OCC), the Commodity Futures Trading Commission (CFTC), and the Securities and Exchange Commission (SEC).
Among other changes, this proposal intends to:
- Create categories of banking entities based on the size of their trading assets and liabilities
- Tailor compliance requirements based on a banking entity’s level of trading activity
- Modify the term “trading account” in the Rule
- Modify or remove select compliance requirements specific to certain proprietary trading and covered funds exemptions
- Create a presumption of compliance with the underwriting and market-making exemptions for certain trading desks whose activities fall within certain internal risk limits
- Modify certain requirements related to metrics reporting and streamline the related data collection process
Scope of applicability
The proposal establishes three categories of banking entities based on their level of trading activity:
- Banking entities with “significant trading assets and liabilities”: Would include banking entities with trading assets and liabilities of at least $10 billion. For US banking entities this calculation would be based on worldwide trading assets and liabilities whereas for foreign banking entities this would be based on trading assets and liabilities of their combined US operations (including its US branches, agencies, and subsidiaries). These entities would be required to comply with the most extensive set of requirements under the proposal.
- Banking entities with “moderate trading assets and liabilities”: Would include banking entities which have trading assets and liabilities equal to or above $1 billion but less than $10 billion. These banking entities would be subject to reduced compliance requirements.
- Banking entities with “limited trading assets and liabilities”: Would include banking entities with trading assets and liabilities of less than $1 billion. This calculation would be based on worldwide trading assets and liabilities for both US and foreign banking entities. These banking entities would be able to operate under a presumption of compliance.
Key proposed changes: Proprietary trading
The proposal contains several changes to the proprietary trading provisions, including the following:
- Changes to the short-term intent prong (“Purpose test”): The proposal amends the definition of “trading account” with the aim to increase clarity regarding the positions included in the definition. Per the 2013 Final Rule “trading account” was defined based on three main prongs: (1) short-term intent prong1, (2) market risk capital prong2, and (3) dealer prong3. The proposal removes the short-term intent prong and the associated 60-day rebuttable presumption4 and replaces it with a new accounting prong that captures positions recorded at fair value on a recurring basis under the applicable accounting standards, which would cover derivatives, trading securities, and available-for-sale securities.
- New presumption of compliance: The proposal introduces a limited presumption of compliance for those trading desks that are subject to the accounting prong and would apply only if the sum of their absolute value of daily profit and loss for the prior 90-day calendar period is less than $25 million. If the $25 million
thresholdis exceeded, the banking entity would be required to promptly notify the appropriate Agency.
- Expansion of liquidity management exclusion: The proposal expands the liquidity management exclusion to include, in addition to securities, FX forwards, FX swaps and physically-settled cross-currency swaps.
- Changes to the underwriting and market making exemption (related to
RENTD): As proposed, a banking entity’s purchase or sale of a financial instrument in connection with its underwriting or market making-related activities is presumed to meet the “Reasonably Expected Near-term Demands of Clients, Customers and Counterparties” (“ RENTD”) requirement if the banking entity has established and enforced internal risk limits at the trading desk level.
- Changes to the risk mitigation hedging exemption: For banking entities with significant trading assets and liabilities, the proposal removes the requirements for correlation analysis as well as the requirement that the hedging activity must “demonstrably reduce or otherwise significantly mitigate” one or more specific identifiable risks. In addition, the proposal removes enhanced documentation requirements for financial instruments commonly used by the trading desk to hedge risk. For banking entities with moderate trading assets and
liabilitiesthe proposed requirements are further simplified in that the only requirement that applies is that the hedge is designed at inception to reduce or significantly mitigate one or more specific risks and is subject to ongoing calibration.
Key proposed changes: Covered funds
The changes proposed with respect to the covered
- Definition of covered funds: While the Agencies have
posedseveral questions seeking comments with respect to the definition of covered funds, the proposal does not include any specific change yet with respect to the definition.
- Banking entity status of foreign excluded funds: No changes have been proposed to address the banking entity status for foreign excluded funds while comments have been requested. However, temporary relief from enforcement for qualifying foreign excluded funds is extended for
additionalyear, i.e., until July 21, 2019.
- Underwriting and market making for
thirdparty covered funds: As per the proposal, bankingentity that does not organize or sponsor the covered fund would no longer need to include in its aggregate fund limit and capital deduction that value of any ownership interests of the covered fund acquired or retained under these exemptions.
- Expansion of the
risk mitigatinghedging exemption: The proposal restores the exemption from the original 2011 proposal that would allow the banking entity to hold a covered fund interest as a risk mitigatinghedge when acting as an intermediary on behalf of a customer to facilitate the exposure by the customer to the profits and losses of the covered fund.
Key proposed changes: Compliance program and metrics reporting
- Compliance program: Banking entity with significant trading assets and liabilities would be required to implement a six-pillar compliance program and would be required to report metrics. Banking entities with moderate trading assets and liabilities would be required to implement a simplified and tailored compliance program by incorporating Volcker Rule compliance into its existing policies and procedures. Banking entities in the limited trading assets and liabilities category would benefit from presumed compliance and would have no obligation to demonstrate compliance on an ongoing basis.
- CEO attestation requirements: The proposal would maintain the CEO attestation requirements for all banking entities with significant and moderate trading assets and liabilities. However, the proposal would eliminate Appendix B of the 2013 Final Rule, which specified enhanced minimum standards for compliance programs of large banking entities and banking entities engaged with significant trading activities.
- Metrics reporting requirements: The Agencies propose several changes with respect to metrics reporting including the following: a) replacing the Customer-Facing Trade Ratio with a new Transaction Volumes metric, Inventory Turnover with a new Positions metric, and eliminating inventory aging data for derivatives; b) limiting the applicability of Position, Transaction Volume and Securities Inventory Aging to market making and underwriting desks; (c) adding requirements to provide qualitative and descriptive information with respect to: each trading desk, quantitative measurements and narrative statement; (d) extending the time for reporting to 20 days after the calendar month end ( as opposed to 10 days per the 2013 Final Rule) for banks with trading assets and liabilities greater than $50 billion.
Key proposed changes: Specific to foreign banking organizations (FBOs)
The proposal offers some relief to FBOs with respect to the Trading Outside the US (TOTUS) proprietary trading exemption and Solely Outside the US (
- TOTUS exemption: The proposal removes or modifies certain requirements from this exemption
including:(a) removes the prohibition on financing from USbranch or affiliate (“financing prong”); (b) removes the requirement that the purchase or sale not be with or through a US entity (“counterparty prong”); and (c) modifies the requirement such that it would allow some limited involvement by US personnel in the arranging or negotiating of a transaction. SOTUSexemption: Similar to the TOTUS exemption above, the proposal removes the financing prohibition from SOTUSexemption. Additionally, the proposal would codify one of the FAQs (i.e. FAQ #13) issued by the Agencies staff in 2015 which allows SOTUSto be available for investing in covered funds so long as the foreign banking entity does not participate in the offer or sale of ownership interests to US residents.
The proposal, which includes 342 specific questions (which in turn include several sub-questions) across all aspects of the provisions, is now open to a 60 day comment period which would inform and influence
1Short-term intent prong: Any account that is used by a banking entity to purchase or sell one or more financial instruments principally for the purpose of short-term resale, benefitting from short-term price movements, realizing short-term arbitrage profits, or hedging another trading account position.
2Market risk capital prong: Trading positions that are both covered positions and trading positions for purposes of the Federal banking agencies’ market risk capital rules, as well as hedges of covered position.
3Dealer prong: Any account used by a banking entity that is a securities dealer, swap dealer, or security-based swap dealer that is licensed or registered, or required to be licensed or registered, as a dealer, swap dealer, or security-based swap dealer, to the extent the instrument is purchased or sold in connection with the activities that require the banking entity to be licensed or registered as such.
4Rebuttable presumption: Purchase or sale of a financial instrument by a banking entity is for the trading account if the banking entity holds the financial instrument for fewer than 60 days or substantially transfer the risk of the financial instrument within 60 days of purchase (or sale).
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