On December 10, 2013, five federal agencies, including the Federal Reserve Board, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, the Securities and Exchange Commission, and the Commodity Futures Trading Commission (CFTC) issued the final Volcker Rule (the Volcker Rule). The Volcker Rule imposes limitations on proprietary trading and certain investment activities by insured depository institutions and their affiliates (Banking Entities). The final rule implements section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.
The text of the final rule is available here, and the accompanying fact sheet is available here. Four of the federal agencies issued a joint preamble to the final rule that is almost 1,000 pages long and available here. The CFTC issued a separate preamble to the final rule that is available here.
The Volcker Rule applies only to Banking Entities, but it will have indirect consequences on buy-side participants in the securities, derivatives and commodities markets. Sutherland is in the process of evaluating the final rule and will provide a summary of the main consequences for these market participants at a later date. The following is a preliminary overview of the Volcker Rule.
Generally, the Volcker Rule imposes the following limitations on the trading and investment activities of Banking Entities, subject to several exemptions.
1. Proprietary Trading. The Volcker Rule prohibits Banking Entities from short-term proprietary trading in financial instruments, which includes securities, derivatives, commodity futures, and any options on these instruments.1 The final rule exempts certain proprietary trading activities, including underwriting, market making-related activities, risk mitigation hedging, trading in certain government obligations, and certain trading activities of an insurance company for its general or separate account, from this prohibition.
2. Investments in Covered Funds. The Volcker Rule prohibits Banking Entities from directly or indirectly acquiring or retaining an ownership interest in, sponsoring, or having certain relationships with, “covered funds.” The term “covered fund” includes certain investment companies, foreign funds and commodity pools, and excludes certain entities such as registered investment companies, business development companies, small business investment companies, and certain insurance company separate accounts and bank-owned life insurance separate accounts, among others. The final rule exempts certain investments in covered funds, including investments in connection with organizing and offering a covered fund, underwriting, market making-related activities, risk mitigation hedging, and certain insurance company activities, among others.
To ensure compliance with the final rule, Banking Entities must establish compliance programs that will vary based on the size of, and the scope of the trading activity conducted by, the particular Banking Entity. Specifically, the final rule requires that Banking Entities establish programs that include, among other elements, written policies and procedures, internal controls, a management framework, recordkeeping, and metrics reporting for certain trading activities.
The final rule becomes effective on April 1, 2014; however, Banking Entities will have until July 21, 2015, to comply with the prohibitions on proprietary trading and investing in covered funds, barring an extension. Compliance dates for certain other requirements under the Volcker Rule vary based on the amount of trading assets and liabilities of the Banking Entity. With respect to the metrics reporting requirement, Banking Entities with more than $50 billion in trading assets and liabilities must comply with the metrics reporting requirements starting June 30, 2014. Banking Entities with less than $50 billion in assets, but $25 billion or more and $10 billion or more in trading assets and liabilities, are required to comply beginning on April 30, 2016, and December 31, 2016, respectively.
1 Note that the term “financial instrument” does not include loans and spot foreign exchange or spot physical commodities.