The Volcker Rule—A Suggested Approach for Banking Entities When Analyzing its Impact on Business Models, Activities and Transactions

by Pillsbury Winthrop Shaw Pittman LLP

More than three years following the passage of the Dodd-Frank Act, and intense inter-agency negotiations, the federal financial regulatory agencies collectively adopted the final version of the “Volcker Rule,” or “Rule”—which imposes new and potentially severe limitations on domestic and foreign banking entities’ activities in regard to proprietary trading and investments in “covered funds.” The 72-page final Rule is accompanied by over 800 pages of interpretative guidance, to address more than 1,200 questions that the federal agencies asked commenters to address.

This Alert provides an overview of the principal elements of the Rule and identifies several significant concerns that have already been raised by industry participants. Importantly, we provide our thoughts regarding the process by which banking entities might analyze their current business models and transactional structures, with the goal of avoiding an interruption in deal flow and/or business models by identifying possible coverage by the Rule, as well as adopting modifications to comply with the Rule and prevent or minimize adverse business consequences.

Additional client communications will explore in detail categories of activities and transactions impacted by the Rule, as well as interpretative guidance issued by the federal financial regulatory agencies.

Overview of the Final Rule
The final version of the Rule addresses numerous criticisms of the proposed Rule raised by the industry, and adopts modifications that range from liberalizations in regard to the Rule’s coverage to exemptions for specific transactions that expand coverage. What follows is a short synopsis of pertinent components of the Rule, including: (a) coverage; (b) proprietary trading; (c) investment in and sponsorship of covered funds; (d) compliance and governance obligations and (e) the effective date of the Rule and the compliance period.

Following the summary, this Alert provides a short discussion of financial activities and categories of financial transactions that are significantly affected by the Rule, as well as our recommendations to analyze the impact the Rule will have on deal flow and business plans in order to avoid disruption of the same.

An appropriate starting point for understanding the Rule is the definition of a “banking entity,” which includes:

  • An FDIC-insured depository institution;
  • Any company that controls an FDIC-insured depository institution;
  • Any company that is treated as a bank holding company under the International Banking Act; and
  • Any affiliate or subsidiary of any of the foregoing entities.1

Proprietary Trading
For banking entities, the Rule establishes a general prohibition on all forms of “proprietary trading.” The term “propriety trading” is defined as “engaging as principal for the trading account of the banking entity in any purchase or sale of one or more financial instruments.”

The Rule focuses on a banking entity’s “trading account,” from which trades are conducted, and includes any account used to purchase or sell financial instruments principally for the purpose of:

  • Short-term resale;
  • Benefiting from price movements;
  • Realizing short-term arbitrage; or
  • Hedging any of the above.2

Stated another way, the prohibitions on proprietary trading apply to all trading accounts of a banking entity, which means that an institution must undertake to properly identify the location or locations within its corporate structure where trading as principal takes place.3

The following types of “financial instruments” are subject to the prohibition:

  • Securities;
  • Options on securities;
  • Derivatives;
  • Options on derivatives;
  • Foreign exchange swaps and forwards; and
  • Contracts of sale for commodities for future delivery (and options thereon)

Importantly, excluded from the prohibition on proprietary trading are purchases and sales of financial instruments when a banking entity is acting solely as agent, broker or custodian. In addition (but in certain cases subject to conditions) the following trading activities in financial instruments are excluded from the prohibition on proprietary trading:

  • Loans;
  • Certain commodities;
  • Repurchase agreements;
  • Reverse repurchase agreements;
  • Securities lending agreements;
  • Foreign exchange and currency;
  • Trades relating to a banking entity’s role as a derivatives clearing organization or clearing agency;
  • Trades satisfying the banking entity’s delivery obligations, or relating to the failure of a customer to delivery, clear or settle;
  • Satisfying the obligation of the banking entity in regard to a judicial or administrative proceeding;
  • Trades through a deferred compensation, profit-sharing , pension or similar plan by a banking entity as trustee for the employees of the banking entities; and
  • Trades relating to the collection of a debt.

In addition to the above-described exceptions, the Rule creates several important activity exceptions that permit trading in financial instruments otherwise subject to the Rule’s prohibition: (a) underwriting; (b) market-making; (c) risk-mitigating hedging; (d) liquidity management; (e) trading in U.S. Government and foreign sovereign debt; and (e) trading by foreign banking entities.

Significant considerations as to each of these activity exceptions are as follows:

Underwriting. The Rule permits a banking entity’s trading desk to participate in the underwriting of securities, subject to the adoption of policies and procedures relating to reasonable limits and demands of clients and customers, as well as factors such as liquidity, maturity and the depth of the market of the underwritten security.

Market-Making. In a similar manner to the exception for underwriting, the Rule permits a banking entity and its trading desk to make a market in a security, subject to the adoption of policies and procedures addressing, among other things, the near-term needs of clients, customers and counterparties.

Risk-Mitigation Hedging. While the Rule permits risk-mitigation hedging activities, the Rule limits hedging to “specifically identifiable risks including market risk, counterparty or other credit risk,…arising in connection with and related to identifiable positions, contracts or other obligations of the banking entity.” As stated in the supplementary information accompanying the Rule, hedging of an entire portfolio is not contemplated by this exception (as compared to hedging specific risks identified within a portfolio). Further, for personnel charged with hedging, compensation arrangements cannot be designed to reward proprietary trading.

Liquidity Management. The Rule provides an important exception for liquidity management from the prohibition on proprietary trading. Written policies and procedures must be adopted, including the identification of the specific securities to be used for liquidity purposes.

Trading in U.S. Government Obligations and Foreign Sovereign Debt. The Rule provides a broad exception permitting a banking entity to trade in U.S. government securities, GSE-related securities, as well as obligations issued by States and any State political subdivision.

In regard to foreign sovereign obligations, the trading exception is narrower. For a non-U.S. banking entity owned by a U.S. banking entity, trading is permitted in the government obligations of the chartering country of the non-U.S. banking entity. For the U.S. offices of a non-U.S. banking entity (a “foreign banking organization” pursuant to the International Banking Act), trading is permitted in the home-country obligations.

Trading by Foreign Banking Entities. Although the proprietary trading prohibitions of the Rule generally apply to the trading operations of U.S. operations of foreign banks, the Rule exempts foreign trading operations of foreign banks provided the trades take place “solely outside of the U.S.” The Rule clarifies that certain trades may occur on an anonymous basis in the U.S. on an exchange or through an unaffiliated intermediary. However, elements of the trade, including the risk, strategy and oversight must take place outside of the U.S.

  1. Excluded from the definition are the following: (a) a covered fund that is not itself a banking entity; (b) companies controlled by a small business investment company (provided that the company not a banking entity); and (c) the FDIC when acting as a receiver or conservator.
  2. In addition, a trading account includes trading relating to market-risk capital rules for banking entities subject to the market risk capital rules, and all trades if the banking entity is engaged in the business of a dealer, swap dealer or security-based swap dealer.
  3. Although the prohibition on proprietary trading applies to banking entities of all asset size, the related compliance and reporting requirements, discussed below, are imposed based upon the size of the banking entity and are extremely rigorous for those exceeding $50 billion in U.S. assets.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Pillsbury Winthrop Shaw Pittman LLP | Attorney Advertising

Written by:

Pillsbury Winthrop Shaw Pittman LLP

Pillsbury Winthrop Shaw Pittman LLP on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
Privacy Policy (Updated: October 8, 2015):

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.


JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at:

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.