It’s here. The Federal Reserve Board and the Federal Deposit Insurance Corporation have released a proposed rule (Proposed Rule) that would make important modifications to Section 13 of the Bank Holding Company Act, commonly known as “the Volcker Rule.” The Proposed Rule is intended to address the “complexity” of the Volcker Rule, which has created “compliance uncertainty” and, in the words of Fed Chairman Jerome Powell, to “allow firms to conduct appropriate activities without undue burden and without sacrificing safety and soundness.”

The remaining three agencies responsible for implementation of the Volcker Rule (Office of the Comptroller of Currency, the US Securities and Exchange Commission, and the Commodity Futures Trading Commission) are expected to release their proposals shortly. Other than agency-specific variations, the proposal released by each of the five agencies is expected to be the same. The comment period for the Proposed Rule will be 60 days from the date of publication of the proposal in the Federal Register.

Most of the specific proposed changes in the regulations address the proprietary trading prohibitions and limitations of the Volcker Rule, although the agencies pose 342 questions for commenters, many of which ask for comments about recommendations of changes to the covered fund prohibitions.

Among other changes, the Proposed Rule would

  • establish three categories of banking entities based on their level of trading activity: banking entities with $10 billion or more in trading assets and liabilities, banking entities with more than $1 billion but less than $10 billion of trading assets and liabilities, and banking entities with less than $1 billion of worldwide consolidated trading assets and liabilities;
  • remove the trading account definition, to which the basic Volcker Rule proprietary trading prohibition applies, that defines a trading account as one that that is used for the purpose of short-term gain or similar purpose, and replace that definition with a new definition that a trading desk that buys or sells a financial instrument that is regularly recorded at fair value under applicable accounting standards is doing so for a “trading account”;
  • remove the presumption that an account that is used by a banking entity for short-term trading (60 days under the current definition) is a “trading account” under the Volcker Rule;
  • for entities with less than $10 billion in trading assets and liabilities, reduce the restrictions on trading activity of that entity qualify as permitted risk-mitigating hedging activity;
  • clarify the scope of the underwriting and market-making exemptions and simplify the financial metrics used to measure such activities, including adding a presumption of compliance with the “reasonably expected near-term demands of clients” (RENTD) requirement if the banking entity establishes internal risk limits that ensure the trading desk does not exceed such limits;
  • relax the current conditions for a banking entity’s reliance on the risk mitigation hedging exemption by removing the requirement for a strict correlation of permissible hedging positions with the underlying traded positions being hedged;
  • modify the “solely outside the United States” exemptions for trading activities of a foreign banking entity and acquisition of an ownership interest or sponsorship of a covered fund by a foreign banking entity, including incorporating one of the Volcker Rule FAQs that concluded that an ownership interest in a covered fund will not be considered offered for sale or sold to a US resident if it is not sold and has not been sold pursuant to an offering that targets US residents;
  • extend the current no-action period until July 21, 2019, for foreign excluded funds, registered investment companies, and foreign public funds to be considered “banking entities” consistent with a July 21, 2017, policy statement while the agencies seek and consider comments on whether and to what extent such entities should be considered banking entities under the Volcker Rule; and
  • tailor the compliance program requirements based on level of trading activity by the banking entity.

The proposal also incorporates presumptions of compliance for banking entities that engage in limited proprietary trading activities:

  • Banking entities with less than $1 billion of worldwide consolidated trading assets and liabilities would be subject to a presumption of compliance with both the proprietary trading and the covered fund prohibitions of the Volcker Rule, subject to rebuttal by their supervisory agency
  • If the absolute value of the daily net gain and loss of the trading desk for the preceding 90-calendar-day period does not exceed $25 million, the activities of the trading desk will be presumed to have been conducted in compliance with the Volcker Rule’s proprietary trading restrictions

The Proposed Rule does not implement the changes to the Volcker Rule contained in the newly-enacted Dodd-Frank Act reform legislation (Economic Growth, Regulatory Relief, and Consumer Protection Act), which, according to the Proposed Rule, will be implemented through separate rulemaking.

Takeaways

Taking into account the pre-publication reports and speculation on what changes the agencies might make to the Volcker Rule regulations, the proposed changes to the Volcker Rule do not contain any real surprises and seek to address a number of industry concerns regarding compliance difficulties due to lack of clarity, unintended consequences, and lack of individual tailoring of the requirements. The 21 interpretive FAQs released by the agencies since the implementation of the Volcker Rule are a clear indication that the Volcker Rule regulations as adopted need updating and revisions.

The Proposed Rule is, not surprisingly, already being met with criticism from some quarters as a “bailout” of banks and a “rolling back” of regulations to pre-2008 financial crisis levels. In our view, these criticisms are inaccurate. The Proposed Rule does not eliminate or change the basic prohibitions and requirements of the Volcker Rule. Any changes to the statutory Volcker Rule itself would require congressional action, as the agencies plainly recognize. Further, particularly for the banking entities with significant trading desks, the Proposed Rule does not materially loosen the restrictions or prohibitions of the Volcker Rule. Also, we note that the risk-based approach of the Proposed Rule, including establishing tiers with increasing regulatory requirements in each tier, is consistent with the supervisory approach of the agencies over the past few years, particularly the banking agencies.

We are in the process of reviewing the Proposed Rule in greater depth and will provide further analysis and updates. We will also monitor the progress of the Proposed Rule and the comment period.