On January 30, the five federal financial agencies (Agencies) responsible for the administration of the Volcker Rule—the federal prohibitions on proprietary trading and private fund (covered funds) investments and sponsorship by banking organizations—released a notice of proposed rulemaking (NPR) that, if adopted, would liberalize the ability of US and foreign banking organizations that are subject to the Volcker Rule (banking entities) to sponsor and invest in various additional types of private funds that previously were subject to the Volcker Rule prohibitions. The NPR also would liberalize and simplify the conditions applicable to various categories of funds already exempt or excluded from the Volcker Rule. The NPR is the second major initiative to ameliorate and reduce the compliance burdens associated with the Volcker Rule prohibitions.

The prior Volcker Rule regulatory regulation changes, published in October 2019, primarily addressed the restrictions and exemptions under the Volcker Rule’s proprietary trading prohibitions. The current NPR, which had been promised by the Agencies for some time, addresses some potentially important aspects of the Volcker Rule’s private funds coverage and its applicability to diverse types of private funds.

The NPR would permit banking entities to invest in or sponsor additional types of investment entities, including venture capital funds, credit funds, family wealth management entities, and funds established at the request of a specific customer (“customer facilitation vehicles”). In addition, the NPR would permanently extend the exemption from the Volcker Rule proprietary trading and covered fund investment restrictions for qualifying foreign excluded funds controlled by a foreign banking entity that are established and operated in connection with the foreign banking entity’s asset management business.

Our first review of the NPR indicates that it will provide meaningful relief for various types of fund investment and sponsorship activities that arguably should not have been subject to the Volcker Rule in the first place. Banking organizations and other interested observers, however, should pay careful attention to the terms and conditions of the proposed exemptions, because they contain important details that would have an impact on their availability and utility to affected banking entities. For instance, the NPR would continue to subject certain of these newly authorized funds to the “Super 23A” prohibitions of the Volcker Rule that prohibit “covered transactions” (as specified in Section 23A of the Federal Reserve Act) between a banking entity and a covered fund. Further, observers should pay close attention to the eligibility criteria for these exemptions, because they may prove problematic in certain cases.

The NPR also proposes an important liberalization of the “Super 23A” prohibitions noted above to allow a banking entity to engage in “covered transactions” with a covered fund that would be exempt from the quantitative limits, collateral requirements, and low-quality asset prohibitions applicable to transactions between state member banks and their affiliates under Section 23A. This would include certain short-term credit transactions, albeit subject to conditions. When the Volcker Rule regulations were adopted in 2013, the Agencies determined not to incorporate the Section 23A exemptions into the Volcker Rule’s Super 23A prohibitions, but it now appears that the Agencies have at least partially reversed course on this prior determination.

Finally, the Agencies are proposing changes to the definition of a covered fund “ownership interest” to clarify that a debt relationship with a covered fund typically would not constitute an ownership interest for purposes of the Volcker Rule. In addition, the NPR would revise the existing regulations such that a banking entity would not be required to treat direct parallel investments alongside a covered fund as an investment in the covered fund for purposes of applicable ownership limits, including under the asset management (organized and offered) exemption.

We are continuing to review the NPR and expect to have further and more detailed observations on it in the near future.