Volcker Rule: New FAQs Regarding Foreign Public Funds and Joint Venture Covered Fund Exclusions

June 15, 2015

Additional guidance issued five weeks before the July 21, 2015 conformance date.

On June 12, the five federal agencies jointly responsible for implementing the Volcker Rule (the Agencies)[1] released two new “Frequently Asked Questions” (FAQs) providing additional guidance on two exclusions from the definition of “covered fund” under the Final Rule[2]: the foreign public fund exclusion and the joint venture exclusion. Although the FAQ that addresses the foreign public fund exclusion will provide some level of helpful clarity to ongoing questions concerning the exclusion’s applicability, the FAQ regarding joint venture activities potentially could create uncertainty about the availability of this exclusion in certain circumstances. As the July 21, 2015 conformance date approaches, additional guidance on other Volcker Rule issues could be released by the Agencies in the form of FAQs.[3]

FAQ 14: “How does the final rule apply to a foreign public fund sponsored by a banking entity?”

Under the Volcker Rule, foreign public funds are excluded from the definition of “covered fund.” The Agencies stated in the Preamble to the Final Rule that the intention of the exclusion is to exclude foreign funds that are similar to US-registered investment companies. However, questions have arisen regarding the scope of applicability of the foreign public funds exclusion. Permissible activities for sponsors (including bank sponsors) of foreign public funds in some foreign jurisdictions (e.g., selecting the majority of directors or trustees of the fund), if performed by a banking entity, could result in the bank sponsor being deemed to control the fund for purposes of the Bank Holding Company Act. This would have the effect, among other things, of causing the fund to be an “affiliate” of the banking entity. In such a case, the fund would become a “banking entity” in its own right that is independently subject to the Volcker Rule’s proprietary trading and covered fund prohibitions.

FAQ 14 states that the Final Rule was intended to recognize that foreign jurisdictions have different frameworks governing the operation and distribution of foreign public funds, and that the Agencies are not requiring that foreign public funds organize themselves identically to US-registered investment companies. To that end, FAQ 14 says that the staff of the Agencies would not advise that activities and investments of a foreign public fund be attributed to the banking entity, provided that

  1. the fund meets the requirements in the definition of “foreign public fund;”[4] and
  2. the banking entity’s relationship with the foreign public fund does not meet the bank regulatory definition of “affiliate” as applied to registered investment companies, SEC-regulated business development companies, and foreign public funds—meaning that the banking entity 
  1. does not own, control, or hold the power to vote 25 percent or more of the voting shares of the fund after the seeding period; and 
  2. provides investment advisory, commodity trading advisory, administrative, and other services to the fund in compliance with applicable regulations, including that the sponsoring banking entity’s relationship with the fund is in compliance with applicable limitations in the foreign public fund’s foreign jurisdiction.[5]

The clarification in FAQ 14 should enable banking entities and foreign public funds sponsored by a banking entity to more easily determine if they can rely on the foreign public fund exclusion without causing the fund to be treated as a banking entity affiliate of the sponsoring banking entity. In this regard, features of foreign fund organization and management that ordinarily might result in banking entity “control” under the Bank Holding Company Act will be disregarded for purposes of determining whether the foreign fund is “affiliated” with a banking entity under the Volcker Rule, with the affiliation analysis instead being dependent primarily on the level of a banking entity’s voting ownership of the foreign fund.  As a matter of best practices, however, the banking entity should document its analysis that the foreign public fund and its activities with respect to the foreign public fund meet the definition of “foreign public fund” in the Volcker Rule, as well as comply with applicable law in the home jurisdiction of the foreign public fund.

FAQ 15: “May an issuer that would be a covered fund rely on the joint venture exclusion from the definition of covered fund?”

In FAQ 15, staff of the Agencies emphasize that the joint venture exclusion cannot be used to evade the general restrictions on a banking entity’s investment in covered funds, and that any joint venture should be engaged predominately in non-investment or non-securities related activities.

The Final Rule excludes from the definition of “covered fund” a joint venture between a banking entity or any of its affiliates and one or more unaffiliated persons, provided that the joint venture

(i) is comprised of no more than 10 unaffiliated co-venturers;

(ii) is in the business of engaging in activities that are permissible for the banking entity or affiliate, other than investing in securities for resale or other disposition; and

(iii) is not, and does not hold itself out as being, an entity or arrangement that raises money from investors primarily for the purpose of investing in securities for resale or other disposition or otherwise trading in securities.[6]

FAQ 15 makes clear that the Agencies’ staffs expect the joint venture exclusion to have limited applicability. In the Agencies’ view, the joint venture exclusion is not intended to include entities that invest in securities for resale or other disposition, or entities or arrangements that raise money from investors primarily for the purpose of investing in securities and sharing the gains or losses on the securities.

More specifically, FAQ 15 clarifies that the joint venture exclusion is not available under the following scenarios:

  • An issuer that raises money from a small number of investors primarily for the purpose of investing in securities, regardless of whether the securities are intended to be traded frequently or held for a longer period of time.
  • An entity that raises money from investors primarily for the purpose of investing in securities for resale or other disposition or otherwise trading in securities, even if one of the purposes for establishing the vehicle is to provide financing to the entity to obtain and hold securities.
  • A vehicle that raises funds from investors primarily for the purpose of sharing in the benefits, income, gains or losses from the ownership of securities, rather than for conducting a business or engaging in operations or other non-investment activities.

In a footnote to FAQ 15, the staff of the Agencies states that they generally expect a participant in a joint venture to have some degree of control over the business of the joint venture entity.

FAQ 15 understandably draws a distinction between joint ventures that are organized to engage in substantive business activities on the one hand, and those that are organized primarily for investment purposes on the other hand. In some respects, however, the FAQ could be problematic for joint venture activities where, among other things, one party takes the lead in managing the joint venture’s business activities. Banking entities seeking to rely on the joint venture exclusion will need to assess the nature and extent of securities and other investment-related activities of the joint venture with a view to determining whether the joint venture is “primarily” (and therefore impermissibly) engaged in securities and investment activities.


If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers

Washington, DC
Melissa R. H. Hall

Roger P. Joseph

[1] The Volcker Rule is jointly interpreted by the Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the Securities and Exchange Commission, and the Commodity Futures Trading Commission.

[2] “Prohibitions and Restrictions on Proprietary Trading and Certain Interests in, and Relationships With, Hedge Funds and Private Equity Funds; Final Rule,” 79 Fed. Reg. 5525 (January 31, 2014); 79 Fed. Reg. 5807 (January 31, 2014) (final rule as issued by the Commodity Futures Trading Commission).

[3] The Agencies have extended the conformance period until July 17, 2016 for covered funds and foreign funds that were in place prior to December 31, 2013. The Agencies have additionally announced that they intend to grant banking entities an additional extension until July 21, 2017.

[4] See, e.g., 12 C.F.R. § 248.10(c)(1).

[5] See, e.g., 12 C.F.R. § 248.12(b)(1).

[6] See, e.g., 12 C.F.R. § 248.10(c)(3).