Ever since the final Volcker Rule regulations were made public in December 2013, foreign banks and their regulators have expressed concern about the extraterritorial reach of the Volcker Rule to certain foreign funds that have a foreign bank as sponsor or investor. This policy issue has, as is often the case in banking law, played out through the technical definitions that provide which funds (and the portfolio companies in which those funds invest) are captured by the Volcker Rule and which are not. After almost three and a half years of discussions with foreign banks and their home country regulators, the Federal Reserve, OCC, and FDIC have signaled that they, as well as the SEC and CFTC, are still unable to reach agreement on the issue. Today’s joint statement makes clear that the agencies will not take action for a one-year period, until July 21, 2018. The one-year delay provides relief by protecting a foreign banking entity from being viewed as violating the Volcker Rule due to the activities or investments of a “qualifying foreign excluded fund” that is “controlled” by that foreign banking entity. This relief is available so long as the foreign banking entity’s investment in and sponsorship of the qualifying foreign excluded fund would meet the requirements of the SOTUS exemption as if the qualifying foreign excluded fund were a covered fund. The statement defines “qualifying foreign excluded fund” to include a fund that:
- is organized, offered and sold outside of the United States;
- would be a covered fund if it were organized or established in the United States or owned or sponsored by a U.S. banking entity;
- would not otherwise be a banking entity except by virtue of a foreign banking entity’s acquisition or retention of an ownership in, or sponsorship of, the fund;
- is established and operated as part of a bona fide asset management business; and
- is not operated in a manner that enables a foreign banking entity to evade the requirements of the Volcker Rule.
The statement also explains that staffs of all the agencies charged with implementing the Volcker Rule, including the SEC and CFTC, consulted on the statement and are considering ways in which the Volcker Rule may be amended, or other appropriate action taken, to address any unintended consequences of the Volcker Rule for certain non-U.S. non-covered funds in non-U.S. jurisdictions. The statement suggests that Congressional action may be necessary to fully address the issue.
The agency staffs previously recognized that foreign non-covered funds should not be treated as banking entities when they issued FAQ 14 in June 2015. That FAQ provided that foreign public funds would not be treated as banking entities, nor would the activities or investments of these foreign public funds be attributed to a controlling banking entity, so long as the banking entity does not, after any applicable seeding period, own, control, or hold with the power to vote 25 percent or more of the voting shares of the foreign public fund. Today’s statement is both broader and narrower than FAQ 14. It is broader because today’s statement provides relief from banking entity status for a fund due to both corporate governance and ownership of 25% or more of the voting shares of a fund. It is, however, narrower for a number of reasons, including most importantly because the statement is not a permanent fix to the status of qualifying foreign excluded funds as banking entities.
Today’s statement is directionally consistent with the recommendation in June’s U.S. Treasury report that foreign funds owned or controlled by a banking entity be excluded from the definition of banking entity. It is welcome because it is a recognition by the federal banking agencies and the staff of all of the Volcker Rule agencies that treating controlled foreign excluded funds as banking entities is in tension with other parts of the statute where Congress limited the extent to which the Volcker Rule applies to foreign banks and their foreign funds. It has long been clear that some type of fix is needed so that these foreign funds are not subject to the Volcker Rule and today marks the first official recognition of the problem. Unfortunately, the statement is not a permanent fix, does not address questions that may exist around non-U.S. securitizations and other fund-like structures, and does not actually exempt a qualifying foreign excluded fund from being treated as a banking entity. Today’s temporary solution leaves foreign banking entities, and other interested parties such as investors in qualifying foreign excluded funds for which a foreign banking entity serves as general partner or otherwise has control for purposes of the Bank Holding Company Act, without certainty as to whether and how the Volcker Rule might apply to these foreign funds.
While helpful in some ways, the statement will be seen by some as not going far enough to address the fundamental issue, as highlighted in the U.S. Treasury report, of the unreasonable and unnecessary extraterritorial limitations placed on foreign banks and foreign funds by the Volcker Rule. The agencies have given themselves another year to solve it after three and half years of reflection on the problem. We are hopeful as always that they will use this additional year wisely.