Guidelines on covered fund seeding extensions from the Federal Reserve yesterday, following on the heels of last Friday’s guidance for foreign excluded funds, is a hopeful sign that the freeze on Volcker Rule guidance is finally thawing. Perhaps these green shoots signal that broader, common sense relief is coming. Yesterday’s guidelines provide important procedural and timing relief for applications to extend covered fund seeding periods by specifying required content for these applications and delegating approval authority for most applications to the Federal Reserve Banks.
As background, the Volcker Rule permits a banking entity that organizes and offers a covered fund to acquire and retain an ownership interest in that fund for the purpose of (i) establishing the fund and providing it with sufficient equity for investment to permit the fund to attract unaffiliated investors (that is, seeding a covered fund), or (ii) making a de minimis investment. The Volcker Rule provides a default one-year seeding period that permits a banking entity involved in establishing a covered fund to have over 3 percent of the ownership interests in that fund. Market realities are such that banking entities often require additional time to reduce their ownership interests to the 3 percent level. The Volcker Rule also permits the Federal Reserve, upon an application by a banking entity, to provide up to an additional two years for a banking entity to conform seeding investments in covered funds to the requirements of the Volcker Rule. Requirements for requesting an extended seeding period for these investments were set out in the December 2013 final regulations implementing the Volcker Rule.
Yesterday the Federal Reserve issued guidelines regarding the content of and process for submitting seeding period extension applications for a covered fund under the Volcker Rule. The Federal Reserve explained that authority to approve, but not to deny, extension requests has been delegated to the Federal Reserve Banks, in consultation with staff of the Federal Reserve Board, so long as certain criteria are satisfied. Those criteria include:
- No significant issues have been identified regarding the banking entity’s compliance program under the Volcker Rule;
- The banking entity has represented that all of the requirements under the Asset Management Exemption have been met, including the restrictions related to aggregate investments in covered funds and associated capital deduction for covered fund investments;
- The banking entity provides a plan for reducing the permitted investment through redemption, sale, dilution, or other methods by the end of the extension period; and
- The primary agency charged with enforcing the Volcker Rule with respect to the banking entity does not object to the extension.
Yesterday’s guidelines provide important potential administrative and procedural benefits to both the Federal Reserve in considering and processing seeding extension applications and banking entities in seeking those extensions. Yesterday’s guidelines, including the delegation of authority to approve requests to the Federal Reserve Banks, is similar in spirit to the December 2016 guidance provided by the Federal Reserve regarding banking entities seeking an extended transition period for their interests in illiquid funds. That guidance regarding illiquid funds, and how extension applications would be processed, was viewed by many as an important step towards a more efficient and predictable process for such applications under the Volcker Rule. But in practice the process was, in some cases, not as predictable or efficient as hoped. It is therefore important that the process outlined in yesterday’s guidelines be implemented carefully so that these administrative and procedural benefits are realized. We will be watching intently for signs of how the Federal Reserve and other Volcker Rule agencies implement the process outlined in yesterday’s guidelines, as well as, hopefully, for new green shoots of Volcker Rule relief.