2014 Morrison & Foerster LLP All Rights Reserved mofo.com The Volcker Rule: Impact of the Final Rule on Banking Institutions West Legal Webcast January 6, 2014 Presented by Jay G. Baris Oliver I. Ireland Morrison & Foerster LLP
Caveat This outline is for informational purposes only and does not constitute legal advice or create an attorney-client relationship Consult your own attorney for legal advice on the issues discussed in this outline IRS Circular 230 Disclosure To ensure compliance with the requirements imposed by the IRS, we inform you that any tax advice contained in this communication was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or (ii) promoting, marketing, or recommending to another party any matters addressed herein This outline may constitute attorney advertising 2
Late Addition Banking Entities Origin in Dodd-Frank Prohibitions - proprietary trading and sponsoring investment funds Statute broad Rules required 3
Volcker Rule 71-page Rule 882-page preamble Rule Effective April 1, 2014 Conformance period to July 21, 2015 Reporting for $50 billion and up on June 30, 2014 4
Proprietary Trading Financial Instrument Trading Account Exclusions Repos financing Securities lending Trades for liquidity management specific requirements Clearing organization transactions Trades to satisfy delivery obligation or legal obligation Agent, broker, custodian H.R. plans DPC 5
Proprietary Trading Permitted Underwriting related to distribution of securities Market making Risk mitigating hedging Government securities Foreign government securities for FBOs Fiduciary trades or as a riskless principal Insurance company trading for general or separate account 6
Proprietary Trading FBO Solely outside the U.S. or SOTUS Liberalized Offices outside the U.S. Trading decisions made outside the U.S. Booked outside the U.S. Cannot be with or through a U.S. entity Can trade through unaffiliated market intermediaries or with foreign operations of U.S. entity 7
Proprietary Trading Prudential backstops for proprietary trading that is permitted Prohibit material conflict of interest Conflict material if banking interests materially adverse to interest of clients Material exposure of banking entity to a high risk asset or trading strategy Threat to safety and soundness of banking entity for U.S. financial stability Standards unclear 8
Basic six-point program Compliance Programs Written policies and procedures to document, describe and limit proprietary trading Internal controls reasonably designed to prevent prohibited proprietary trading Appropriate management framework Independent testing or audit of the effectiveness of the program Internal or external Training Recordkeeping 9
Compliance Programs Reporting for those with substantial trading assets and liabilities $50 billion trading assets and liabilities June 30, 2014 $25 billion April 1, 2016 $10 billion December 31, 2016 Enhanced standards Reporters $50 billion in consolidated assets Simplified procedures No covered activities $10 billion in assets or less Administratively enforced by appropriate agency 10
Covered Funds General prohibition The Volcker Rule prohibits a banking entity, as principal, directly or indirectly, from acquiring or retaining an ownership interest in, or sponsoring, a covered fund Definition of a banking entity Insured depositary institution BHC or SLHC FBO that operates a branch or agency or commercial lending company in the U.S. Affiliates of the foregoing Exceptions BE affiliate that is a covered fund unless the covered fund falls in one of the three above categories Portfolio company held by a FHC under the merchant banking authority or the FHC s investment authority, or a portfolio company held by an SBIC, as long as it is not a BE under the first three categories above 11
Covered Funds Prohibition does not apply to certain banking entities Acting solely as agent, broker or custodian for the account of a customer Through deferred compensation and similar plans In the ordinary course of collecting a debt previously contracted On behalf of customers as trustee or similar capacity, on behalf of the customer 12
Covered Funds Funds exempt from the definition of an investment company Any issuer that would be an investment company but for the exemptions provided by Section 3(c)(1) or 3(c)(7) of the Investment Company Act of 1940 Commodity pools For which the CPO has claimed an exemption under Rule 4.7 under the CEA, or The CPO is registered in connection with the operation of a pool that limits investors to QEPs Foreign covered funds Covered funds include foreign funds organized abroad and whose interests are sold abroad to non-u.s. residents that are sponsored by a U.S. BE or an affiliate, or in which the BE or affiliate holds ownership interests Foreign covered fund would not include a fund which, if organized in the U.S., would be an investment company but for section 3(c)(1) or 3(c)(7) of the 1940 Act Foreign covered funds do not include foreign funds sponsored by FBOs, or in which FBOs invest, and that are not organized in the U.S. or offered or sold to U.S. residents, including foreign equivalent funds 13
Covered Funds Entities excluded from the definition of covered fund Foreign public funds Wholly-owned subsidiaries Joint ventures Acquisition vehicles Securitization related vehicles Registered investment companies Other excluded entities Foreign pension or retirement funds Insurance company separate accounts Bank-owned life insurance company separate accounts SBICs and certain permissible public welfare and similar funds Entities used by FDIC to dispose of assets as receiver or conservator Federal agencies will evaluate requests for more exclusions 14
Covered Funds Entities not specifically excluded from the definition of covered fund The agencies expressly excluded certain entities from the definition of covered fund. In some cases, these entities may be able to rely on exclusions from the definition of investment company other than section 3(c)(1) and section 3(c)(7) Entities include Financial market utilities Collateral cash pools Pass-through REITs Municipal securities tender option bond transactions Venture capital funds Credit funds Employee securities companies 15
Covered Funds Scope of prohibition The basic prohibition is that banking entities are not permitted to sponsor or acquire an ownership interest in a covered fund, subject to certain exceptions Sponsorship means To serve as a general partner, managing member, trustee or CPO of a covered fund To select or control selection of a majority of directors, trustees or management of a covered fund To share with the covered fund the same name or a variation of the name Ownership interest Means any equity, partnership or other similar interest Other similar interest includes an interest in or security issued by a covered fund that exhibits certain characteristics on a current, future or contingency basis Definition of ownership interest may include interests in a covered fund that might not be considered an ownership interest or an equity interest in other contexts Does not include restricted profit interest 16
Covered Funds Permitted covered fund sponsorship and investments Notwithstanding the prohibition on sponsorship and investment in ownership interests in covered funds, the rule permits investment and sponsorship of the certain covered funds, subject to prescribed limitations and conditions Customer funds A BE may acquire ownership interests in or sponsor a covered fund, including acting as a general partner, managing member, trustee or CPO as a means of offering investment opportunities to customers Covered fund activity must be in connection with BE s trust, fiduciary or investment management services for customers pursuant to a written plan Conditions BE cannot guarantee performance of covered funds BE cannot share same name as covered fund BE directors and employees can take ownership interests BE must disclose certain information 17
Covered Funds Permitted covered fund sponsorship and investments Customer funds Per-fund investment limitation BE s investment in customer fund may not exceed either 3% of the value of the covered fund, or 3% of the number of ownership interests of the covered fund Seeding period BE may exceed the 3% limit during a seeding period of up to one year No quantitative or percentage limitation that BE may hold during seeding period Entities issuing asset-backed securities Permissible underwriting and market making Restrictions do not apply to BE s underwriting and market-making related activities provided they conform to the requirements for permitted activities under the proprietary trading prohibitions Aggregate value may not exceed 3% of Tier 1 capital 18
Covered Funds Super 23A BEs may not enter into with the funds discussed above (customer funds, etc.) transactions that are covered transactions under Section 23A of the FRA No BE that (directly or indirectly) serves as investment manager, investment adviser, CTA or sponsor of a covered fund may engage in any transaction with the covered fund if the transaction would be a covered transaction as defined in Section 23A, as if the BE or its affiliate were a member bank and the covered fund were an affiliate Covered transactions include Loan or extension of credit (including repo) Purchase or investment of securities issued by affiliate Purchase of assets from the affiliate Acceptance of securities as collateral for a loan Issuance of guarantee, acceptance or LOC on behalf of affiliate Transaction with affiliate that involves borrowing or lending securities Derivative transactions 19
Covered Funds Super 23A Volcker Rule imposes an absolute transactional prohibition, subject to explicit exceptions Thus, we call the Volcker Rule s 23A prohibitions Super 23A Exceptions Acquisitions of ownership interests in covered funds that are not proscribed to the extent permitted elsewhere in the rule Bes, subject to certain conditions, may enter into prime brokerage transactions with covered fund that is managed, sponsored or advised by the BE or its affiliates Other permitted covered fund activities Permitted risk-mitigating hedging activities Fund investment and sponsorship by FBOs solely outside the U.S. Permitted fund activities by regulated insurance companies Prudential backstops Above activities not permissible if they result in material conflicts of interest 20