Earlier this week, the Federal Reserve Board and other federal regulatory agencies (the “Agencies”) responsible for implementing the Volcker Rule agreed to seek public comment on proposed changes (the “Proposed Rule”) to the regulations implementing the Volcker Rule, one of the hallmark provisions of the landmark 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act. Consistent with prior rulemaking regarding the Volcker Rule, this proposal to streamline the Volcker Rule is lengthy, running to 373 pages with 342 specific questions posed for comment. The feedback received in response to these comments has the potential to make any revisions to the final rule more far-reaching than the specific changes in the Proposed Rule.

The changes set forth in the Proposed Rule appear to be intended to streamline compliance burdens under the Volcker Rule rather than to bring about significant changes to actual trading and other banking activity. Senior agency officials noted that the proposed changes reflect several years of regulators’ experience implementing the Volcker Rule, as opposed to a political effort by recent appointees under the Trump administration. The following provisions are among the more significant changes in the Proposed Rule:

  • replacing the intent prong of the trading account definition and its 60-day “trading account” presumption with an accounting-based prong and a limited rebuttable presumption that trading desks subject only to the accounting prong that fall within a $25 million profit and loss threshold comply with the Volcker Rule;
  • expanding the market risk capital prong of the trading account definition to encompass foreign banks that are subject to Basel market risk capital requirements under their home country rules;
  • adding a rebuttable presumption of compliance with the current RENTD requirements for the market-making and underwriting exemptions when a banking entity establishes specified internal risk limits, so long as such risk limits are appropriate;
  • eliminating the correlation analysis requirement for using the hedging exemption;
  • liberalizing the so-called TOTUS exemption for proprietary trading outside the United States by foreign banks by eliminating the “funding” restriction, permitting trades to be conducted with or through a U.S. entity, and permitting U.S.-based personnel to be involved in arranging and negotiating (but not executing) transactions;
  • for covered funds that a banking entity does not organize or offer, removing the requirement that the banking entity include in its aggregate fund limit and capital deduction the value of any ownership interests in covered funds acquired or retained under the underwriting or market-making exemptions;
  • dividing banks into three tiers for compliance purposes, and basing compliance obligations on the amount of a banking entity’s trading assets and liabilities, with the most stringent requirements applying only to the 18 banking organizations with over $10 billion in trading assets and liabilities (not counting trading assets and liabilities involving obligations of or guaranteed by the United States or any agency of the United States); and
  • removing the CEO attestation requirement regarding compliance with the Volcker Rule for banks with the lowest trading activity and presuming that such banks are in compliance with the Volcker Rule (based on this rebuttable presumption of compliance, such banks would not be required to establish or maintain a separate Volcker Rule compliance program, unless directed to do so by the appropriate Agency).

The Proposed Rule also refrains from specific proposals regarding certain difficult issues that have arisen under the Volcker Rule and instead requests further comment on those matters. These include the following:

  • the definition of “covered fund” is left unchanged, although comment is requested on various aspects of the definition;
  • the “Super 23A” provisions of the Volcker Rule remain in place, although comment is sought on whether to apply the exemptions of Section 23A of the Federal Reserve Act to the prohibition of Super 23A; and
  • the treatment of foreign private funds as banking entities remains unresolved, although comment is requested and the no-action relief granted in July 2017 will be extended until July 21, 2019.

These and other highlights of the proposed revisions are described in more detail below. Changes to the statutory provisions of the Volcker Rule made by legislation enacted on May 24, 2018, will be implemented through a separate rulemaking, though the Agencies have indicated that they will not enforce the Volcker Rule in a manner inconsistent with the statutory amendments.1 In addition to the Federal Reserve Board, the other Agencies responsible for administering the Volcker Rule are the Federal Deposit Insurance Corporation (the “FDIC”), the Office of the Comptroller of the Currency (the “OCC”), the Securities and Exchange Commission (the “SEC”) and the Commodity Futures Trading Commission. Comments on the Proposed Rule are due within 60 days after publication in the Federal Register.

While certain changes to the Volcker Rule require Congressional action, the proposed revisions appear to offer significant relief to the financial industry, especially with respect to compliance burdens under the Volcker Rule. Moreover, recent legislation also accomplished certain changes that reduce the compliance burdens of the Volcker Rule. As a result, the Volcker Rule of 2019 is likely to look significantly different from the Volcker Rule of 2017. Nevertheless, the changes are not of a type that should result in significant changes to the activities of trading desks at banking organizations, much less the return of true proprietary trading desks at large banking organizations.

Volcker Rule 2.0 in Context

The Volcker Rule applies to banking entities, which is a broadly defined term. It covers not only FDIC-insured banks and thrifts, but also their affiliates, which include companies that control such a bank or thrift. Foreign banks and their affiliates are also covered under the provision that encompasses any company that is treated as a bank holding company for purposes of Section 8 of the International Banking Act of 1978, e.g., foreign banks that operate a branch or agency office in the United States.

From the time they were originally proposed in 2011 and adopted in 2013, the Volcker Rule regulations have been recognized as exceedingly complex, ambiguous, and requiring extensive compliance efforts.2Unsurprisingly, calls for reform have come from various sectors. In October 2017, the U.S. Department of the Treasury issued a report (the “Treasury Report”) in response to an executive order issued by President Trump soon after he took office calling for a study of financial services regulation in the United States. In addition, the OCC solicited public comment on potential reforms to the Volcker Rule regulations in the summer of 2017. Prominent criticisms of the Volcker Rule have focused on its general complexity, the compliance burden imposed on banking entities, especially those with limited trading or covered funds activities, the extent to which exemptions intended to provide relief to foreign banks operating outside the United States (as well as other exemptions) have been unworkable as a practical matter, and inadvertent capture of foreign private funds as banking entities that are subject to the Volcker Rule. The combination of new senior leadership at the regulatory agencies, together with several years of experience in implementing the Volcker Rule, have now resulted in a concrete proposal for regulatory change. The proposed changes to the Volcker Rule regulations are generally in line with the proposals included in the Treasury Report. Absent statutory changes to the Volcker Rule, there are limits on how much the Agencies can change the regulations. For example, Congress recently passed a bill that exempted banks with limited trading activity and less than $10 billion in total consolidated assets from the Volcker Rule, a change that would be beyond the regulatory authority of the Agencies. Nevertheless, the proposed changes appear to offer significant simplification and relief with respect to some aspects of the Volcker Rule, and the Agencies have posed numerous questions for specific comment that indicate more significant changes may be made in the final regulation if public comments in response to these questions provide substantive support for more wide-ranging changes.