Volcker Rule: Conformance Period Extended for Certain Legacy Covered Funds
On December 18, 2014, the Board of Governors of the Federal Reserve System (the Board) issued an order (the Extension Order)1 that extends the conformance period until July 21, 2016 under the Volcker Rule2 for purposes of permitting banking entities additional time to conform investments in, and relationships with, “covered funds” and certain foreign funds (legacy covered funds). The Board indicated in the Extension Order that it also intends, for these purposes, to grant an additional one-year extension of the conformance period until July 21, 2017 (which would be the latest possible extension).3 These actions supplement the Board’s more general extension of the conformance period last year, which the Board granted when the final rule implementing the Volcker Rule was adopted (the Final Rule);4 that extension is set to end on July 21, 2015.5 Earlier this year, the Board had stated its intention to provide conformance period relief with respect to certain collateralized loan obligations (CLOs).
Time Limitation. The Extension Order applies to banking entities only with respect to investments in, and relationships with, legacy covered funds that were in place prior to December 31, 2013.6
- The Extension Order did not provide significant guidance regarding either the meaning of “relationships” or the related activities after the December 2013 cutoff date that will be covered by the Extension Order. However, in the context of discussing relationships generally, the Extension Order cited not only the prohibition on banking entities’ sharing their names with sponsored covered funds but also the Volcker Rule’s so-called Super 23A prohibitions. This suggests that the requisite relationship exists where Super 23A prohibitions would be triggered–i.e., serving, directly or indirectly, as investment manager, investment adviser, commodity trading advisor or sponsor of a covered fund. Because the Extension Order focuses on the existence of relationships at year end, and not the completion of particular related transactions, the Extension Order suggests that “covered transactions” subject to Super 23A that are executed post-2013 will benefit from the Extension Order’s relief if they arise out of a qualifying pre-existing relationship.
- For covered fund investments not in place prior to December 31, 2013, conformance will be required by July 21, 2015. Thus, for example, covered fund investments acquired as a result of ongoing secondary market trading will not benefit from the Extension Order. This may be of particular concern for banking entities holding debt securities of, or other interests in, CLOs or other securitization vehicles that are covered funds if such securities or interests qualify as “ownership interests” under the Final Rule.
Certain Foreign Funds. The Extension Order provides conformance period relief to banking entities with respect not only to covered funds in general (as defined under the Final Rule) but also to a second category of legacy covered funds, which the order describes as “foreign funds that may be subject to the provisions of [the Volcker Rule].”
- The Extension Order did not elaborate on the second category. The category would seem to be designed for foreign funds that are not covered funds (given the Extension Order’s separate express inclusion of covered funds). In light of recent industry comments concerning foreign funds that are not covered funds but may be considered banking entities themselves (and thus subject directly to the Volcker Rule),7 the Extension Order likely was intended to cover such foreign funds and to provide additional time for banking entities to address issues that may arise in relation to them.
Employee Investments in Covered Funds. The investment relief under the Extension Order extends to legacy covered fund investments made by banking entity employees, officers and directors, provided the investments were in place prior to December 31, 2013.
Relation to Potential Relief for CLOs and for Illiquid Investments. The Extension Order is akin to the Board’s announced approach to CLOs that fall within the definition of covered fund and are predominantly backed by commercial loans.8 Both the Board’s approach to CLOs and its Extension Order demonstrate the Board’s concern with the potential adverse consequences of conforming or divesting ownership interests in legacy covered funds.
- Although the Extension Order does not so state, its breadth–covering banking entity investments in, and relationships with, covered funds made prior to the cutoff date–indicates that separate CLO relief will not be forthcoming, at least not to the extent previously announced. It is not known if further relief for CLOs is forthcoming.
The Extension Order states that the Board will consider whether to take additional action regarding “illiquid funds,” for which the Volcker Rule provides the possibility of transition periods in addition to any general conformance period.9
Actions Expected During the Extended Conformance Period. The Extension Order reiterates previous Board statements that banking entities are expected, during the conformance period, to engage in “good-faith efforts” to conform activities and investments to the Final Rule no later than the end of the conformance period. The Extension Order emphasizes that banking entities are expected to make plans “well in advance of the end of the extended conformance period” regarding how they will conform or divest legacy covered fund investments.
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1 See Federal Reserve, Order Approving Extension of Conformance Period Under Section 13 of the Bank Holding Company Act (December 18, 2014), available at: http://www.federalreserve.gov/newsevents/press/bcreg/bcreg20141218a1.pdf.
2 The Volcker Rule refers to Section 13 of the Bank Holding Company Act of 1956, which was added by Section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.
3 That additional extension, if granted, will need to be formalized by the Board pursuant to an order issued before July 21, 2016. The Volcker Rule included an original conformance period ending July 21, 2014, and it authorized the Board to extend the conformance period, one year at a time, for up to three years (until July 21, 2017).
4 For detailed information regarding the Final Rule, see our earlier Sidley Update, Volcker: The Final Rule (December 20, 2013).
5 Proprietary trading activities are not covered by the Extension Order. The conformance period for such activities will expire as anticipated on July 21, 2015.
6 Although the Extension Order uses the phrase “prior to December 31, 2013,” the Board’s press release refers to “investments and relationships in a covered fund made after December 31, 2013” as those that will be required to conform to the Volcker Rule by July 21, 2015.
7 See, e.g., SIFMA Comment Letter, dated October 20, 2014, available at: http://www.sifma.org/issues/item.aspx?id=8589951710.
8 In April 2014, the Board issued a statement indicating that it intended to grant two additional one-year extensions of the conformance period for banking entities with respect to their ownership interests in, and sponsorship of, certain CLOs that were in place as of December 31, 2013. See Federal Reserve, Statement Regarding the Treatment of Collateralized Loan Obligations Under Section 13 of the Bank Holding Company Act (April 7, 2014), available at: http://www.federalreserve.gov/newsevents/press/bcreg/bcreg20140407a1.pdf.
9 The Federal Reserve adopted a final rule in 2011 regarding, inter alia, extended transition periods for investments in illiquid funds. See Federal Reserve, Final Rule, Conformance Period for Entities Engaged in Prohibited Proprietary Trading or Private Equity Fund or Hedge Fund Activities, 76 FR 8265 (February 14, 2011), available at: http://www.gpo.gov/fdsys/pkg/FR-2011-02-14/pdf/2011-3199.pdf; see also Federal Reserve, Statement of Policy Regarding the Conformance Period for Entities Engaged in Prohibited Proprietary Trading or Private Equity Fund or Hedge Fund Activities, 77 FR 33949 (June 8, 2012), available at: http://www.gpo.gov/fdsys/pkg/FR-2012-06-08/pdf/2012-13937.pdf.
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