The Board of Governors of the Federal Reserve System (the Board) recently issued an order granting the second of three statutorily permitted one-year extensions for compliance by banking entities with the requirements of the covered funds provisions (but not the proprietary trading restrictions) of the Volcker Rule. The first such extension—until July 21, 2015—was granted simultaneously with joint issuance of the rule (also known as the Final Rule) in December 2013 by the Board and four other agencies: the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the Securities and Exchange Commission, and the Commodity Futures Trading Commission.
The order came in response to comments received from myriad industry sources (including private funds that are sponsored by non-banking entities but that have foreign bank investors) seeking additional time for compliance and, where necessary, the orderly sale of covered fund investments that must be divested. Such divestitures include those that are required, by statute, to be made by employees, officers, and directors of banking entities. The Board concluded that this latest extension will enhance the safety and soundness of the banking industry by precluding losses that could be occasioned by mandatory divestitures at potentially “fire-sale” prices.
Though issued solely by the Board, the order is binding on all the agencies. This is because Section 13 of the Bank Holding Company Act authorizes only the Board to extend the original two-year conformance period, one year at a time, for a maximum of three years, so long as the Board determines that such an extension is consistent with the purposes of Section 13 and would not be detrimental to the public interest. The Board may also grant up to a five-year extension for illiquid funds but has not yet done so.
The current extension until July 21, 2016, is for conforming investments in and relationships with covered funds and foreign funds that may be subject to the Volcker Rule and applies only to funds that were in place prior to December 31, 2013 (“legacy covered funds”). The extension affects not only banking entities’ investments in legacy covered funds (including illiquid funds) but also sponsorship, advisory activities, management, and having “certain relationships.” In addition, the order increases the time until a banking entity must deduct its investments in legacy covered funds from Tier 1 capital, conform to the Final Rule’s per-fund and aggregate investment limitations, and ensure compliance related to employee, officer, and director investments.
The order expressly excludes from its coverage any investments in or relationships with a covered fund made after December 31, 2013. Assuming that the order’s scope is not expanded, any trading, market-making transactions, or other transactions involving legacy covered funds after that date must still be brought into compliance by the July 21, 2015, cut-off. Further, the Board took the opportunity in the order to reiterate the expectation expressed by all the agencies in the Final Rule that banking entities make good faith efforts “well in advance” of the end of the compliance period (now as extended by the order) to conform their covered fund activities and investments to all applicable requirements. It would not be at all surprising if the agencies were to request evidence of such good faith efforts at some point during 2015.
Given the Volcker Rule’s complexity, there are some gray areas. As noted, the order’s coverage includes “certain relationships.” This language is broad enough to include “covered transactions” within the meaning of Section 23A of the Federal Reserve Act, and suggests that, at least for covered transactions entered into prior to December 31, 2013, the extension applies. Many covered transactions involve extensions of credit or credit support (e.g., a letter of credit).
An open question is what happens to such a transaction if it is renewed or subject to novation after December 31, 2013. Similarly, one wonders whether the extension applies to items that are supposed to have (but in fact have not) come into compliance, such as seeding of a registered investment company where the banking entity has held more than 25 percent of the voting securities for longer than the permitted seeding period.
Finally, the order explicates the Board’s intention, this time next year, to grant the third and final permissible one-year extension for the same legacy covered funds investments and relationships until January 21, 2017.
