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The Volcker Rule Proposals on Bank Investments in Private Funds: Expected Impact and Open Questions
18 October 2011
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On October 11th and 12th, U.S. federal regulators proposed rules for public comment (the "Proposed Rules") implementing Section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Volcker Rule”). Among other things, the Volcker Rule generally prohibits U.S. depository institutions and their affiliates and non-U.S. banks with a U.S. presence (“banking entities”) from investing in U.S. and non-U.S. hedge funds or private equity funds (“covered funds”), subject to certain exemptions.
The Proposed Rules would clarify the so-called “customer fund” exemption in the Volcker Rule that permits banking entities to sponsor and make limited investments in covered funds. Of particular importance, the Proposed Rules would allow a banking entity to offer a customer fund to both new and existing customers, without requiring pre-existing relationships between the banking entity and the investors in the customer fund. Furthermore, the Proposed Rules would not restrict customer funds from investing in unaffiliated (third-party) private equity and hedge funds. Thus, under the Proposed Rules, banking entities would be permitted to provide their customers with access to private fund investment opportunities by organizing direct investment funds, feeder funds and funds of funds. The Proposed Rules are silent on whether and how a covered fund organized and offered prior to the Volcker Rule’s effective date could continue in existence as a customer fund.
The Proposed Rules would allow non-U.S. banking organizations with a U.S. banking presence to invest in covered funds, so long as those funds are offered solely to non-U.S. residents. These covered funds offered solely to non-U.S. residents would be permitted (
) to invest inside or outside the United States, (
) to be organized inside or outside of the United States and (
) to be advised by U.S. or non-U.S. investment advisers.
The Proposed Rules do not address whether insurance companies with bank affiliates would be permitted to invest in covered funds through their general account or separate accounts.
For U.S. and non-U.S. private equity and hedge fund managers that are not affiliated with banking entities, the Volcker Rule and the Proposed Rules would restrict the ability of these firms’ funds to access the capital of U.S. banking organizations and non-U.S. banking organizations with a U.S. banking presence. Under the Proposed Rules, however, U.S. and non-U.S. private equity and hedge fund managers would be permitted to raise capital for their funds from (
) banking entity-sponsored customer funds (organized as feeder funds or parallel funds), (
) non-U.S. banks with no U.S. banking presence, (
) non-U.S. banks that have a U.S. banking presence, so long as the funds in which those non-U.S. banks invest are offered only to non-U.S. persons, and (
) bank-sponsored pension plans. Such managers may also be able to raise capital from (
) insurance company general accounts and separate accounts and (
) employees of banking entities.
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