Yesterday, the Federal Deposit Insurance Corporation and Comptroller of the Currency
approved revisions to the regulations implementing section 13 of the Bank Holding
Company Act, referred to as the “Volcker Rule.” The final rule—sometimes called
Volcker Rule 2.0—deals mostly with proprietary trading, compliance and metrics issues
and adopts as proposed covered funds changes for which the agencies had proposed rule
text. In general, the final rule reflects the agencies’ intent to resolve ambiguity,
overbroad application, and unduly complex and inefficient requirements. The agencies
anticipate a second round of proposed revisions to deal with a broader set of covered
funds issues. Below are our preliminary takeaways on key matters in the final rule.
We anticipate providing a comprehensive summary of the final rule in the future. A
redline showing changes to the regulatory text is available here.
Trading account and trading desk.
MRCR and short-term intent prongs. The accounting prong was not adopted. The
final rule retains the short-term intent prong but provides that banking entities
subject to the market risk capital rule (“MRCR”) prong are not also subject to the
short-term intent prong. Banking entities that are not subject to the MRCR may
elect to apply this prong instead of the short-term intent prong. The agencies
declined to modify the MRCR prong to incorporate foreign market risk capital
60-day rebuttable presumption. The final rule reverses the 60-day rebuttable
presumption such that financial instruments held for 60 days or longer are
presumed not to be within the short-term intent prong, as long as the banking
entity does not transfer substantially all of the risk of the financial instrument
within 60 days of the purchase or sale.
Dealer prong. The final rule retains the 2013 final rule’s dealer prong without any
substantive changes, and the agencies reaffirmed how to interpret it.
Trading desk. A new multi-factor definition that incorporates aspects of the
approach in the Basel Committee’s fundamental review of the trading book was
added; banking entities subject to the MRCR may rely on the definition that they
use for MRCR purposes.
Liquidity risk management exclusion. The exclusion is expanded to cover the
purchase or sale of foreign exchange forwards, foreign exchange swaps, and crosscurrency swaps (including non-deliverable cross-currency swaps) entered into by
a banking entity for the purpose of liquidity management in accordance with a
documented liquidity management plan.
Error trades. An exclusion is added for error trades and correcting transactions;
unlike the proposal, there is no requirement to use a separately managed error
Matched derivatives transactions. Customer-driven swaps and security-based
swaps and contemporaneous matching trades are excluded if: (i) the banking
entity retains no more than minimal price risk; and (ii) the banking entity is not a
Hedges of mortgage servicing rights. Purchases and sales of financial instruments to
hedge mortgage servicing rights or mortgage servicing assets in accordance with
a documented hedging strategy are excluded.
Non-trading assets or liabilities. Any purchase or sale of a financial instrument that
does not meet the definition of “trading asset” or “trading liability” under the
applicable reporting form as of January 1, 2020 is excluded.
Underwriting and market making-related activities. There is a new compliance
presumption for trading within risk limits set by the banking entity. Breaches and
limit increases do not require reporting; instead banking entities are required to
maintain records that need to be available to regulators on request.
Risk-mitigating hedging. The requirements for correlation analysis and that a
banking entity show a hedge “demonstrably reduces” risk were removed. For
banking entities with significant trading assets and liabilities (see below),
commonly used hedges would not be subject to documentation requirements that
otherwise apply to cross-desk hedges and aggregated hedges.
Trading outside of the United States (“TOTUS”). The TOTUS exemption was
revised. U.S. personnel would be permitted to help arrange and negotiate
transactions, and trading would be permitted with U.S. counterparties. There
would be no prohibition on financing from U.S. offices or affiliates. The decision
to trade and principal risks and actions of transactions would need to be located
outside of the United States.
Underwriting and market-making. Banking entities no longer have to include the value of
ownership interests of third-party covered funds held as underwriting or market
making positions for purposes of the aggregate covered fund ownership limit and
capital deduction. A third-party covered fund is one that the banking entity does not
sponsor, advise, or organize and offer. The agencies continue to consider whether this
approach should be extended to other covered funds, such as advised funds, and intend
to address this issue in the round two covered fund proposal.
Risk-mitigating hedging exemption. Banking entities would be permitted to hold covered
fund interests to hedge fund-linked products. The agencies state that they do not believe
that this type of hedging activity “necessarily” constitutes a high-risk trading strategy
that could threaten the safety and soundness of the banking entity.
Solely outside the United States (“SOTUS”) fund exemption. The final rule adopts the
proposal to remove the financing prong from the SOTUS fund exemption and adds to
the rule text language reflecting the marketing restriction guidance in FAQ No. 13.
Registered fund and foreign excluded fund banking entity status. The final rule does not
amend the definition of banking entity. The agencies also state that they are not
modifying or revoking any previously issued staff FAQs or guidance related to the
banking entity status and seeding of registered investment companies, foreign public
funds, and foreign excluded funds. The agencies do not revise the statement emphasized
in the proposal that FAQ No. 16 does not set “any maximum prescribed period for a RIC
or FPF seeding period.”
Super 23A prime brokerage exemption. FAQ No. 18’s guidance that a banking entity must
provide the annual CEO certification required under the prime brokerage exemption by
March 31 of each year is codified.
COMPLIANCE DATE AND PROGRAM REQUIREMENTS
Compliance date. The final rule’s effective date is January 1, 2020 and mandatory
compliance date is January 1, 2021; voluntary early compliance is permitted.
Compliance tailored by size. The final rule, like the proposal, establishes three tiers of
banking entities, based on dollar amount of trading assets and liabilities (excluding
financial instruments that are obligations of or guaranteed by the United States, its
agencies, or a government-sponsored enterprise) and each subject to differing
compliance obligations. The final rule raises the threshold for “significant” trading
assets and liabilities from $10 billion to $20 billion. Trading assets and liabilities are
measured on a worldwide consolidated basis for U.S. banking entities and using
combined U.S. operations for foreign banking organizations.
Significant trading assets and liabilities: ≥ $20 billion. Subject to the most stringent
compliance requirements, including CEO attestation.
Moderate trading assets and liabilities: Not in the other two categories. Less
stringent compliance requirements; no CEO attestation.
Limited trading assets and liabilities: < $1 billion. Benefit from a rebuttable presumption of compliance; no CEO attestation.
Quantitative metrics. The final rule makes a number of changes to the reporting and
recordkeeping requirements applicable to banking entities with significant trading
assets and liabilities.
Metrics. The final rule: (1) largely retains the metrics for “Risk and Positions
Limits and Usage” (renamed the “Internal Limits and Usage”); “Value-at-Risk”;
and “Comprehensive Profit and Loss Attribution”; (2) replaces the “Inventory
Turnover” and “Customer-Facing Trade Ratio” metrics with “Positions” and
“Transaction Volumes” metrics, respectively, which only would be applicable to
trading desks that rely on the underwriting or market making-related activities
exemptions; and (3) eliminates the “Risk Factor Sensitivities” and “Inventory
Aging” metrics, as well as the requirement to report “Stressed Value-at-Risk.”
Information schedules. The final rule also introduces an “Internal Limits
Information Schedule” and a “Risk Factor Attribution Information Schedule” that
provide identifying and description information relevant to the “Internal Limits
and Usage” and “Comprehensive Profit and Loss Attribution” metrics,
Descriptive information and narrative statements. The final rule introduces a
requirement to provide descriptive information for each trading desk engaged in
covered trading activity; banking entities have the option to provide narrative
statements to supplement their submissions. This requirement is streamlined
compared to the proposal.
Timing. The final rule reduces the frequency of required metrics reports from
monthly to quarterly, to be submitted within 30 calendar days of quarter-end.