Fund managers that are affiliated with U.S. banks, or that have historically courted U.S. banks  (or their affiliates) as investors in their funds, are by now very familiar with the restrictions imposed by the “Volcker Rule” since its adoption in December 2013.  A massive regulatory undertaking, the rule was adopted by five of the U.S. financial regulators (namely, the Federal Reserve, the FDIC, the Office of the Comptroller of the Currency, the SEC, and the CFTC) acting in concert, and resulted in sweeping changes to how U.S. banks and their affiliates make proprietary investments and how they interact with so-called “covered funds.”  From the perspective of a ’40 Act practitioner, it was clear at the time, and has remained so ever since, that the group of august regulators did not, collectively, grasp some of the implications of the way the final regulation approached some issues involving covered funds–including the very way that term was defined.

After several years of Congressional logjam and the regulators addressing some of the more vexing issues in the Volcker Rule through FAQs, we now suddenly find ourselves moving forward with changes to the Volcker Rule on multiple fronts.  Unfortunately–at least from this practitioner’s perspective as an investment management lawyer–most of the changes we’ve seen so far are targeted at the proprietary trading side of the rule, rather than the covered fund side.  That said, there are still a few things on the covered fund side worth mentioning, especially for industry participants interested in making their voice heard by the regulators.

The Economic Growth, Regulatory Relief, and Consumer Protection Act

The wide-ranging, relatively bi-partisan regulatory relief bill sponsored by Senator Mike Crapo (R-ID) was passed in late May and among a host of other provisions (check out Mayer Brown’s full report, or a deeper drive into changes related to capital markets, if you’re so inclined) was one change to the Volcker Rule that will certainly be welcomed by many bank-affiliated private fund sponsors.  Originally, the Volcker Rule prohibited funds being offered pursuant to the so-called “asset management exemption” from sharing a name (or a variation of a name) with a bank subject to the Volcker Rule, or any of its affiliates (including the fund’s manager, or even the fund’s general partner).  The new bill relaxes this requirement to permit the fund to share a name with its investment adviser as long as the investment adviser (i) is not an insured depository institution (or a parent of an insured depository institution, or certain foreign banking organizations), (ii) does not share a name with an insured depository institution (or parent or foreign banking organization), and (iii) does not have the word “bank” in its name.

Rule Proposal

Not long after the passage of the regulatory relief bill, the five regulators released a proposal to revise many aspects of the Volcker Rule.  As noted above, the vast majority of the proposed changes would apply to the proprietary trading aspects of the Volcker Rule, which are outside the scope of this post (but please check out Mayer Brown’s full report for more information, if you’re interested).  In contrast, with respect to covered funds, the agencies mostly asked questions–a lot of questions–rather than make firm proposals.  A few items that they did include in the proposal were to incorporate prior agency guidance on the “solely outside the United States” exemption and to make some tweaks to the underwriting and market-making exemptions for ownership of covered funds.  As for the subjects on which the agencies sought industry views, those included, among others:

  • Reviewing the scope of the “covered fund” definition, including:
    • Whether to switch from a definition based on exclusions under the Investment Company Act of 1940 to one based on the characteristics of the funds,
    • Whether some of the exclusions from the definition of covered fund need to be revised), and
    • Whether to add new exclusions to address other types of fund vehicles, such as family wealth management vehicles, certain small business investment companies, and municipal tender option bond vehicles.
  • The treatment of foreign excluded funds (that is, non-US funds that do not fall within the definition of “covered fund,” and may then inadvertently be treated as affiliates of banks and thus subject to the Volcker Rule’s prohibitions on proprietary trading).
  • The potential to incorporate certain exemptions into the Volcker Rule’s “Super 23A” prohibition on certain transactions between a covered bank affiliate and a covered fund.

For those interested, the comment period will run for 60 days after the proposal is published in the Federal Register.  And, despite being released by the last of the five regulators on June 5, that still hasn’t happened yet as of the time I clicked “publish” on this post.