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Volcker Rule Reform: What It Means for Private Funds (Debevoise & Plimpton LLP)
By Satish M. Kini, Partner; David L. Portilla, Partner; and Jennifer T. Barrows, Associate, Debevoise & Plimpton LLP

On July 17, 2018, the Federal Reserve Board, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, the Commodity Futures Trading Commission and the Securities and Exchange Commission published in the Federal Register a proposal that would revise various aspects of the regulations implementing the Volcker Rule.

As relevant for AIC’s members, the proposal seeks public comment on a variety of ways in which the agencies could address issues that touch on how the current implementing regulations affect private funds. In this regard, we believe the proposal (and the rule changes that will likely follow from it) is an opportunity for the agencies to make broad regulatory revisions that would address the undue limits on banking entities’ ability to invest in private funds; in particular, we believe there are good reasons to exclude many long-term investment funds from the scope of the rule. The public comment period on the proposal ends on September 17, 2018.

As background, the current implementing regulations, which were finalized in late 2013, generally prohibit banking entities from engaging in short-term proprietary trading and limit their investments in and activities with respect to “covered funds,” a term that captures many private funds. Historically, the agencies have characterized the covered fund provisions as designed to prevent the use of fund structures to evade the proprietary trading prohibition and to minimize the risks of banking entities bailing out funds. Market participants, however, have emphasized repeatedly to the agencies that the implementing regulations are overbroad and that the “covered fund” definition captures fund structures and relationships that do not further the policy objectives of the Volcker Rule.

For example, the implementing regulations limit banking entities’ investment in, or sponsorship of, fund vehicles that make long-term investments in portfolio companies. This prohibition exists despite the fact that banking entities may invest directly on their balance sheet in portfolio companies under various authorities (including “merchant banking” authority). This is an incongruous result and an example of the over breadth of the covered fund definition. To resolve this incongruity, the agencies could revise the regulations to provide banking entities flexibility to engage in permissible long-term investing whether through a private fund structure or otherwise. For AIC members, such changes could reduce the hurdles banking entities face when investing in third-party funds, thereby expanding the potential pool of capital for fundraising.

The proposal advances few specific modifications to the covered fund provisions. Instead, the proposal asks open-ended questions and, on this basis, it appears that the 2 agencies are relying on the industry to provide feedback on how to revise the implementing regulations both to reduce unnecessary complexity and to implement the underlying statute appropriately. Indeed, the Federal Reserve’s Vice Chairman for Supervision Randal Quarles called the proposal “an important milestone in comprehensive Volcker Rule reform, but not the completion of our work.” We expect many industry participants, including the AIC, to comment on the over breadth of the covered fund definition and to present their views on how the agencies should refocus the Volcker Rule’s implementing regulations. Reducing the Volcker Rule’s unnecessary reach to many private funds certainly will be an important issue as the agencies seek to complete this work.