The Volcker rule is coming. European and North
American bank counsel speak anonymously – and candidly
– about how they plan to comply with its covered fund
European and Canadian mutual funds are facing
an unlikely enemy. Five US regulators charged with reining in
banks' reckless proprietary trading have, unwittingly, devised
a framework that threatens to bring some foreign fund
industries to their knees.
While the extraterritorial reach of US laws is not new, this
drastic outcome under the Volcker Rule – which takes
effect next month – has not received the air time it
deserves. Yet it's a pressing matter, and one of the most
striking findings from IFLR's Bankers' Counsel Poll on European
and North American banks' compliance with the rule's covered
Respondents are from financial institutions that are the
target of lawmakers who, as part of the Dodd-Frank Act, agreed:
'A banking entity shall not engage in proprietary trading, or
acquire or retain any equity, partnership, or other ownership
interest in or sponsor a hedge fund or a private equity fund'.
But the implementing rule has cast a wide net, capturing Ucits
[Undertakings for Collective Investment in Transferable
Securities] and Canadian mutual funds within the 'banking
The crux of the problem, is that the term includes
'affiliates' of US insured depository institutions (and their
holding company) and foreign banks with US operations; a
relationship established by 25% ownership or another form of
control. Canadian banks sponsor, appoint the trustees and
control the investment managers of around 44% of the country's
mutual funds. The vast majority of Ucits have a similar
For bulge brackets, the Volcker Rule places a huge strain on
their business. For mutual funds, it makes their business
unsustainable. "The European fund business cannot really exist
on these rules, as every fund that a European bank
issues…is a banking entity," says a European bank
In a matter of weeks, these funds must comply with the full
swathe of Volcker Rule obligations. It makes the business model
economically unviable; they simply can't afford to be
classified as banking entities. And if US regulators don't
respond to banks' lobbying on the point, it could mark the
death knell for the fund structure.
"This is the number one thing we need an answer to. And not
just any answer, but a good answer," says a non-US bank
counsel. "Basically every single mutual fund that we offer
outside of the US is in that position. We have hundreds that
will be considered banking entities if the regulators do not
fix the problem."
The other major message from respondents' candid discussion
with IFLR is one of optimism. Trading terminal provider
Bloomberg is spearheading a market-wide solution to banks'
secondary trading issues (see boxout overleaf). Before buying
or investing in a security they didn't structure, banks must
determine whether it is or isn't a covered fund, to ensure they
won't flout the Volcker Rule. As an unaffiliated issuer, any
such decision would be based on third party attestations and
documentation drafted before the vague 'covered fund' criteria
was devised. IFLR exclusively reveals detail of the covered
fund tag based on frank discussions with respondents and
July 21 2015 is a watershed moment for global financial
regulation. After five years of working tirelessly to structure
compliance systems, lobbying regulators for change and
designing industry solutions, financial entities around the
world must comply with the Volcker Rule. Here's how they plan
to do it.
Funds as banking entities
Seventy five percent of respondents are suffering under the
so-called deemed banking entity issue. And of those not
affected, half have avoided the problem altogether by not
sponsoring any non-US mutual funds, while the other half have
already restructured their funds' management.
The US mutual fund model sidesteps the issue. "They don't
have the same control considerations because, even though they
are structured in a similar way, they confer more rights to
remove the decision-maker," explains a foreign bank counsel.
"As those rights are in place in the US, they [the banks] are
not deemed to be controlling those funds."
|1. Have any Ucits or other
non-US mutual funds that your institution sponsors been
determined to be 'banking entities’ by
virtue of affiliations or common control?
||2. How many covered funds is the
institution deemed to control, which may therefore be
considered 'banking entities’ themselves
subject to Volcker?
Foreign banks and their industry representatives –
the Institute of International (IIB) and Securities Industry
and Financial Markets Association (Sifma) – are still
lobbying the regulators on this point, and have seen some
They have met with regulators in Washington DC and explained
how the control aspect of the affiliate test captures the bulk
of their publicly offered funds. They also explained that
because the Volcker Rule prohibitions are designed for
bank-like entities, they won't work for a typical fund.
Poll respondents say that the regulators have, over the past
few months, started to listen and have asked Sifma to draft an
interpretive clarification which could be incorporated into the
Federal Reserve's 13 FAQs on the Volcker Rule. One respondent
believes the industry body will suggest narrowing the affiliate
definition by removing the control test, leaving only the 25%
ownership test. Sifma didn't respond to IFLR's request for
comment on this point.
Some poll respondents are confident. Foreign public funds'
exclusion from the covered fund definition (see poll question
8) suggests their categorisation as banking entities is
unintended. The point being made by banks is, they say,
following the spirit of the law.
regulators that think it solved all our problems, but
it absolutely did not"
The deemed banking entity point was included in Sifma's and
many non-US banks' extension requests filed in January
(question 10). It seems no one received a formal response from
the regulators, but some bank counsel believe no news is good
news. "They haven't granted us more time, but they also haven't
indicated that we are expected to take any action," says
Some received verbal confirmation that the regulators were
putting together a clarification for the whole industry. As
such, one respondent claims that, as far as she is aware, the
only restructuring done by banks is as contingency planning.
But 12.5% of poll respondents have followed the rule as it
stands today, and responded by modifying their funds'
"We've changed the organisational governance to be
comfortable that they wouldn't [be banking entities]. Basically
the management and control of the adviser have independent
management, so it's not deemed to be an affiliate," explains a
US bank counsel.
A related issue is covered funds being deemed banking
entities. While mutual funds escape the 'covered fund'
definition, similar foreign structures don't. If, in addition,
they are classed as affiliates of their sponsor bank, they will
be deemed banking entities.
The majority of respondents have not encountered this
problem, and 25% have not given it full consideration. For
those that have identified a handful of such funds, they are
restructuring them to avoid the classification come July.
|Bloomberg terminal tag
identifies 'covered funds’
Along with the banking entity definition,
respondents' biggest compliance headache involves
secondary trading. But they are hopeful that a 'covered
fund' tag identifier being developed by Bloomberg for
securities traded on its terminals presents a
market-wide solution to the problem.
Starting June 1, the tag will attach to instruments
traded on Bloomberg Professional that are classified as
covered funds under the incoming rule, Bloomberg's
global head of regulatory and accounting products
Ilaria Vigano confirms with IFLR. "The identifier tag
will deliver a wide variety of data sets, including an
indicative flag called 'covered funds yes', 'covered
funds no' or 'needs legal review'," says Vigano.
While banks can monitor and control their interests
in structures they develop themselves, investing in
third party funds is more difficult. As an unaffiliated
issuer, they can't validate a registration status.
Instead they must determine whether something is or
isn't prohibited based on third party attestations and
documentation drafted before the vague 'covered fund'
criteria was devised.
One US bank counsel says the secondary market issue
is creating much more heartache than any of the
origination pieces. Even for some foreign banks that
are suffering under the banking entity problem,
secondary trading is a bigger concern.
"On the deemed banking entity point, there is
nothing in the rule that says we would be restricted in
trading; it is just the absence of clarity that has got
the industry so upset," says one non-US bank counsel.
"Whereas with secondary trading there is a positive
requirement. It is pretty clear that we have to
identify and capture that in the tier 1 test."
secondary market issue is creating much more
heartache than any of the origination
They are buoyed by the market-wide solution
spearheaded by Bloomberg: a label similar to an ISIN or
CUSIP that attaches to securities traded on the popular
trading terminal will indicate what is and isn't a
The tag will indicate that the security has been
reviewed against the covered fund definition and, based
on that analysis, either is or isn't treated as a
covered fund. So before executing a trade, the bank can
confirm that it will not fall foul of the rules.
Vigano says the product provides data feeds for
clients to feed into their databases. "The data will
also appear on a Bloomberg Professional service screen
that will be permissioned to clients that subscribe to
the premium service," she adds.
The product will require banks selling securities
via the terminal to inform Bloomberg whether it is a
covered fund. Bloomberg must also determine whether the
legacy instruments being traded today are or aren't
covered funds; IFLR understands some US banks and law
firms have helped devise criteria on which Bloomberg
will base its internal validations.
The idea has been discussed since late last year,
but it started to gain momentum in February when the
Federal Reserve failed to grant the industrywide relief
sought by Sifma on the issue. There will be a "not
insignificant subscription fee" according to one bank
counsel, who adds that Bloomberg is guarding the data
Many banks are still deciding whether to sign up to
Bloomberg's Vigano confirms that the issuer will be
responsible for the tag. Issues around liability, and
who would be responsible if something went wrong, have
been raised by counsel as a potential challenge faced
by any tag.
Another potential challenge counsel raise is timing.
Some say that Bloomberg, the consultancy firm
– believed to be KPMG – and banks
devising the tags had hoped it would launch mid-May.
When that time passed, some were concerned that it
would not be online by July 21, when the Volcker
conformance period ends.
"Most of these [securities] probably aren't covered
funds, but some of them could be. So everyone [was]
taking a risk-based approach to bridge the gap between
now and July 21, without going too crazy knowing that
there is a solution on the horizon at some point in the
future," says one US counsel. However if the product is
live by June 1, this will no longer be an issue.
Another difficulty is the reliability of the
categorisation of legacy instruments. A covered fund
includes, inter alia, funds that rely on sections
3(c)(1) or 3(c)(7) as exemptions from the Investment
Company Act. "The challenge is that the documents for a
lot of the older deals don't get into different types
of [Volcker] exceptions or 3(c)(1) or 3(c)(7); it just
wasn't on anyone's radar so no one felt the need to
define those aspects," says one counsel. "So when you
ask the question 'could it rely on something other than
3(c)(1) or 3(c)(7)', the answer could very well be
'maybe'. So that's the hardest thing."
Nevertheless, respondents note that most of the
industry is using these terminals, so if these issues
are addressed, it would be an industry solution. It
begs the question whether the next industry concern
should be a lack of secondary market appetite for any
securitisations backed by bonds.
KPMG did not respond to IFLR's request for
Identifying covered funds
All respondents have done a thorough review of fund-like
structures to determine which would be classified as covered
funds. After taking into account the rule's exceptions, half
have identified more than 50 covered funds; some, drastically
more. "By 'more than 50' do you mean thousands or millions?"
one respondent jokes.
While the poll statistics are interesting, respondents'
comments reveal differences in how banks conducted their review
and the hurdles they faced in tallying up their numbers.
Some business lines were easier to review than others.
According to one Europe-based counsel of a US bank,
securitisations required more action than thought. "We all know
what they [covered funds] look and smell like. It's just a
question of going through the analysis on each deal, and that's
what we are doing. For each new and existing deal, we are going
through the covered fund analysis."
Yet the general feedback is that a 'covered fund' definition
that, essentially, includes anything that looks or acts like an
equity or hedge fund has created difficulties.
|3. Has the entity done a review
of all passive investment vehicles to determine whether
any would be subsumed within the covered fund
|4. How many covered fund
entities have been identified?
Identifying structures that aren't part of the bank's
routine client-facing business, but may have been acquired by
its head-office, have proved problematic. Covered funds have
also cropped up in unexpected situations; one respondent gives
the example of a bond out of Africa which was relying on an
Investment Company Act exemption noted in the Volcker Rule.
That the definition can catch structures so far removed from
the provision's underlying premise sets a high bar for
"As a former regulator I can empathise with what they are
trying to do," says one US counsel. "But some of these vehicles
and passive investments don't announce themselves as having
relied on 3(c)1 and 3(c)7, and maybe should have," adds the
In this situation, someone needs to make a judgement call.
"If the position is that they might have to rely on one of
those 40 Act exemptions, then it is just internally determining
what we are comfortable with," says a US bank counsel. "I'll
assert my opinion, and it's a matter of whether the company is
comfortable with that."
Banks have tried a triage approach, where they bucket assets
depending on how likely they are to be covered funds, and then
pay greater attention to those that are clearly prohibited.
Some respondents asked for relief on this point, but the
regulators did not oblige. "If you are 95% not expecting
something to be a covered fund, having to go through 20,000
structures to identify 50 seems like a large exercise,"
explains one. It's exactly this type of security that the
Bloomberg tag will help with in the secondary market.
The issue is exacerbated in the context of a review. If an
internal lawyer struggles to define and classify some
structures, how can they expect someone outside of the legal
team to understand? "The problem is that if you ask someone if
their business has covered funds they will say 'no', without
even having told them what a covered fund is," says one
respondent. They tried to address this by asking questions
about the way the assets were collected and organised, rather
than their structure.
Another respondent asked the bank's finance and statutory
reporting groups to see if there were any ownership
registrations in the types of vehicles flagged as possible
covered funds. "So we aren't going to the business to see if
they have registered investment vehicles or funds with US
agencies pursuant to the Volcker Rule, instead we are going to
corporate head office areas where we might also have holdings
and which we wouldn't normally come across as part of the
Some respondents' banks had already done an assessment of
passive investment vehicles as part of a previous project,
which they relied upon rather than instituting another
Despite the deemed banking entity issue, US regulators
overseeing the Volcker Rule did attempt to carve out those
funds from the scope of the covered funds definition. The
foreign public fund exception relates to issuers organised
overseas that sell ownership interests to non-US retail
investors predominantly through non-US public offerings. It is
designed to put the likes of Ucits and Canadian mutual funds on
equal footing with US mutual funds which fall outside the
'covered funds' definition as they are regulated under the
Investment Company Act (ICA).
This aspect of the rule is well received by the market. One
respondent says that dual-share class fund offered to both
institutional and retail investors are presenting problems. But
nearly two thirds believe the exception is adequately drafted
and addresses their needs. Some have restructured funds offered
to sophisticated investors to take advantage. "We had a subset
of funds that we decided wouldn't satisfy that requirement. So
we revisited the reason why the European regulator had asked
for that label and limit, and we addressed the concerns in a
different way so that we could satisfy that prong," says a US
|5. Does the publicly offered
covered fund exception address the
institution’s Ucits and other non-US mutual
|6. Does the institution intend
to rely on the SOTUS exemption for its covered fund
|7. Does the institution intend
to establish 'parallel’ offshore funds in
which no US persons will be permitted to
A quarter of respondents want further regulatory
clarification on the 'predominantly offered to non-US persons'
prong of the exception. One says the retail investor aspect is
"pretty decent", but could also do with some clarification.
But as a whole, the exception is proving of great benefit to
the market; including as leverage in discussions with
regulators on the deemed banking entity issue. "The correlation
between the definitions of covered funds and banking entities
leads one to question if treating Ucits and other foreign funds
like banking entities really serves the purpose of the Volcker
Rule," says one European counsel.
Since the covered funds prohibition was enacted in 2010,
foreign banking entities have complained that its
extraterritorial reach risked capturing their activities that
had a remote connection to the US.
The regulatory response to this was SOTUS – the
solely outside the US exemption. This waives the prohibition so
long as the foreign bank is not located in the US or controlled
by a US entity, the sponsoring or investing occurs overseas,
and the covered fund is sold via an offering that does not
target US residents.
Until recently, a lack of clarity around this last prong
– known as the marketing restriction – had
effectively limited SOTUS's use to sponsorship. A foreign bank
looking to invest in a third party SOTUS fund would need to
ensure it had never been offered in the US.
A FAQ clarification in February 2015 solved this problem by
confirming that the marketing restriction only applied to the
foreign bank seeking to rely on SOTUS.
Respondents from foreign banks agree the clarification is
extremely helpful, and 62.5% of those polled intend to rely on
"If you had of asked me this question before February I
would have voted 'no'. It was not usable as you would have to
go to a third party and get them to swear on a stack of bibles
that they had never sold it into the US," says one. "But now we
just have to know our own actions and then we can rely on it."
Some respondents say that at the start of the year, they were
having to divest. Others were trying to get third party funds
to reveal if they took US investors or not: "That was proving
to be a very difficult exercise."
One non-US bank counsel is reluctant to provide regulators
with too much positive feedback. "The February clarification
helped a lot, but it didn't solve all our problems. I think
there are regulators that think it did solve all our problems,
but it absolutely did not as it didn't solve the banking entity
While US banks can't rely on SOTUS for their own sponsorship
and investment, some are benefitting indirectly from the
February clarification by structuring deals for foreign
Before the regulators stepped in, a group of 15 law firms
had devised a market-wide initiative to help foreign banks
overcome the shortcomings of the SOTUS exemption. In May 2014
they issued a consensus interpretation letter confirming that a
foreign bank could invest in so-called parallel funds set up by
This involves a covered fund set up in the US and marketed
to US investors, and a SOTUS fund, with both making the same
investments. If a foreign banking entity can convince a sponsor
to structure certain funds this way, they can still gain
exposure to the underlying assets by investing in the SOTUS
Three quarters of respondents do not intend to set up
parallel funds. Some of these are US banks which never could
have benefitted from the structure, but for the foreign bank
respondents, it's because of the recent clarification. "We may
have planned to rely on these as we couldn't rely on SOTUS. But
now with the FAQ, I don't imagine we will be using that at
all," says one.
Yet some claim that parallel offshore funds still have a
role (see page 35 for sponsor firm MoFo's response), but no
poll respondents are sure they will use the structure. At best,
25% are still considering their position.
|Volcker: back to basics
Section 619 of the Dodd-Frank Act is one of the US's
most controversial post-crisis financial reforms.
Starting July 21, banks must comply with the provision,
better known as the Volcker Rule, after former Federal
Reserve chairman Paul Volcker who championed its
Of its two limbs, the ban on banks'
proprietary trading has gained the most
attention. But it is now clear that the so-called
covered fund restriction is just as problematic
– particularly for non-US banks. This
prohibits a banking entity, as principal, from
acquiring or retaining an ownership interest in, or
sponsoring, a covered fund.
A banking entity is a US-insured
depository institution, any company
that controls an insured depository institution,
foreign banks that have US operations, along with any
of their affiliates.
Something is classified as a covered fund if it
falls into one of three categories, which can be
broadly described as:
- collective investment vehicles that would be an
investment company under US law, but for the
exemption contained in sections 3(c)(1) or 3(c)(7) of
the Investment Company Act;
- commodity pools; and
- foreign funds sponsored by US banking entities
that would rely on sections 3(c)(1) or 3(c)(7) of the
Investment Company Act if they were registered in the
The general prohibition is subject to a litany of
exceptions and exemptions. The most important
exceptions include US mutual funds, covered bonds and
securitisations that invest solely in
loans, and foreign public funds (although these may
still be classed as banking entities in their own
Under the exemptions, a banking entity can own up to
three percent of a covered fund, and engage in market
making and underwriting of covered funds (so long as it
abides by Volcker's proprietary trading ban). However,
a bank's aggregate investment in covered funds cannot
exceed three percent of its tier 1 capital. Foreign
banking entities can invest in and sponsor a covered
fund solely outside of the US (the SOTUS
As part of Dodd-Frank, the Volcker Rule was enacted
in July 2010. The five US authorities charged with
overseeing Volcker issued their proposed rule in
November 2011, and final rule in December 2013. That
became effective April 2014, but the conformance period
was extended until July 21 2015.
Securitisation and covered bonds
As many US securitisations rely on sections 3(c)(7) or
3(c)(7) the ICA to avoid registration, they fall within the
covered fund definition. This increases regulatory pressure on
what's already a highly scrutinised industry, given its status
as a scapegoat for the financial crisis. Covered bonds,
particularly those backed by predominantly non-mortgage assets,
could also be subsumed within the definition.
Half of poll respondents are actively reliant on
securitising their assets or issuing covered bonds as part of
their funding. One says its structured notes business is also
creating issues as, before looking at the exceptions, it is
considered a covered fund.
Regulators did create a safe harbour for asset-backed
securities (ABS) that invest solely in loans. Upon asking about
the usability of this and any other ABS-related exception, the
response is mixed.
|8. Was the institution actively
reliant on securitisations and/or covered bond
|9. Do the covered bond and
securitisation exceptions adequately address the
For some it is a non-issue: either they don't engage in
securitisation or covered bond issuances, or they are foreign
banks that issue only overseas and so will rely on SOTUS. For
one US bank, this was only a minor part of its Volcker enquiry
as its structures fall clearly within the exception.
Respondents are happy with the covered bond exception,
however securitisations are proving more problematic.
The general response has been to remove bond buckets from
structures sold in the US, so they can rely on the loan-backed
exception. For those issued out of London, SOTUS creates more
options. "There has been talk among the different banks on the
best way to move forward in that space," says a European bank
counsel. "For the ones we have done recently that still do have
some bonds, ownership interests aren't being offered in the
For vehicles issuing notes in the US, there is the option of
relying on another ICA exemption – primarily section
3(c)(5). At least two respondents are restructuring their
securitisation vehicles to rely on this or another ICA
exemption, to take them out of the scope of Volcker by
The bank tackling its structured notes business is close to
a solution that would bring it into conformance with the rule.
But even speaking anonymously, its respondent was not willing
While these poll questions are directed at banks acting as
originators, from the interviews it's clear that securitisation
restrictions are also impacting banks structuring deals for
unaffiliated issuers. Not only is it making their services more
expensive, they also need more information from borrowers to
make sure that their relationship – no matter how
short term – does not fall foul of the multifaceted
covered fund prohibition.
A Europe-based respondent believes it could be more of a
problem on his side of the Atlantic. "I don't think borrowers
here are that familiar yet with some of the issues we are
facing. We are requiring certain disclosure regarding covered
funds, which I think is quite standard in the US. But in Europe
some people aren't yet familiar with the ramifications of
disclosure, and reps and warranties, we need."
The rule empowered the Federal Reserve to extend the
conformance period for individual banks. Nearly two thirds of
respondents took advantage of this, submitting their requests
by the January 21 2015 filing deadline. Yet none of them
– nor, it seems, any other applicant –
received a formal response. Instead, most banks received a
This particular power of the Fed was craftily drafted such
that banks could ask for more time – but not relief.
Nevertheless, they and Sifma used it as an opportunity to drill
down on the issues which even more time would not solve. The
two most important were the deemed banking entity and secondary
trading issues. In the conversations that followed, regulators
made clear they did not want to address either of those two
"I personally view it as they are in a corner and they don't
know how to approach it," says one respondent. "I almost view
the application as a matter of protocol."
|10. Has the institution sought
an extension in respect of its compliance date for its
covered funds activities?
|11. Has the institution
attempted to quantify the costs of putting in place
Volcker-compliant policies, procedures and systems?
Indeed, of those that didn't apply for an extension, one
thought it fruitless and decided to use their resources more
efficiently. Another believed they were already "in reasonably
Others decided against it because they had already got what
they wanted. On December 18, the Fed announced a blanket
extension of the conformance period until July 2016 for covered
funds in place before 2014. The regulator also said it is
likely to grant a similar year-long extension once that first
extension expires. "Obviously the aspirational goal is to be
zero percent ownership by 2017," says a US counsel. For such
banks, the legacy extension is more than adequate. For others,
it falls short. "It helps but it doesn't help enough," says a
respondent from a non-US bank that owns funds to hedge against
products they have sold. "Some have built in optionality which
means we must buy and sell funds to hedge the product. If we
aren't allowed to do that, we can't risk manage our products
with our clients, and we will have a lot more risk than we need
For question 11, the response statistics (50/50) belie the
situation. Though most respondents aren't involved in tracking
expenses, they believe someone outside of legal is. Placing
monetary limits on the exercise, however, is useless. "It's not
like compliance is optional, so there is no point having a
budget," says a US bank counsel.
Those that haven't attempted to calculate in advance were
put off by the number of unknowns and variables that could
impact any estimate. For those that have, they've most
struggled with the business changes. "It is easy enough to pull
together IT, legal and consulting costs as they are all
external. But when trying to attempt to quantify some of the
costs internally, including in changes to business direction
for any new funds that we have created, it is a bit harder,"
says a European counsel.
And the bigger the bank the more difficult. "The frustrating
part about the internal compliance programme is how to keep
covered funds out," says one bulge bracket counsel.
"When you have a merger coming through, the vehicle must be
carefully created so that it doesn't inadvertently become a
covered fund – it's evaluating the close cases and
getting that information funnelled to the right place that is
The lack of certainty that still surrounds the rule is
creating some internal tensions. All banks need to get their
compliance programmes approved by their boards. But, as one
respondent notes, directors don't like approving things when
the legal team's best answer is 'we don't know exactly what we
will have to do, as the rule is still unclear.'
Irrespective of whether estimates, budgets or tallies are
being put in place, it is clear that the final expense will be
exorbitant. It's a point eloquently made by a European
"It is a crazy thing to be spending so much time and money
on, as everything is already being structured differently. So
in the next three to five years, all those investments will
have run-off and no longer exist."
It might come at a big price, but the idea of a post-Volcker
world might just be the silver lining to a very large, dark
cloud that has long-loomed over the global financial
IFLR's Bankers' Counsel Poll was compiled with the
help of the poll's sponsor firm – Morrison
With input and insight from partners Anna Pinedo and
Oliver Ireland, poll questions were devised and
targeted to best address the issues faced by North
American and European banks in complying with the
covered fund prohibition under the Volcker Rule.
Using recommendations of in-house counsel from the
editorial team and Morrison & Foerster, the poll
was distributed to counsel at the largest investment
banks across the two continents. Responses were
obtained from a representative cross-section of those
banks. All respondents are counsel at institutions
classified as 'banking entities' under, and therefore
are subject to, the Volcker Rule.
The poll provides banks with an anonymous forum to
learn how their peers are coping with the Volcker
Rule's restrictions on banks' involvement with covered
funds. To ease the concerns of the participants,
anonymity was guaranteed to all respondents. To that
end IFLR will not name the banks that agreed to
Responses and comments were obtained via
off-the-record telephone calls between March and May
2015. A select number provided written answers. While
the more structured responses to the poll questions
provided interesting statistics, a real sense of the
concerns of in-house counsel emerged from their
explanatory comments. The topics raised in those
interviews formed the basis of the conclusions drawn
out of the main body of IFLR's analysis.
The results and analysis will be submitted to the
five US regulators overseeing the Volcker Rule.
IFLR's next Bankers' Counsel Poll, which will focus
on IPO-related issues, will be published in
In association with:
|The other side of the story
SOTUS, foreign mutual funds and vague
definitions are at the heart of bank
counsel’s candid discussion. On some
issues, opinions differ
IFLR speaks with Morrison & Foerster's Oliver
Ireland, who helped compile the poll questions, about
the most pressing issues presented by the incoming
covered fund prohibition under Volcker.
Are you surprised that the breadth and lack
of clarity regarding the 'covered fund' definition has
created difficulties in conducting
We are seeing this all over the place. Sorting out
to what is and isn't a covered fund, what is a banking
entity, and particularly how the Volcker Rule applies
to foreign fund operations is very challenging.
So 50% of respondents have 50 or more of these
things. And based on what we have seen, they won't be
50 of the same thing. There are variations in the
structures, they are in different countries, the legal
structures are a little different and they have
different investors. And that potentially leads to
different results under the Volcker Rule. So if you are
looking at 50 funds that fall into six or seven
classes, that's a complicated review process.
Do you agree with one respondent's comment
that regulators may mistakenly believe that the
February SOTUS FAQ clarification solves all non-US
banks' covered fund problems?
It solves a class of problems by focussing on
banking entities' marketing of the funds, rather than
other people's marketing of the funds. I don't think
that the regulators are so naïve that they think
it solves all the problems. And I'm talking to
regulators about fund issues on an ongoing basis that
are not solved by that FAQ.
Do you think the marketing restriction FAQ
clarification has effectively made redundant the
parallel offshore funds solution devised by the US
No. I think there are still a class of situations
where you may want to have a parallel offshore fund.
So, the question is: is the fund covered in the US? And
if the banking entity wants to sell to US and foreign
customers, it puts the two funds together so it is
covered across the board. The FAQ takes out the issue
about third party marketing and downstream fund
marketing, so it reduces the number of situations where
this may arise. But I don't think that completely
eliminates the problem. I think it makes it easier to
structure a foreign fund, but I don't think it solves
Some foreign banks are wanting guidance on
whether Super 23A applies globally. What are your
expectations regarding this?
The safer assumption is that it applies globally.
Anyway, with questions like this, the issue is that we
are running out of time. You may get some more
clarification from the regulators, but I would be
surprised if you get a lot more before July 21.
there are still a class of situations where you
may want to have a parallel offshore fund"
I go through this conversation all the time;
explaining to foreign entities that this applies to
them because they have US operations. If they want to
get rid of their US operation, they can get out of it.
But that is the business decision they will have to
make. Is it fair? Probably not. But that is the
reality. And I think most people understand that, but
they aren't happy with it.
On the issue of Ucits and other non-US
mutual funds being caught as 'banking entities', do you
agree with some banks' approach of not seeking to
comply until a formal response has been granted by the
That is not what we are advising people. We are
telling people that you have to read and comply with
the rule until you learn you don't have to or receive
some different clarification. I don't know what the
regulators will do as they move forward into
enforcement of the rule. I think there will be a lot of
problems out there.
And when we start talking about Ucits to foreign
banks, the point needs to be made that Ucits aren't
completely uniform. It's a name that a lot of people
use for mutual funds, but as we drill down in relation
to individual banks, the structures they use can be
different. Also, whether or not the banking entity has
an ownership interest may be different. So I don't
think there is a one-size-fits-all solution for the
Ucits. I think the banking entity issue is a problem,
but I don't see regulators completely reversing their
Are there any other key messages from the
This is one of the most challenging regulatory
requirements seen. It seems to be potentially working
fundamental shifts in how people do business, and I
think there are still a lot of unanswered questions.
There are going to be a lot of people that make
judgements that may or may not be consistent. It seems
some banking entities are expecting clarification and
think the banking entity definition will be cleared up.
But it will take a while for the rule to sort itself
out, and it will take a while after July 21.
IFLR spoke to Oliver Ireland on May 13