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Concerns Voiced Over International Impact of Volcker Rule

By Jim Hamilton

International banks with U.S. banking operations are subject to Federal Reserve Board supervision and regulation as bank holding companies under the Bank Holding Company Act of 1956. As a result, they are ?banking entities? for purposes of the Volcker Rule, and their U.S. operations are subject to the same prohibitions and empowerments under the Volcker Rule as domestic banking organizations. Consistent with the longstanding approaches of the BHC Act, Congress drew an appropriate territorial boundary regarding the scope of the Volcker Rule?s prohibitions. The Volcker Rule specifically authorizes international banks to conduct proprietary trading and fund activities solely outside the United States under Sections 4(c)(9) and 4(c)(13) of the BHC Act, subject to certain limitations.

The Japanese Bankers Association has asked the federal financial regulators formulating the Volcker Rule regulations for an explicit statement that the rule does not apply to the operations of non-US banks outside the United States. The exceptions for extra-territorial application in Section 619 refers to "the acquisition or retention of any equity, partnership, or other ownership interest in, or the sponsorship of, a hedge fund or a private equity fund by a foreign banking entity... solely outside of the United States, provided that no ownership interest in such hedge fund or private equity fund is offered for sale or sold to a resident of the United States.

The association believes that the phrase "solely outside of the United States" must be defined more precisely. In that context, the group suggested that the definition of ?solely outside of the United States? consider the fund's domicile, the location at which it is managed and the location of its bookings. The group seeks an explicit statement that regulations do not apply to foreign funds, funds managed outside the United States and investments in hedge funds booked outside the United States (for example, in Tokyo for Japanese banks) because these constitute "transactions outside of the United States.?

Under the wording of regulations on investments in funds, noted the association, the Volcker Rule could apply to a non-US bank that has been licensed under the Bank Holding Company Act investing in a limited partnership ownership interest in a non-US fund if the fund's ownership interest is, or in the future will be, sold in the United States.

However, it is not always possible for investors in limited partnership interests to obtain information in advance regarding the participation of US investors in funds in which they invest, and even if such confirmation is made in advance, other investors may sell their ownership interest in the United States. An additional problem is the lack of means by which foreign financial institutions investing in funds can actively adhere to the Volcker Rule. The Japanese Bankers Association asked that these issues be fully considered when formulating detailed regulations and that the exceptions explicitly describe the differences in treatment for general partnership ownership interests and limited partnership ownership interests.

The Institute of International Bankers noted that Section 619 limited the extraterritorial reach of the Volcker Rule, which should reduce the likelihood of conflicts with international banks? home country banking laws and regulations. In its view, implementation of the Volcker Rule?s non-U.S. activities authorization for international banks, which is based on Sections 4(c)(9) and 4(c)(13) of the BHC Act, can be adequately addressed in the rulemaking process implementing the Volcker Rule.

Full post as published by Jim Hamilton's World of Securities Regulation on November 12, 2010 (boomark / email).