[Federal Register Volume 76, Number 30 (Monday, February 14, 2011)]
[Rules and Regulations]
[Pages 8265-8278]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2011-3199]
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Rules and Regulations
Federal Register
________________________________________________________________________
This section of the FEDERAL REGISTER contains regulatory documents
having general applicability and legal effect, most of which are keyed
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The Code of Federal Regulations is sold by the Superintendent of Documents.
Prices of new books are listed in the first FEDERAL REGISTER issue of each
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Federal Register / Vol. 76, No. 30 / Monday, February 14, 2011 /
Rules and Regulations
[[Page 8265]]
FEDERAL RESERVE SYSTEM
12 CFR Part 225
Regulation Y; Docket No. R-1397
RIN 7100-AD58
Conformance Period for Entities Engaged in Prohibited Proprietary
Trading or Private Equity Fund or Hedge Fund Activities
AGENCY: Board of Governors of the Federal Reserve System (``Board'').
ACTION: Final rule.
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SUMMARY: The Board is adopting a final rule to implement the
conformance period during which banking entities and nonbank financial
companies supervised by the Board must bring their activities and
investments into compliance with the prohibitions and restrictions on
proprietary trading and relationships with hedge funds and private
equity funds imposed by section 619 of the Dodd-Frank Wall Street
Reform and Consumer Protection Act (``Dodd-Frank Act''). Section 619 is
commonly referred to as the ``Volcker Rule.'' The final rule is similar
to the proposal issued for comment in November 2010. The Board,
however, has incorporated a number of changes to the final rule to
address issues raised by public commenters, to reduce potential
regulatory burdens, and to clarify application of the rule.
DATES: The final rule is effective on April 1, 2011.
FOR FURTHER INFORMATION CONTACT: Brian P. Knestout, Senior Attorney,
(202) 452-2249, Jeremy R. Newell, Senior Attorney, (202) 452-3239,
Christopher M. Paridon, Senior Attorney, (202) 452-3274, or Kieran J.
Fallon, Associate General Counsel, (202) 452-5270, Legal Division;
David K. Lynch, Division of Banking Supervision and Regulation, Board
of Governors of the Federal Reserve System, 20th Street and
Constitution Avenue, NW., Washington, DC 20551. Users of
Telecommunication Device for Deaf (TDD) only, call (202) 263-4869.
SUPPLEMENTARY INFORMATION:
I. Background
The Dodd-Frank Act was enacted on July 21, 2010.\1\ Section 619 of
the Dodd-Frank Act adds a new section 13 to the Bank Holding Company
Act of 1956 (``BHC Act'') (to be codified at 12 U.S.C. 1851) that
generally prohibits banking entities \2\ from engaging in proprietary
trading or from investing in, sponsoring, or having certain
relationships with a hedge fund or private equity fund.\3\ The new
section 13 of the BHC Act also provides that nonbank financial
companies supervised by the Board that engage in such activities or
have such investments shall be subject to additional capital
requirements, quantitative limits, or other restrictions.\4\ These
prohibitions and other provisions of section 619 are commonly known,
and referred to herein, as the ``Volcker Rule.''
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\1\ Dodd-Frank Wall Street Reform and Consumer Protection Act,
Public Law 111-203, 124 Stat. 1376 (2010).
\2\ The term ``banking entity'' is defined in section 13(h)(1)
of the BHC Act, as amended by section 619 of the Dodd-Frank Act. See
12 U.S.C. 1851(h)(1). The term means any insured depository
institution (other than certain limited-purpose trust institutions),
any company that controls an insured depository institution, any
company that is treated as a bank holding company for purposes of
section 8 of the International Banking Act of 1978 (12 U.S.C. 3106),
and any affiliate or subsidiary of any of the foregoing.
\3\ The Volcker Rule defines the terms ``hedge fund'' and
``private equity fund'' as an issuer that would be an investment
company, as defined under the Investment Company Act of 1940 (15
U.S.C. 80a-1 et seq.), but for section 3(c)(1) or 3(c)(7) of that
Act, or any such similar funds as the appropriate Federal banking
agencies, the Securities and Exchange Commission (``SEC''), and the
Commodity Futures Trading Commission (``CFTC'') may, by rule,
determine should be treated as a hedge fund or private equity fund.
See 12 U.S.C. 1851(h)(2).
\4\ See 12 U.S.C. 1851(a)(2) and (f)(4). A ``nonbank financial
company supervised by the Board'' is a nonbank financial company or
other company that has been designated by the Financial Stability
Oversight Council (``FSOC'') under section 113 of the Dodd-Frank Act
as requiring supervision and regulation by the Board on a
consolidated basis because of the danger such company may pose to
the financial stability of the United States.
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The Board and several other agencies have responsibilities with
respect to the Volcker Rule. As required by the Dodd-Frank Act, the
FSOC recently issued a study of the Volcker Rule, which included
several recommendations regarding the implementation of its
prohibitions and restrictions.\5\ As a general matter, authority for
developing and adopting regulations to implement the prohibitions and
restrictions of the Volcker Rule is divided between the Board, the
Office of the Comptroller of the Currency (``OCC''), the Federal
Deposit Insurance Corporation (``FDIC''), the SEC and the CFTC in the
manner provided in section 13(b)(2) of the BHC Act.\6\ The Board and
these other agencies are directed to adopt implementing rules not later
than 9 months after completion of the FSOC's study.\7\ The restrictions
and prohibitions of the Volcker Rule become effective 12 months after
issuance of final rules by the agencies, or July 21, 2012, whichever is
earlier.
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\5\ See FSOC, Study & Recommendations on Prohibitions on
Proprietary Trading & Certain Relationships with Hedge Funds &
Private Equity Funds (January 18, 2011), available at http://www.treasury.gov/initiatives/Documents/Volcker%20sec%20%20619%20study%20final%201%2018%2011%20rg.pdf.
\6\ See 12 U.S.C. 1851(b)(2). The Secretary of the Treasury, as
Chairperson of the FSOC, is responsible for coordinating the
agencies' rulemakings under the Volcker Rule. See id. at Sec.
1851(b)(2)(B)(ii).
\7\ See id. at Sec. 1851(b)(2)(A).
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The Board, however, is solely charged with adopting rules to
implement the provisions of the Volcker Rule that provide a banking
entity or a nonbank financial company supervised by the Board a period
of time after the effective date of the Volcker Rule to bring the
activities, investments, and relationships of the banking entity or
company that were commenced, acquired, or entered into before the
Volcker Rule's effective date into compliance with the Volcker Rule and
the agencies' implementing regulations.\8\ This period is intended to
give markets and firms an opportunity to adjust to the Volcker Rule.\9\
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\8\ See id. at Sec. 1851(c)(6).
\9\ See 156 Cong. Rec. S5898 (daily ed. July 15, 2010)
(Statement of Senator Merkley).
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In November 2010, the Board requested public comment on a proposed
rule that would implement the conformance period provisions of the
Volcker Rule.\10\ The proposed rule included the general two-year
conformance period available to all banking entities and nonbank
financial companies supervised by the Board, as well as the provisions
of the Volcker
[[Page 8266]]
Rule that allow the Board to extend, by rule or order, this two-year
period by up to three, one-year periods.\11\ In addition, the proposal
implemented the special five-year extended transition period available
for certain qualifying investments in hedge funds and private equity
funds that are ``illiquid funds.'' \12\ The proposed rule also defined
certain terms related to the conformance period, specified how an
application or request for extension should be submitted, and
identified the factors that the Board may consider when evaluating such
a request. The public comment period on the proposed rule closed on
January 10, 2011.
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\10\ See 75 FR 72741 (Nov. 26, 2010).
\11\ 12 U.S.C. 1851(c)(2).
\12\ 12 U.S.C. 1851(c)(3), (c)(4), and (h)(7).
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II. Overview of Comments
The Board received 12 comments on the proposed rule. Commenters
included financial trade associations, banking entities, individuals,
and a member of Congress. In general, commenters supported the proposed
rule but recommended one or more changes to specific provisions of the
proposal. A majority of the commenters focused on the 5-year extended
transition period available to banking entities to the extent necessary
to fulfill a contractual obligation in place on May 1, 2010, to take or
retain an interest in a hedge fund or private equity fund that
qualifies as an ``illiquid fund'' under the Volcker Rule. For example,
some commenters suggested that the Board broaden its definition of
``illiquid assets,'' which is used in determining whether a hedge fund
or private equity fund is an illiquid fund. Others requested that the
Board lower the proposed rule's requirement that at least 75 percent of
a fund's assets be invested in ``illiquid assets'' (either as of May 1,
2010, or on a future date) in order for the fund to qualify for the
extended transition period. Many commenters also asserted that the
proposed rule's definition of when a banking entity has a ``contractual
obligation'' to invest or remain invested in an illiquid fund was too
narrow and would limit the number of hedge funds and private equity
funds that could take advantage of the extended transition period for
illiquid funds.
Some commenters also asked that the Board, in the final rule,
address several aspects of the Volcker Rule that were not covered by
the proposal. For instance, some commenters requested that the final
rule state that section 13 of the BHC Act does not prohibit insurance
companies from conducting their normal business operations, or does not
prohibit foreign companies from engaging in prohibited proprietary
trading in the securities of U.S. companies if such trades were booked
outside of the United States.
Additionally, some commenters addressed the procedural aspects of
the proposed rule governing the receipt and review of applications for
an extension of the conformance period. For example, some commeters
requested that the rule permit the Board to grant all possible
extensions to a banking entity at a single time. Other commenters
suggested that the final rule permit banking entities to submit a
request for extension well in advance of the date an extension might be
needed, and expressly provide for a standard time period for the Board
to review any extension requests. The comments received on the proposed
rule are discussed in greater detail in the following parts of this
SUPPLEMENTARY INFORMATION.
III. Explanation of Final Rule
In developing this final rule, the Board has carefully considered
the comments received on the proposal, as well as the language and
legislative history of the Volcker Rule, and the Board's experience in
supervising and regulating banking entities' trading activities and
investments in, or relationships with, hedge funds and private equity
funds. The Board also consulted with the Department of the Treasury,
the OCC, the FDIC, the SEC, and the CFTC.
After this review, the Board has determined to adopt a final rule
that is substantially similar to the proposed rule. However, in
response to comments, the Board has modified the proposed rule in a
number of respects. For example, the Board has--
Expanded the conditions under which an asset may be
considered an ``illiquid asset'' to include situations where an asset
is subject to a contractual restriction on sale or redemption for a
period of 3 years or more;
Broadened the types of documents that may be considered in
determining whether a hedge fund or private equity fund is
``contractually committed'' to principally invest in illiquid assets or
whether a banking entity that has sponsored a hedge fund or private
equity fund is ``contractually obligated'' to invest or remain invested
in the fund;
Extended, from 90 days to 180 days, the number of days in
advance a request for an extension of the conformance period by a
specific company must be filed with the Board; and
Clarified that the Board expects to act on extension
requests within 90 days from receipt of a complete record.
These changes as well as the Board's responses to the comments
received are discussed in greater detail below.
The final rule does not address definitional or other aspects of
the Volcker Rule that are subject to, or more appropriately addressed
as part of, the separate interagency rulemaking to be conducted under
section 13(b)(2) of the BHC Act.\13\ For example, the final rule
incorporates without modification the definitions of ``banking
entity,'' ``hedge fund,'' and ``private equity fund'' contained in the
Dodd-Frank Act. In addition, the final rule does not address several
topics suggested by commenters--such as, for example, the general
application of the Volcker Rule to banking entities that are insurance
companies or foreign entities, or whether banking entities should also
have an extended period of time to conform investments in funds that do
not qualify for the statute's extended transition period for illiquid
funds--that are appropriately addressed through the coordinated
interagency rulemaking process provided for in section 13(b)(2) of the
BHC Act.\14\ The Board expects to review the final rule after
completion of the interagency rulemaking process under section 13(b)(2)
to determine whether modifications or adjustments to the rule are
appropriate in light of the final rules adopted under that section.
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\13\ See id. at Sec. 1851(b)(2).
\14\ See, e.g., 12 U.S.C. 1851 (d)(1)(F), (H), (I), and (J).
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A. General Conformance Period
The prohibitions and restrictions of the Volcker Rule do not take
effect until the earlier of July 21, 2012, or 12 months after the
issuance of final regulations by the rulewriting agencies under section
13(b)(2) of the BHC Act. However, in order to allow the markets and
firms to adjust to these prohibitions and restrictions, the Volcker
Rule, by its terms and without any action by the Board, provides
banking entities and nonbank financial companies supervised by the
Board an additional conformance period during which the entity or
company can wind down, sell, or otherwise conform its activities,
investments, and relationships to the requirements of the Volcker Rule.
Under the statute, this conformance period generally extends through
the date that is 2 years after the date on which the prohibitions
become effective or, in the case of a nonbank financial company
supervised by the Board, 2 years after the company is designated by the
FSOC for supervision by the Board, if that period is later.
[[Page 8267]]
Section 225.181(a) of the final rule implements these provisions.
In addition, section 225.181(a)(2) of the final rule clarifies how the
conformance period applies to a company that first becomes a banking
entity after July 21, 2010 (the date of enactment of the Dodd-Frank
Act), because, for example, the company acquires or becomes affiliated
with an insured depository institution for the first time. In these
circumstances, the restrictions and prohibitions of the Volcker Rule
would first become effective with respect to the company only at the
time it became a banking entity. Accordingly, the final rule (like the
proposal) provides that such a company generally must bring its
activities, investments, and relationships into compliance with the
requirements of the Volcker Rule before the later of: (i) The date the
Volcker Rule's prohibitions would otherwise become effective with
respect to the company under section 225.181(a)(1) of the rule; or (ii)
2 years after the date on which the company first becomes a banking
entity. Thus, for example, a company that first becomes a banking
entity on January 1, 2015, would have until January 1, 2017, to bring
its activities and investments into conformance with the requirements
of section 13 of the BHC Act and its implementing regulations. In this
way, the final rule provides comparable treatment to ``new'' banking
entities and nonbank financial companies supervised by the Board, and
is consistent with the manner in which newly established bank holding
companies are treated for purposes of the nonbanking restrictions under
section 4 of the BHC Act.\15\
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\15\ See 12 U.S.C. 1843(a)(2).
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B. Extension of Conformance Period
The Volcker Rule also permits the Board, by rule or by order, to
extend the generally available two-year conformance period by up to
three additional one-year periods, for an aggregate conformance period
of 5 years.\16\ In order to grant any extension, the Board must
determine that the extension is consistent with the purposes of the
Volcker Rule and would not be detrimental to the public interest.\17\
The process and standards for obtaining a one-year extension are
discussed in Part III.E of this SUPPLEMENTARY INFORMATION.
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\16\ 12 U.S.C. 1851(c)(2).
\17\ Id.
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Several commenters requested that the Board modify the rule to
allow the Board to grant a banking entity at one time all three of the
one-year extensions potentially available under section 13(c)(2) of the
BHC Act.\18\ One commenter, however, suggested that multiple extensions
of the conformance period would not be in keeping with the purpose of
the Volcker Rule and urged the Board to restrict extensions to a single
one-year general extension (with potentially one additional one-year
extension in the case of an illiquid fund investment). Section 13(c)(2)
of the BHC Act specifically provides that the ``Board may, by rule or
order, extend [the general two-year conformance period] for not more
than one year at a time,'' with a maximum of three, one-year
extensions.\19\ Accordingly, the Board has modified the rule to clarify
that the Board may only grant up to three separate one-year extensions
of the general conformance period (and may not grant all three one-year
extensions at a single time).
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\18\ If the extension request pertained to an investment in an
illiquid fund, some commenters also requested that the rule allow
the Board, at the same time, to also approve a five-year extended
transition period for the investment.
\19\ See 12 U.S.C. 1851(c)(2) (emphasis added).
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Several commenters requested that the Board clarify that the final
rule provides a conformance period for both investments in hedge funds
and private equity funds and activities prohibited under the Volcker
Rule. The general conformance period (including any extension thereof)
is available to both banking entities and nonbank financial companies
supervised by the Board for activities commenced prior to the Volcker
Rule's effective date and applies to any activities, investments and
relationships that may be prohibited or restricted by the Volcker Rule.
C. Extended Transition Period for Illiquid Funds
Section 619 of the Dodd-Frank Act includes a special provision to
address the difficulty banking entities may experience in conforming
investments in illiquid funds. This provision expressly permits a
banking entity to request the Board's approval for an additional
extension of up to 5 years in order to permit the banking entity to
meet contractual commitments in place as of May 1, 2010, to a hedge
fund or private equity fund that qualifies as an ``illiquid fund.''
Specifically, the statute provides that the Board may extend the period
during which a banking entity may take or retain an ownership interest
in, or otherwise provide additional capital to, an illiquid fund, but
only if the extension is necessary to allow the banking entity to
fulfill a contractual obligation that was in effect on May 1, 2010.\20\
The statute also provides that any extended transition period granted
with respect to an illiquid fund automatically terminates on the date
during any such extension on which the banking entity is no longer
under a contractual obligation to invest in, or provide capital to, the
illiquid fund.
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\20\ Id. at Sec. 1851(c)(3)(A).
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As provided in the Volcker Rule, the Board may grant a banking
entity only one extended transition period with respect to any illiquid
fund, which may not exceed 5 years.\21\ Any extended transition period
granted may be in addition to the conformance period available under
other provisions of the Volcker Rule.\22\ The purpose of this extended
transition or ``wind-down'' period for investments in an illiquid fund
is to minimize disruption of existing investments in illiquid funds and
permit banking entities to fulfill existing obligations to illiquid
funds while still steadily moving banking entities toward conformance
with the prohibitions and restrictions of the Volcker Rule.\23\
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\21\ The statute provides that a banking entity may apply for a
single extension with respect to an illiquid fund, and that such
extension may not exceed 5 years. In light of the statutory
language, and as noted in the notice of proposed rulemaking, the
Board retains the right to grant an extended transition period of
less than 5 years if, based on all the facts and circumstances, it
determines a limited extension is appropriate.
\22\ Id. at Sec. 1851(c)(3)(B).
\23\ See 156 Cong. Rec. S5899 (daily ed. July 15, 2010)
(statement of Sen. Merkley).
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Section 225.181(b) of the final rule implements the statute's
extended transition period for illiquid funds.\24\ As a general matter,
and consistent with the terms of the Volcker Rule, the final rule
[[Page 8268]]
requires that a banking entity's investment in, or relationship with, a
hedge fund or private equity fund must meet two sets of criteria to
qualify for the statute's extended transition period. The first set of
criteria focuses on the nature, assets and investment strategy of the
hedge fund or private equity fund itself. The second set of criteria
focuses on the terms of the banking entity's investment in the hedge
fund or private equity fund.
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\24\ Section 13(h)(7)(B) of the BHC Act provides that, for
purposes of the definition of an ``illiquid fund,'' the term ``hedge
fund'' shall not include a ``private equity fund,'' as such term is
used in section 203(m) of the Investment Advisors Act of 1940 (15
U.S.C. 80b-3(m)).'' See 12 U.S.C. 1851(h)(7)(B). However, section
203(m) of the Investment Advisors Act, as added by section 408 of
the Dodd-Frank Act, does not contain a definition of, nor does it
use the term, ``private equity fund.'' Moreover, as the Board noted
in the proposal, Congress' intent in adopting this exclusion is
unclear. For example, a fund that invests primarily in nonpublic
portfolio companies, which are commonly referred to in the
investment community as ``private equity funds,'' appears to be the
type of fund that the Volcker Rule intended to potentially qualify
as an ``illiquid fund.'' The Board does not believe that it is
necessary to resolve the ambiguity surrounding this provision
because the exclusion would not have any effect on the ability of a
fund to qualify as an illiquid fund. This is because the Volcker
Rule defines a ``hedge fund'' and a ``private equity fund''
synonymously. 12 U.S.C. 1851(h)(2). Thus, any illiquid fund that
would have been excluded from the definition of ``hedge fund''
because it met the missing definition of a ``private equity fund''
in the Investment Advisors Act could still qualify for the extended
conformance period afforded to illiquid funds as a ``private equity
fund'' under the Volcker Rule itself.
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1. Fund-Focused Criteria
As noted above, the extended transition period under section
13(c)(3) of the BHC Act is available only with respect to investments
made in an ``illiquid fund,'' and then only with respect to investments
in or obligations to these funds made as of May 1, 2010. In accordance
with the language of the Volcker Rule, the final rule retains the
definition of an ``illiquid fund'' to mean a hedge fund or private
equity fund that: (i) As of May 1, 2010, was principally invested in
illiquid assets, or was invested in, and contractually committed to
principally invest in, illiquid assets; and (ii) makes all investments
pursuant to, and consistent with, an investment strategy to principally
invest in illiquid assets.\25\ In determining how to implement the
definition of an illiquid fund, the Board has considered, among other
things, the terms of the statute, as well as public comments submitted
on the proposed rule, information (including confidential supervisory
information) concerning the terms of investments in hedge funds or
private equity funds, the characteristics of liquid and illiquid
assets, and the ability of a fund to divest assets held by the fund.
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\25\ 12 CFR 225.180(f).
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a. ``Illiquid Asset.''
The final rule, like the proposal, generally defines an ``illiquid
asset'' as any asset that is not a liquid asset. In turn, the final
rule defines ``liquid assets'' to include:
Cash or cash equivalents;
Any asset that is traded on a recognized, established
exchange, trading facility or other market on which there exist
independent, bona fide offers to buy and sell so that a price
reasonably related to the last sales price or current bona fide
competitive bid and offer quotations can be determined for the asset
almost instantaneously;
Any asset for which there are bona fide, competitive bid
and offer quotations in a recognized inter-dealer quotation system or
similar system or for which multiple dealers furnish bona fide,
competitive bid and offer quotations to other brokers and dealers on
request;
Any asset the price of which is quoted routinely in a
widely disseminated publication that is readily available to the
general public or through an electronic service that provides
indicative data from real-time financial networks;
Any asset with an initial term of one year or less and the
payments on which at maturity may be settled, closed-out, or paid in
cash or one or more other liquid assets described above; and
Any other asset that the Board determines, based on all
the facts and circumstances, is a liquid asset.\26\
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\26\ 12 CFR 225.180(h).
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These standards are designed to capture the wide range of
instruments and assets (or their equivalents) that one actively or
routinely trades on markets or trading facilities, or for which bid,
offer or price quotations are widely available. For example, these
standards would treat as a liquid asset: (i) Equity and debt
securities, derivatives, and commodity futures traded on a registered
securities exchange, board of trade, alternative trading system,
electronic trading platform or similar market that provides
independent, bona fide offers to buy and sell; (ii) assets traded on an
electronic inter-dealer quotation system, such as OTC Bulletin Board or
the system maintained by PINK OTC Markets, Inc., as well as over-the-
counter derivatives, debt securities (such as corporate bonds), and
syndicated commercial loans for which active inter-dealer markets
exist; and (iii) financial instruments for which indicative price data
is supplied by an electronic service, such as Markit Group Limited.
The standards contained in the second, third, and fourth standards
above are based on existing standards in the Federal banking and
securities laws that are designed to identify securities that are
liquid and may be sold promptly at a price that is reasonably related
to its fair value. Specifically, the second standard above is based in
part on the SEC's definition of securities for which a ``ready market''
exists for purposes of the net capital rules applicable to broker-
dealers under the Securities Exchange Act of 1934 (``Exchange
Act'').\27\ Similarly, the third standard above is based, in part, on
the actions regularly taken by a ``qualified OTC market maker'' as
defined in the SEC's Rule 3b-8, with respect to securities under the
Exchange Act.\28\ The fourth standard above is based, in part, on the
criteria used to identify whether a security or other asset is a
``marketable security'' or a ``liquid asset'' for purposes of the
Board's Regulation W governing transactions between member banks and
their affiliates.\29\ In each instance, the Board has modified the
standard as incorporated into the final rule to reflect the broader
range of financial instruments (including derivatives) or other assets
that may be held by a hedge fund or private equity fund and that should
be considered ``liquid'' if traded or quoted in the manner described.
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\27\ See 15 CFR 240.15c3-1(c)(11)(i).
\28\ See 15 CFR 240.3b-8(a).
\29\ See 12 CFR 223.42(e) and (f)(5).
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The fifth standard is designed to capture instruments with a
relatively short (one year or less) duration and that can be monetized
or converted at maturity into a liquid asset. In light of these
features, the Board believes it is appropriate to treat such
instruments as liquid assets for purposes of the Volcker Rule's
conformance period. The final rule recognizes that there may be
situations where other, non-enumerated assets may be liquid even though
they are not included in the standards contained in sections
225.181(h)(1)-(5) of the final rule. In order to address these
situations, the Board has expressly retained the ability to determine
that any other asset is a liquid asset, based on all the facts and
circumstances.
On the other hand, consistent with the language of the Volcker
Rule, the definition of illiquid assets in the final rule should
generally encompass investments made by hedge funds or private equity
funds in privately-held portfolio companies, real estate (other than
those made through publicly traded REITs), and venture capital
opportunities, as well as investments in other hedge funds or private
equity funds where such investments do not qualify as liquid
assets.\30\ The Volcker Rule specifically refers to portfolio company
investments, real estate investments, and venture capital investments
as examples of the types of investments that should normally be
[[Page 8269]]
considered illiquid assets for these purposes.\31\
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\30\ Some commenters requested that the Board specifically
include in the definition of ``illiquid asset'' any investment in
real estate or a portfolio company and venture capital investments.
While the Board agrees that such investments are typically illiquid,
the Board does not believe it appropriate to include as illiquid
assets all investments that potentially could be characterized as a
real estate, portfolio company, or venture capital investment. For
example, the Board believes that an investment in the equity
securities of a small or recently established company should be
considered a liquid asset for purposes of the Volcker Rule if such
equity securities are traded on a national security exchange.
\31\ 12 U.S.C. 1851(h)(7)(A)(i)
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In addition, the final rule, like the proposed rule, provides that
an asset--including a liquid asset such as a security--may be
considered an ``illiquid asset'' if, because of statutory or regulatory
restrictions applicable to the hedge fund, private equity fund or
asset, the asset cannot be offered, sold, or otherwise transferred by
the hedge fund or private equity fund to a person that is unaffiliated
with the banking entity. This exception to the general ``liquid asset''
definition recognizes that funds frequently acquire assets that are
normally liquid in transactions that cause the asset to be subject to
one or more statutory or regulatory restrictions under the Federal
securities laws that temporarily prohibit the transferability or resale
of the security. For example, hedge funds or private equity funds often
acquire equity securities in private transactions that result in the
security being subject to restrictions on resale (such as under Rule
144A of the Securities Act of 1933).\32\ Several commenters requested
that the final rule also permit an asset to be an illiquid asset due to
contractual restrictions on sale or transfer (in addition to statutory
or regulatory restrictions). In response to comments, the Board has
modified the final rule to provide that an asset may be considered an
illiquid asset if contractual restrictions applicable to the hedge
fund, private equity fund or asset prohibit the fund from offering,
selling, or otherwise transferring the asset to a person that is
unaffiliated with the relevant banking entity for a period of 3 or more
years.
---------------------------------------------------------------------------
\32\ See 15 CFR 230.144a.
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Similarly, the proposed rule also provided that an asset would be
considered illiquid only for so long as the relevant statutory or
regulatory restriction was applicable. In light of the foregoing, as
well as the forward-looking nature of the ``principally invested'' and
``contractually committed'' to principally invest in illiquid assets
tests discussed below, the Board has removed those provisions of the
proposal. Accordingly, assets subject to the type of statutory,
regulatory, or contractual restrictions specified in the final rule
would generally be considered illiquid assets for purposes of the
Volcker Rule. However, because these restrictions may lapse at a future
date (including prior to the point in time when a banking entity
submits its request for an extended transition period), the final rule
has been modified to specifically provide that, in connection with its
review of a banking entity's request for an extended transition period,
the Board will consider the extent to which the fund's current assets
are no longer illiquid (e.g. due to the lapse of applicable
restrictions on an investment because a previously illiquid venture
capital or portfolio company investment has become liquid, such as
through the initial public offering of the company's stock).
Some commenters requested that the Board broaden the definition of
``illiquid assets'' to specifically include assets that would otherwise
meet the rule's definition of a liquid asset, but that the relevant
fund may have difficulty selling (or selling at a price the fund
believes to be reasonable) because the size of the fund's position in
the security or instrument is large relative to daily trading volume in
the security or instrument or the outstanding number of securities or
instruments of the same class or type. Some commenters also requested
that the rule provide the Board flexibility to determine, on a case-by-
case basis, that an asset that otherwise meets the definition of a
liquid asset was illiquid. Similarly, some commenters asked that the
rule specifically provide that a liquid asset could be considered
illiquid due to adverse market conditions that might make it difficult
for the fund to sell the security or instrument or sell it at a price
the fund believes is reasonable.
The Board recognizes that market conditions (including trading
volumes) at the time a security or instrument is being sold may have a
material effect on the price of the security or instrument. However, by
including only investments in portfolio companies, real estate
investments, and venture capital investments as examples of illiquid
assets, the Volcker Rule itself suggests that the term ``illiquid
asset'' was intended to encompass only those types of investments that
are illiquid by their nature, rather than those that may be illiquid
due only to prevailing market conditions or the size of a particular
fund's holdings of the security or instrument. This intent is
reinforced by the fact that the statute requires that a banking entity
determine whether a hedge fund or private equity fund is an illiquid
fund as of May 1, 2010.\33\ If the status of an investment by a fund as
a liquid or illiquid asset was dependent on market conditions at a
future date, it would be difficult or impossible for banking entities
and the Board to determine which funds qualify as illiquid funds and,
potentially, all hedge funds and private equity funds could qualify as
illiquid funds. The statute provides a general conformance period of up
to 5 years for any asset, which should assist banking entities in
transitioning large positions or assets to the requirements of the
Volcker Rule. Moreover, as discussed in Part III.E below, for those
funds that do qualify as illiquid funds, the Board may consider market
conditions, as well as the actions taken by the banking entity to
divest the impermissible investment, in determining whether to grant up
to a 5-year extended transition period with respect to the fund. For
these reasons, the Board has not modified the rule to allow an asset to
be considered illiquid based on market conditions or the absolute or
relative size of a fund's holdings.
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\33\ 12 U.S.C. 1851(h)(7)(A)(i).
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b. ``Principally invested.''
The statute's fund-related criteria also require that the hedge
fund or private equity fund either (1) have been principally invested
in illiquid assets as of May 1, 2010, or (2) have been invested to some
degree in illiquid assets and contractually committed to principally
invest in illiquid assets as of such date. In addition, in either case,
the fund must make all of its investments pursuant to, and consistent
with, an investment strategy to principally invest in illiquid assets.
The proposed rule provided that a hedge fund or private equity fund
would be considered to be ``principally invested'' in illiquid assets
if at least 75 percent of the fund's consolidated total assets are, or
were expected to be, comprised of illiquid assets or risk-mitigating
hedges entered into in connection with, and related to, individual or
aggregated positions in, or holdings of, illiquid assets. The proposal
allowed a fund to count risk-mitigating hedging positions that are
related to the fund's holdings of illiquid assets towards the 75
percent asset test because such positions are, by definition,
associated with the fund's illiquid holdings.
Commenters supported the inclusion of risk-mitigating hedging
positions related to illiquid assets in the determination of whether a
fund is ``principally invested'' in illiquid assets.\34\ However, many
commenters asserted that the proposed 75 percent threshold for a fund
to be principally invested in illiquid assets was too high and
requested that a lower threshold--no higher than approximately 50
percent--be included in the final rule. Many of these commenters noted
that
[[Page 8270]]
the Board had previously interpreted the phrase ``engaged principally''
in section 20 of the Glass-Steagall Act (previously codified at 12
U.S.C. 377) to mean between 5 percent and 25 percent of the relevant
firm's revenue.\35\ On the other hand, one commenter asserted that the
75 percent test was appropriate.
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\34\ The Board expects to interpret the language concerning
risk-mitigating hedges consistent with the manner in which such
language is implemented through the rulemaking process conducted
under section 13(b)(2) of the BHC Act.
\35\ Revenue Limit on Bank-Ineligible Activities of Subsidiaries
of Bank Holding Companies Engaged in Underwriting and Dealing in
Securities, 61 FR 68750 (Dec. 30, 1996); see also J.P. Morgan & Co.,
Inc., The Chase Manhattan Corp., Bankers Trust New York Corp.,
Citicorp, and Security Pacific Corp., 75 Federal Reserve Bulletin
192 (1989); Citicorp, J.P. Morgan & Co., and Bankers Trust New York
Corp., 73 Federal Reserve Bulletin 473 (1987).
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The Board continues to believe that 75 percent is an appropriate
threshold for determining whether a fund is ``principally invested'' in
illiquid assets for purposes of the Volcker Rule. As noted in the
proposed rule, many types of hedge funds and private equity funds have
investment strategies that focus almost exclusively on one type of
illiquid assets, such as real estate or start-up companies (including
new or emerging companies in the technology, life sciences, alternative
energy, or ``clean tech'' areas).\36\ These types of hedge funds and
private equity funds typically request capital contributions from their
investors only when particular investment opportunities have been
identified and hold only a small portion of their assets in cash or
other liquid assets (other than during brief periods pending the
investment of capital or the distribution of proceeds from the sale of
an investment). The Board continues to believe that by limiting the
availability of the extended transition period to hedge funds or
private equity funds that ``principally invest'' in and have an
investment strategy to principally invest in illiquid assets, such as
real estate, nonpublic portfolio companies, and venture capital
opportunities, Congress appears to have intended the extended
transition period to be available to those types of funds that
principally focus and direct their capital towards investments in
illiquid assets. Moreover, the Volcker Rule's extended transition
period is available only to banking entities that are contractually
obligated to invest or remain invested in the fund. Funds that have (or
expect to have) a substantial majority of their investments in illiquid
assets are more likely to prohibit investors from withdrawing their
investments prior to the expiration of the general conformance period
under the Volcker Rule (which, as noted above, may potentially extend
to 2017).
---------------------------------------------------------------------------
\36\ Accordingly, institutional investors, such as pension plans
and endowments, that seek exposure to different types of assets
typically invest in a range of different types of hedge funds or
private equity funds to obtain diversification across asset classes.
---------------------------------------------------------------------------
As the courts have recognized, statutory terms must be read in
light of the purposes of the relevant statutory provision and, thus,
the same or similar terms may appropriately be interpreted differently
when used in different acts.\37\ The Board notes, moreover, that while
commenters requested a lower threshold, commenters did not provide
specific examples of funds that would potentially satisfy the
``principally invested'' asset test if it was set at 50 percent as
opposed to 75 percent or supporting explanations as to why treating
such funds as illiquid funds would be more consistent with the purposes
of the Volcker Rule.
---------------------------------------------------------------------------
\37\ See Environmental Defense v. Duke Energy Corp., 549 U.S.
561, 575 (2007); see also U.S. v. Cleveland Indians Baseball Co.,
532 U.S. 200, 213 (2001); Robinson v. Shell Oil Co., 519 U.S. 337,
343-344 (1997).
---------------------------------------------------------------------------
As noted above, by the terms of the statute, a fund qualifies as an
illiquid fund if, as of May 1, 2010, it (i) was ``principally invested
in illiquid assets,'' or (ii) was invested in illiquid assets to some
degree and contractually committed to principally invest in illiquid
assets. In addition, the fund must actually make all of its investments
(including investments made after May 1, 2010,) pursuant to and
consistent with an investment strategy to principally invest in
illiquid assets.\38\
---------------------------------------------------------------------------
\38\ See 12 U.S.C. 1851(h)(7)(i) and (ii).
---------------------------------------------------------------------------
The final rule provides that the determination of whether a fund
was ``principally invested'' in illiquid assets as of May 1, 2010, must
be made based on the fund's financial statements prepared in accordance
with U.S. Generally Accepted Accounting Principles (``GAAP'') or other
applicable accounting standards. Several commenters noted that funds
often prepare their financial statements at the end of each calendar
quarter and, thus, may not have financial statements dated as of May 1,
2010. In recognition of this, a banking entity may use a fund's most
recent financial statements prepared under GAAP or other appropriate
accounting standards as of any date between February 28, 2010, and May
1, 2010, to determine whether the fund was principally invested in
illiquid assets as of May 1, 2010. Thus, if a fund prepares financial
statements at the end of each calendar quarter, the banking entity
could use the fund's financial statements as of March 30, 2010, to
determine whether the fund was principally invested in illiquid assets
as of May 1, 2010 (assuming the fund did not prepare additional
financial statements between March 30 and May 1, 2010).
Under the proposed rule, a fund would have been considered to be
``contractually committed to principally invest'' in illiquid assets as
of May 1, 2010, if the fund's organizational documents (such as the
limited partnership agreement in the case of a fund organized in this
manner), or other documents that constitute a contractual obligation of
the fund (such as a binding side letter agreement entered into with
investors) that was in effect as of May 1, 2010, provided for the fund
to be principally invested in illiquid assets. The proposed rule would
have required that any such contractual commitments require the fund to
be principally invested in illiquid assets during the period beginning
on the date when capital contributions are first received by the fund
for the purpose of making investments and ending on the fund's expected
termination date. Additionally, the proposed rule provided that a fund
would be considered to have an ``investment strategy to principally
invest'' in illiquid assets if the fund either: (i) markets or holds
itself out to investors as intending to principally invest in illiquid
assets; or (ii) has a documented investment policy of principally
investing in illiquid assets.
The Board has made several changes to the corresponding provisions
of the final rule in response to comments received on the proposal.
First, the Board has modified the final rule to provide that, in
determining whether a fund is contractually committed to principally
invest, or has an investment strategy to principally invest, in
illiquid assets, a banking entity may take into account written
representations contained in the fund's offering documents regarding
its investment obligations and strategy (in addition to the fund's
organizational documents). Funds typically are bound to comply with any
written representations contained in the fund's private placement
memorandum or other offering documents and a fund's failure to do so
may subject the fund to liability under the Federal securities
laws.\39\
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\39\ See, e.g., 17 CFR 240.10b-5. Some commenters requested that
the Board provide that a fund is ``contractually committed'' to
principally invest in illiquid assets if that was consistent with
the reasonable expectations of investors in the fund. The Board has
not modified the rule in this manner because such expectations may
not represent a legally binding obligation of the fund and would be
difficult to verify, thus potentially allowing evasions of the
Volcker Rule.
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Second, the final rule has been modified so that a fund will be
[[Page 8271]]
considered ``contractually committed to principally invest'' in
illiquid assets if the fund's organizational documents or offering
documents provide for the fund to be principally invested in illiquid
assets at all times other than during limited temporary periods. Some
commenters noted that, after its initial pre-investment organizational
period, an illiquid fund may naturally experience certain limited
periods of time when more than 25 percent of its assets may be in
liquid assets, such as when investments are exited and capital has not
yet been reinvested or distributed to investors.
Several commenters also asked that the Board clarify when the
determination of whether a fund is ``contractually committed to
principally invest'' in illiquid assets must be made and how such
determination should be made with respect to investments not yet made.
The Volcker Rule expressly provides that the determination of whether a
fund is ``contractually committed to principally invest'' in illiquid
assets is to be made ``as of May 1, 2010.'' \40\ Thus, a fund that was
contractually committed to principally invest in illiquid assets on May
1, 2010, would meet this prong of the test to be an illiquid fund.
---------------------------------------------------------------------------
\40\ 12 U.S.C. 1851(h)(7)(A)(i).
---------------------------------------------------------------------------
In considering whether a hedge fund or private equity fund's
organizational documents, marketing materials, or investment policy
provide for the fund to principally invest in illiquid assets, banking
entities should consider whether the assets to be acquired by the fund
(as specified in such materials) are of the type and nature that would
make the assets ``illiquid assets'' or ``liquid assets'' for purposes
of the rule. For example, if a fund's investment strategy provides for
the fund to primarily invest in publicly traded stocks or OTC
derivatives that are regularly bought and sold in the inter-dealer
market, the fund would not be considered to have an investment strategy
to principally invest in illiquid assets. This would be the case even
if the fund's investment strategy did not indicate that the assets
acquired by the fund must be traded on a recognized exchange, trading
facility, or market of the type described in section 225.180(h)(2) or
quoted on inter-dealer systems of the type described in section
225.180(h)(3). On the other hand, a fund generally would be considered
to have an investment policy of principally investing in illiquid
assets if the fund's organizational documents or offering materials
provide for the fund to invest in the equity of early-stage nonpublic
companies, even if the fund's documents do not specify that the equity
of such companies must not be traded or quoted in the manner described
in section 225.180(h)(2)-(4). This would be true even if such
investments may later be converted into publicly traded securities of
the company (such as, for example, in connection with an initial public
offering of the company) in order to facilitate the fund's sale of the
investment.
2. Criteria Focused on the Banking Entity's Investment
Besides meeting the criteria described above, a banking entity's
interest in a hedge fund or private equity fund may qualify for the
extended transition period in section 13(c)(3) of the BHC Act only if
the banking entity's retention of that ownership interest in the fund,
or provision of additional capital to the fund, is necessary to fulfill
a contractual obligation of the banking entity that was in effect on
May 1, 2010.\41\ This statutory restriction complements and reinforces
the fund-related criteria discussed above because a fund that is
principally invested in liquid assets is unlikely to require its
investors to commit to remaining invested in the fund for, or provide
additional capital over, the extended period of time covered by the
Volcker Rule's extended transition period.
---------------------------------------------------------------------------
\41\ 12 U.S.C. 1851(c)(3)(A).
---------------------------------------------------------------------------
The proposed rule provided that a banking entity would be
considered to have a ``contractual obligation'' to remain invested in a
fund only if the banking entity, under the contractual terms of its
equity, partnership, or other ownership interest in the fund or other
contractual arrangements with the fund that were in effect as of May 1,
2010, is prohibited from both: (i) Redeeming all of its equity,
partnership, or other ownership interests in the fund; and (ii) selling
or otherwise transferring all such ownership interests to a person that
is not an affiliate of the banking entity. Similarly, the proposed rule
specified that a banking entity has a contractual obligation to provide
additional capital to an illiquid fund only if the banking entity is
required, under the contractual terms of its equity, partnership, or
other ownership interest in the fund or other contractual arrangements
with the fund (such as a side letter with the fund that is binding on
the banking entity) that were in effect as of May 1, 2010, to provide
additional capital to the fund. The proposal also provided that either
of the contractual obligations described above will be considered not
to impose a contractual obligation to invest or remain invested for
purposes of the Volcker Rule if: (i) The obligation may be terminated
by the banking entity or any of its subsidiaries or affiliates; or (ii)
the obligation may be terminated with the consent of other persons
unless the banking entity and its subsidiaries and affiliates have used
their reasonable best efforts to obtain such consent and such consent
has been denied.
The Board received a number of comments on these aspects of the
proposal. For example, some commenters noted that a banking entity's
contractual obligation to remain invested in a fund may be subject to
one or more contractual provisions whereby the obligation may be
excused or otherwise terminated if the banking entity's compliance with
the obligation would cause, or would be reasonably likely to cause, the
banking entity or the fund to be in violation of applicable laws or
regulations (so-called ``regulatory-out'' provisions). Commenters
requested that the final rule permit a banking entity to qualify for
the extended transition period and remain invested in an illiquid fund
despite such regulatory-out provisions. These commenters asserted that
otherwise the purpose of the extended transition period would not be
fulfilled because those banking entities that exercised prudence in
obtaining regulatory outs in their agreements with illiquid funds would
be forced to exit these investments and could not take advantage of the
Volcker Rule's extended transition period for illiquid funds. These
commenters also asserted that such forced sales could have adverse
consequences on the banking entity, other investors in the fund, or the
markets for illiquid assets.
In addition, some commenters requested that the Board strike the
provisions of the final rule that provide that the extended transition
period automatically terminates upon expiration of the banking entity's
contractual obligation to remain invested in, or provide capital to, an
illiquid fund. One commenter specifically requested that the final rule
provide a 6-month ``grace period'' which would allow a banking entity
to conform its investment in and relationship with an illiquid fund
upon termination of the extended transition period. Several commenters
also requested that the final rule allow a banking entity to use
``commercially reasonable efforts'' instead of ``reasonable best
efforts'' to obtain any consents or approvals necessary to terminate
the banking entity's contractual obligation to a fund, and allow the
banking entity to remain
[[Page 8272]]
invested so long as such efforts are not successful.
The Board has carefully considered these comments. The plain
language of the Volcker Rule permits a banking entity to potentially
receive an extended transition period with respect to an investment in
an illiquid fund only if and to the extent necessary to fulfill a
contractual obligation that was in effect on May 1, 2010.\42\ Moreover,
the Volcker Rule specifically provides that any extended transition
granted by the Board will automatically, by operation of law, terminate
on the date on which the contractual obligation to invest in the
illiquid fund terminates.\43\
---------------------------------------------------------------------------
\42\ 12 U.S.C. 1851(c)(3).
\43\ Id. at Sec. 1851(c)(4)(B).
---------------------------------------------------------------------------
If, pursuant to the terms of its obligation in effect on May 1,
2010, a banking entity has the contractual right to terminate its
investment or commitments to an illiquid fund because such investments
would be prohibited by the Volcker Rule after the expiration of the
general conformance period (and any extensions thereof), then an
extended transition period would not be necessary to fulfill the
banking entity's contractual obligation to the fund because the banking
entity could legally withdraw from its investments or commitments
without violating its contractual obligation at the end of the general
conformance period (and any extensions thereof). Thus, the Board does
not believe the statute permits it to grant an extended transition
period to a banking entity if its contractual obligation in place on
May 1, 2010, permits the banking entity to terminate those obligations
because they would violate the Volcker Rule after the end of the
general conformance period (and any extensions thereof).\44\
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\44\ For similar reasons, the Board does not have discretion to
permit the extended transition period to continue after the date the
relevant banking entity's contractual obligation terminates. As
such, the final rule does not provide any ``grace period'' and
retains the requirement that any extended transition period
automatically terminates on the date on which the contractual
obligation to invest in, or provide additional capital to, the
illiquid fund terminates.
---------------------------------------------------------------------------
Whether a banking entity has the right to withdraw its investments
or terminate its obligations to an illiquid fund based on the
contractual provisions in effect on May 1, 2010, will depend on the
specific terms of those obligations. For example, if those obligations
provide the banking entity the right and ability to redeem or sell its
investment if the banking entity determines that continued ownership of
the investment would violate the Volcker Rule, the banking entity must
exercise that right no later than the end of the Volcker Rule's general
conformance period and any extensions thereof and should begin to plan
for such actions. In some instances, however, the banking entity's
right or ability to redeem or sell its investments under a regulatory-
out provision pertaining to its obligations in effect as of May 1,
2010, may be dependent on the consent of an unaffiliated party (such as
the general partner or other investors of the fund).\45\ In such
circumstances, the banking entity and its affiliates must use their
reasonable best efforts to obtain such consent.\46\ The Board will
consider whether a banking entity and its affiliates have used their
reasonable best efforts to obtain the unaffiliated party's consent in
determining whether to grant the banking entity an extended transition
period with respect to the investment.\47\ For example, the Board will
consider whether the banking entity used its reasonable best efforts,
but an unaffiliated general partner or other investors denied the
request due to the failure of the banking entity to agree to
unreasonable demands by the general partner or investors.
---------------------------------------------------------------------------
\45\ For example, the terms of the banking entity's regulatory-
out provision in its contractual obligation may allow the banking
entity to redeem or sell its investments only with the approval of
the general partner, or only if the general partner concurs that
retention of the banking entity's ownership interest would result in
a violation of the law.
\46\ The Board believes that requiring a banking entity to use
its ``reasonable best efforts'' to terminate its obligation
appropriately reflects the Volcker Rule's intent that banking
entities should use all reasonable efforts to conform to the
requirements of the Volcker Rule.
\47\ Some commenters noted that some contractual obligations in
place as of May 1, 2010, may require a banking entity to provide
additional capital to a fund even after the banking entity has fully
sold its investment in the fund (such as, for example, if the person
that acquired the banking entity's ownership interest fails to
comply with any related obligation to provide such additional
amounts). Subject to the conditions and restrictions described above
and in the final rule, such obligations may constitute a contractual
obligation to provide additional capital to the fund.
---------------------------------------------------------------------------
As noted above, the statute provides that the extended transition
period is only available to banking entities in order to take or retain
an interest in an illiquid fund, and then only to the extent necessary
to fulfill a contractual obligation that was in effect on May 1, 2010.
The Board recognizes that there may be instances where, in connection
with its ownership interest in an illiquid fund, a banking entity
serves as the general partner or managing member of, or otherwise
``sponsors,'' an illiquid fund. In such situations, a banking entity
will usually hold some ownership interest in the fund, and that
ownership interest may be in excess of the de minimis interest
permitted under the Volcker Rule.\48\ Accordingly, if a banking entity
is granted an extended transition period to take or retain an interest
in an illiquid fund, the banking entity may continue to serve as the
general partner, managing member, or sponsor of the illiquid fund to
the extent such service is related to the banking entity's retention of
its permitted ownership interest. If, however, a banking entity was not
acting as general partner, managing member, or sponsor of the illiquid
fund as of May 1, 2010, then it may not begin to serve that role during
the extended transition period.
---------------------------------------------------------------------------
\48\ See 12 U.S.C. 1851(d)(4).
---------------------------------------------------------------------------
D. Nonbank Financial Companies Supervised by the Board
As noted above, the Volcker Rule does not prohibit nonbank
financial companies supervised by the Board from engaging in
proprietary trading, or from having the types of investments in or
relationships with hedge funds or private equity funds that banking
entities are prohibited or restricted from having under the Volcker
Rule. However, the Volcker Rule provides that the Board or other
appropriate agency impose additional capital charges, quantitative
limits, or other restrictions on nonbank financial companies supervised
by the Board or their subsidiaries that are engaged in such activities
or maintain such relationships.\49\ The Volcker Rule generally gives
nonbank financial companies supervised by the Board the same general
two-year conformance period (with the potential of up to three, one-
year extensions) to bring their activities into compliance with any
requirements or limits established as is available to banking entities.
Accordingly, section 225.182 of the final rule provides a nonbank
financial company supervised by the Board two years after the date the
company first becomes a nonbank financial company supervised by the
Board to conform its activities to any applicable requirements of the
Volcker Rule, including any capital requirements or quantitative
limitations adopted thereunder and applicable to the company.
Consistent with the conformance period available to banking entities,
the final rule also provides the Board the ability to extend this two-
year conformance period by up to three additional one-year periods, if
the Board determines that such an extension is consistent with the
purpose of the Volcker Rule and would not be detrimental to the public
interest.\50\
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\49\ See id. at Sec. 1851(a)(2), (d)(4).
\50\ See id. at Sec. 1851(c)(2).
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[[Page 8273]]
E. Procedures Governing Extension Requests
The proposed rule also addressed the process for banking entities
and nonbank financial companies supervised by the Board to request a
one-year extension of the general conformance period and for banking
entities to request up to a five-year extended transition period with
respect to an illiquid fund. The proposed rule generally required that
any request for an extension must: (1) Be submitted in writing to the
Board at least 90 days prior to the expiration of the applicable time
period; (2) provide the reasons why the banking entity or nonbank
financial company supervised by the Board believes the extension should
be granted; and (3) provide a detailed explanation of the plan of the
banking entity of nonbank financial company supervised by the Board for
divesting or conforming the activity or investment(s). The proposed
rule also described the factors that the Board may consider in
reviewing any requests for an extension.
The Board received several comments on the procedures for
requesting an extension and the standards for reviewing these requests
set forth in the proposed rule. In general, commenters requested that
the Board allow a firm to submit an extension request well in advance
of the end of the applicable time period. Commenters noted that winding
down the activities and operations subject to the restrictions of the
Volcker Rule could take significant time, and, as a result, companies
subject to the Volcker Rule would benefit from knowing as early as
possible whether or not they had been granted an extension. Some
commenters additionally suggested that the Board modify the final rule
to expressly provide for a standard time period for its review of any
specific extension request, accompanied by an automatic approval of an
extension if the review was not completed in the specified period. One
commenter suggested that the Board require banking entities to provide
extensive information on the steps that the banking entity has taken to
conform to the requirements of the Volcker Rule.
Several comments also addressed the proposed rule's list of factors
that the Board would take into account in reviewing any request for a
conformance period extension. For example, commenters suggested that
the Board take into account the impact that an extension (or denial of
an extension) related to investments in a hedge fund or private equity
fund would have on unaffiliated, third-party investors in the fund,
including the potential creation of conflicts of interest between a
banking entity that sponsored a private equity or hedge fund and other
investors in such fund.
After considering the comments, the Board has modified the
provisions governing the submission and review of extension requests in
several respects. First, the final rule provides that a banking entity
or nonbank financial company supervised by the Board seeking an
extension of the conformance period must submit its request at least
180 days prior to the expiration of the applicable time period, rather
than 90 days as proposed. This additional period is designed to provide
the Board additional time to review any submission, as well as to
request additional information from the requesting company if necessary
or appropriate. This deadline is the date by which an extension request
must be filed. Firms are encouraged to submit their extension requests
to the Board as early as possible. If additional requests are
contemplated as being necessary after a permissible extension has been
granted, a banking entity or nonbank financial company supervised by
the Board may submit an additional request after the first day of the
newly-extended period, and the Board would consider each request
submitted in accordance with the procedures contained in the final
rule. The final rule also provides that the Board will seek to act on
any extension request no later than 90 days after receipt of all
necessary information relating to the request.\51\
---------------------------------------------------------------------------
\51\ See 12 CFR 225.181(d)(2) and 225.182(d)(2).
---------------------------------------------------------------------------
The proposed rule provided that, in reviewing a request for an
extension, the Board may consider all the facts and circumstances
related to the activity, investment, or fund, including each of the
following factors (to the extent they are relevant): (i) Whether the
activity or investment (A) involves or results in material conflicts of
interest between the banking entity (or nonbank financial company
supervised by the Board) and its clients, customers or counterparties;
(B) would result, directly or indirectly, in a material exposure by the
banking entity (or company) to high-risk assets or high-risk trading
strategies; (C) would pose a threat to the safety and soundness of the
banking entity (or company); or (D) would pose a threat to the
financial stability of the United States; (ii) market conditions; (iii)
the nature of the activity or investment; (iv) the date that the
banking entity's contractual obligation to make or retain an investment
in the fund was incurred and when it expires; (v) the contractual terms
governing the banking entity's interest in the fund; (vi) the degree of
control held by the banking entity over investment decisions of the
fund; (vii) the types of assets held by the fund; (viii) the date on
which the fund is expected to wind up its activities and liquidate or
its investments may be redeemed or sold; (ix) the total exposure of the
banking entity (or company) to the activity or investment and the risks
that disposing of, or maintaining, the investment or activity may pose
to the banking entity (or company); (x) the cost to the banking entity
(or company) of disposing of the activity or investment within the
applicable period; and (xi) any other factor that the Board believes
appropriate
After consideration of the comments, the Board has modified one
existing factor and added two additional factors to this list. The
first additional factor is whether divestiture or conformance of the
activity or investment would involve or result in a material conflict
of interest between the banking entity (or nonbank financial company
supervised by the Board) and unaffiliated clients, customers, or
counterparties to which the banking entity owes a duty. Because the
Volcker Rule is intended to help prevent material conflicts of interest
between a banking entity or nonbank financial company supervised by the
Board and its clients, customers or counterparties, the Board believe
this is an appropriate factor to consider in reviewing extension
requests.\52\ The Board expects that this factor may be relevant when
the banking entity serves as general partner or sponsor to a fund in
which unaffiliated persons are investors, but generally would not be
relevant when the banking entity (in addition to having an investment)
serves only as investment advisor to the fund, because serving as an
investment advisor would generally be a permissible activity for a
banking entity even if it divests its ownership interests in the fund
itself. In addition, the Board has modified the list of factors to
specify that the Board may consider the firm's prior efforts to divest
or conform the activity or investments, including, with respect to an
illiquid fund, the extent to which the banking entity has made
reasonable best efforts to terminate or obtain a waiver of its
contractual obligation to take or retain an equity, partnership, or
other ownership interest in, or provide additional capital to, the
illiquid fund. The Board expects all banking entities and nonbank
financial companies supervised by the Board to make
[[Page 8274]]
reasonable and good-faith efforts to divest or otherwise conform their
prohibited activities and investments within the prescribed time
periods. This includes taking all reasonable steps to divest the firm's
interests in private equity and hedge funds covered by the restrictions
in the Volcker Rule, such as making requests of a general partner or
other applicable person(s) to withdraw from or transfer its interest in
the fund whenever authorized or permitted by the relevant fund
documents. The factors listed in the rule are not exclusive, and the
Board retains the ability to consider other factors or considerations
that it deems appropriate.
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\52\ See 12 U.S.C. 1851(d)(2)(A)(i).
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As noted in the proposed rule, the Board expects to carefully
review requests for an extended transition period to ensure that the
banking entity's interest in the fund and the fund's assets and
investment strategy satisfy the requirements contained in the rule in
order to be eligible for an extended transition period. As noted above
in Part III.C.1.a of this SUPPLEMENTARY INFORMATION, the final rule
provides that in evaluating the merits and appropriateness of a request
for an extended transition period for an investment in an illiquid
fund, the Board will consider the extent to which the fund's current
assets are no longer illiquid (e.g. due to lapse of applicable
restrictions on an investment because a previously illiquid venture
capital or portfolio company investment has become liquid, such as
through the initial public offering of the company's stock). The Board
has modified the list of factors the Board may consider in the final
rule to make this clear.
The final rule retains the proposed rule's provision that allows
the Board to impose conditions on any extension granted if the Board
determines such conditions are necessary or appropriate to protect the
safety and soundness of banking entities or the financial stability of
the United States, address material conflicts of interest or other
unsound practices, or otherwise further the purposes of section 13 of
the BHC Act and the final rules.\53\ In cases where the banking entity
is primarily supervised by another Federal banking agency, the SEC, or
the CFTC, the Board will consult with such agency prior to approving
any extension request by the banking entity, as well as before imposing
conditions in connection with the approval of any extension request by
the banking entity.
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\53\ Nothing in the Volcker Rule or the final rule limits or
otherwise affects the authority that the Board, the other Federal
banking agencies, the SEC, or the CFTC may have under other
provisions of law. In the case of the Board, these authorities
include, but are not limited to, section 8 of the Federal Deposit
Insurance Act and section 8 of the BHC Act. See 12 U.S.C. 1818,
1847.
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IV. Administrative Law Matters
A. Paperwork Reduction Act Analysis
In accordance with the Paperwork Reduction Act of 1995
(``PRA''),\54\ the Board has reviewed this final rule under the
authority delegated to the Board by Office of Management and Budget
(``OMB''). The Board may not conduct or sponsor, and a respondent is
not required to respond to, an information collection unless it
displays a currently valid OMB control number.
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\54\ 44 U.S.C. 3506; 5 CFR 1320, Appendix A.1
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Sections 225.181(c) and 225.182(c) of the final rule contain
collections of information that are subject to the PRA. The OMB control
number for these information collections will be assigned. These
collections of information would only be required for banking entities
and nonbank financial companies supervised by the Board that
voluntarily decide to seek an extension of time to conform their
activities to the Volcker Rule or divest their interest in an illiquid
hedge fund or private equity fund. As discussed in the SUPPLEMENTARY
INFORMATION, the Dodd-Frank Act generally requires banking entities and
nonbank financial holding companies supervised by the Board to conform
their activities and investments to the restrictions in the Volcker
Rule within 2 years of the effective date of the Volcker Rule's
restrictions. The final rule implements this conformance period and, as
permitted by the Dodd-Frank Act, permits a banking entity or nonbank
financial company supervised by the Board to request an extension of
time to conform its activities to the Volcker Rule. Section 225.181(c)
would require an application for an extension by a banking entity to be
(1) submitted in writing to the Board at least 180 days prior to the
expiration of the applicable time period, (2) provide the reasons why
the banking entity believes the extension should be granted, and (3)
provide a detailed explanation of the banking entity's plan for
divesting or conforming the activity or investment(s). Section
225.182(c) would require an application for an extension by a nonbank
financial holding company to be (1) submitted in writing to the Board
at least 180 days prior to the expiration of the applicable time
period, (2) provide the reasons why the nonbank financial holding
company believes the extension should be granted, and (3) provide a
detailed explanation of the company's plan for coming into compliance
with the requirements of the Volcker Rule. A request by a banking
entity or nonbank financial company supervised by the Board also must
address the relevant factors set out in section 225.181(d). A banking
entity or nonbank financial company supervised by the Board may request
confidential treatment of information submitted as part of an extension
request in accordance with the Freedom of Information Act.
In connection with the proposal, the Board estimated that there
were approximately 7,200 banking entities as of December 31, 2009. Of
that number, the Board estimated that approximately 720 banking
entities would request an extension of the conformance period under the
proposed rule. The number of nonbank financial companies supervised by
the Board will be determined by the FSOC in accordance with the
procedures established under the Dodd-Frank Act. Accordingly, the Board
was unable and remains unable at this time to estimate the number of
nonbank financial companies supervised by the Board that might request
an extension of the Volcker Rule conformance period under the proposed
rule. In the proposal, the Board estimated the burden request as 1
hour, for a total estimated amount of annual burden of 720 hours.
Some commenters asserted that the Board's proposal underestimated
the regulatory burden and stated that it would take substantially
longer than one hour to prepare a request for an extension and relevant
supporting information. One commenter specifically noted that a banking
entity could potentially be required to submit up to four extension
requests with respect to a single illiquid fund (three requests for
extension of the general conformance period and one request for the
extended transition period provided for illiquid funds). In light of
the comments received, the Board has revised its estimated burden per
request to be 3 hours, and estimates that each of the 720 banking
entities that are estimated to request an extension will file, on
average, 10 requests for an extension, for a total estimated annual
burden of 21,600 hours.
B. Regulatory Flexibility Act Analysis
In accordance with Section 4(a) of the Regulatory Flexibility Act,
5 U.S.C. 601 et seq, (``RFA''), the Board must publish a final
regulatory flexibility analysis with this rulemaking. The RFA requires
an agency either to provide a final regulatory flexibility analysis
with a final rule for which a general notice of
[[Page 8275]]
proposed rulemaking is required or to certify that the final rule will
not have a significant economic impact on a substantial number of small
entities. Based on this analysis and for the reasons stated below, the
Board believes that the final rule would not have a significant
economic impact on a substantial number of small entities.
Nevertheless, the Board is publishing a final regulatory flexibility
analysis.
The Volcker Rule, adopted as a new section 13 of the BHC Act,
applies to all banking entities and nonbank financial companies
supervised by the Board, regardless of size. The Board is amending
Regulation Y to implement the provisions of the Dodd-Frank Act that
allow a banking entity--including a small banking entity--or a nonbank
financial company supervised by the Board to obtain, with the Board's
approval, an extended period of time to conform its activities and
investments to the requirements of the Volcker Rule. Under the rule, a
banking entity of any size may request up to three one-year extensions
of the general two-year conformance period provided under section 13 of
the BHC Act, as well as one extension of up to five years to divest
certain ownership interests in a hedge fund or private equity fund that
qualifies as an ``illiquid fund'' under the statute and proposed rule.
The SUPPLEMENTARY INFORMATION provides additional information regarding
the reasons for, and the objective and legal basis of, the rule.
Under regulations issued by the Small Business Administration
(``SBA''), a bank or other depository institution is considered
``small'' if it has $175 million or less in assets.\55\ As of December
31, 2009, there were approximately 2450 small bank holding companies,
293 small savings association, 132 small national banks, 73 small State
member banks, 665 small State nonmember banks, and 21 small foreign
banking organizations that are subject to section 8 of the
International Banking Act of 1978. As of that date, there were no
nonbank financial companies supervised by the Board. The Volcker Rule
would affect only those entities that engage in activities or that hold
investments prohibited or restricted under the terms of the Volcker
Rule. As explained above, the Board estimates that of the total number
of banking entities that would be affected by the Volcker Rule,
approximately 10 percent would likely file an extension request under
the proposed rule. Based on its supervisory experience, the Board
believes that small banking entities are less likely to be engaged in
the types of activities or hold investments prohibited under the
Volcker Rule, and as such estimates that only 5 percent of small
banking entities likely would file an extension request under the rule.
The Board specifically requested comment on whether this estimate is
appropriate, and no comments were received on this issue. The Board
notes that the impact of the rule on entities choosing to take
advantage of the rule's extended conformance period would be positive
and not adverse. This is because the rule would allow affected entities
to seek and obtain an extended period of time to conform their
activities, investments, or relationships to the requirements of the
Volcker Rule. The Board also has taken several steps to reduce the
potential burden of the rule on all banking entities, including small
banking entities. For example, the rule establishes a straightforward
process for banking entities, including small banking entities, to
request an extension of the conformance period or an extended
transition period with respect to an investment in an illiquid fund,
and permits such requests to be submitted in letter form. The rule also
uses standards drawn from existing federal banking and securities
regulations to help define the types of funds that may qualify as an
``illiquid fund'' under the statute and the rule, which should assist
small banking entities in determining whether their investments qualify
for the extended transition period available for investments in
illiquid funds.
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\55\ 13 CFR 121.201.
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As discussed in the SUPPLEMENTARY INFORMATION, the Dodd-Frank Act
requires that the Board adopt rules implementing the Volcker Rule's
conformance period. The Board does not believe that the final rule
duplicates, overlaps, or conflicts with any other Federal rules.
Plain Language
Section 722 of the Gramm-Leach-Bliley Act requires the Federal
banking agencies to use plain language in all proposed and final rules
published after January 1, 2000. The Board invited comment on whether
the proposed rule was written plainly and clearly, or whether there
were ways the Board could make the rule easier to understand. The Board
received no comments on these matters and believes that the final rule
is written plainly and clearly.
List of Subjects in 12 CFR Part 225
Administrative practice and procedure, Banks, Banking, Holding
companies, Reporting and recordkeeping requirements, Securities.
Authority and Issuance
For the reasons stated in the preamble, the Board is amending
Regulation Y, 12 CFR part 225, as set forth below:
PART 225--REGULATION Y--BANK HOLDING COMPANIES AND CHANGE IN BANK
CONTROL (REGULATION Y)
0
1. The authority citation for part 225 is revised to read as follows:
Authority: 12 U.S.C. 1817(j)(13), 1818, 1828(o), 1831i, 1831p-
1, 1843(c)(8), 1844(b), 1851, 1972(1), 3106, 3108, 3310, 3331-3351,
3907, and 3909; 15 U.S.C. 6801 and 6805.
0
2. Section 225.1(c)(11) is revised to read as follows:
Sec. 225.1 Authority, purpose, and scope.
* * * * *
(c) * * *
(11) Subpart K governs the period of time that firms subject to
section 13 of the Bank Holding Company Act (12 U.S.C. 1851) have to
bring their activities, investments and relationships into compliance
with the requirements of such section.
* * * * *
0
3. Subpart K is added to read as follows:
Subpart K--Proprietary Trading and Relationships With Hedge Fund and
Private Equity Funds
Sec.
225.180 Definitions.
225.181 Conformance Period for Banking Entities Engaged in
Proprietary Trading or Private Fund Activities.
225.182 Conformance Period for Nonbank Financial Companies
Supervised by the Board Engaged in Proprietary Trading or Private
Fund Activities.
Subpart K--Proprietary Trading and Relationships With Hedge Funds
and Private Equity Funds
Sec. 225.180 Definitions.
For purposes of this subpart:
(a) Banking entity means--
(1) Any insured depository institution;
(2) Any company that controls an insured depository institution;
(3) Any company that is treated as a bank holding company for
purposes of section 8 of the International Banking Act of 1978; and
(4) Any affiliate or subsidiary of any of the foregoing entities.
(b) Hedge fund and private equity fund mean an issuer that would be
an investment company, as defined in the Investment Company Act of 1940
(15
[[Page 8276]]
U.S.C. 80a-1 et seq.), but for section 3(c)(1) or 3(c)(7) of that Act,
or such similar funds as the appropriate Federal banking agencies, the
Securities and Exchange Commission, and the Commodity Futures Trading
Commission may, by rule, as provided in section 13(b)(2) of the Bank
Holding Company Act (12 U.S.C. 1851(b)(2)), determine.
(c) Insured depository institution has the same meaning as given
that term in section 3 of the Federal Deposit Insurance Act (12 U.S.C.
1813), except that for purposes of this subpart the term shall not
include an institution that functions solely in a trust or fiduciary
capacity if--
(1) All or substantially all of the deposits of such institution
are in trust funds and are received in a bona fide fiduciary capacity;
(2) No deposits of such institution which are insured by the
Federal Deposit Insurance Corporation are offered or marketed by or
through an affiliate of such institution;
(3) Such institution does not accept demand deposits or deposits
that the depositor may withdraw by check or similar means for payment
to third parties or others or make commercial loans; and
(4) Such institution does not--
(i) Obtain payment or payment related services from any Federal
Reserve bank, including any service referred to in section 11A of the
Federal Reserve Act (12 U.S.C. 248a); or
(ii) Exercise discount or borrowing privileges pursuant to section
19(b)(7) of the Federal Reserve Act (12 U.S.C. 416(b)(7)).
(d) Nonbank financial company supervised by the Board means a
nonbank financial company supervised by the Board of Governors, as
defined in section 102 of the Dodd-Frank Wall Street Reform and
Consumer Protection Act of 2010 (12 U.S.C. 5311).
(e) Board means the Board of Governors of the Federal Reserve
System.
(f) Illiquid fund means a hedge fund or private equity fund that:
(1) As of May 1, 2010--
(i) Was principally invested in illiquid assets; or
(ii) Was invested in, and contractually committed to principally
invest in, illiquid assets; and
(2) Makes all investments pursuant to, and consistent with, an
investment strategy to principally invest in illiquid assets.
(g) Illiquid assets means any real property, security, obligation,
or other asset that--
(1) Is not a liquid asset;
(2) Because of statutory or regulatory restrictions applicable to
the hedge fund, private equity fund or asset, cannot be offered, sold,
or otherwise transferred by the hedge fund or private equity fund to a
person that is unaffiliated with the relevant banking entity; or
(3) Because of contractual restrictions applicable to the hedge
fund, private equity fund or asset, cannot be offered, sold, or
otherwise transferred by the hedge fund or private equity fund for a
period of 3 years or more to a person that is unaffiliated with the
relevant banking entity.
(h) Liquid asset means:
(1) Cash or cash equivalents;
(2) An asset that is traded on a recognized, established exchange,
trading facility or other market on which there exist independent, bona
fide offers to buy and sell so that a price reasonably related to the
last sales price or current bona fide competitive bid and offer
quotations can be determined for the particular asset almost
instantaneously;
(3) An asset for which there are bona fide, competitive bid and
offer quotations in a recognized inter-dealer quotation system or
similar system or for which multiple dealers furnish bona fide,
competitive bid and offer quotations to other brokers and dealers on
request;
(4) An asset the price of which is quoted routinely in a widely
disseminated publication that is readily available to the general
public or through an electronic service that provides indicative data
from real-time financial networks;
(5) An asset with an initial term of one year or less and the
payments on which at maturity may be settled, closed-out, or paid in
cash or one or more other liquid assets described in paragraphs (h)(1),
(2), (3), or (4); and
(6) Any other asset that the Board determines, based on all the
facts and circumstances, is a liquid asset.
(i) Principally invested and related definitions. A hedge fund or
private equity fund:
(1) Is principally invested in illiquid assets if at least 75
percent of the fund's consolidated total assets are--
(i) Illiquid assets; or
(ii) Risk-mitigating hedges entered into in connection with and
related to individual or aggregated positions in, or holdings of,
illiquid assets;
(2) Is contractually committed to principally invest in illiquid
assets if the fund's organizational documents, other documents that
constitute a contractual obligation of the fund, or written
representations contained in the fund's offering materials distributed
to potential investors provide for the fund to be principally invested
in assets described in paragraph (i)(1) at all times other than during
temporary periods, such as the period prior to the initial receipt of
capital contributions from investors or the period during which the
fund's investments are being liquidated and capital and profits are
being returned to investors; and
(3) Has an investment strategy to principally invest in illiquid
assets if the fund--
(i) Markets or holds itself out to investors as intending to
principally invest in assets described in paragraph (i)(1) of this
section; or
(ii) Has a documented investment policy of principally investing in
assets described in paragraph (i)(1) of this section.
Sec. 225.181 Conformance Period for Banking Entities Engaged in
Prohibited Proprietary Trading or Private Fund Activities.
(a) Conformance Period--(1) In general. Except as provided in
paragraph (b)(2) or (3) of this section, a banking entity shall bring
its activities and investments into compliance with the requirements of
section 13 of the Bank Holding Company Act (12 U.S.C. 1851) and this
subpart no later than 2 years after the earlier of:
(i) July 21, 2012; or
(ii) Twelve months after the date on which final rules adopted
under section 13(b)(2) of the Bank Holding Company Act (12 U.S.C.
1851(b)(2)) are published in the Federal Register.
(2) New banking entities.--A company that was not a banking entity,
or a subsidiary or affiliate of a banking entity, as of July 21, 2010,
and becomes a banking entity, or a subsidiary or affiliate of a banking
entity, after that date shall bring its activities and investments into
compliance with the requirements of section 13 of the Bank Holding
Company Act (12 U.S.C. 1851) and this subpart before the later of--
(i) The conformance date determined in accordance with paragraph
(a)(1) of this section; or
(ii) Two years after the date on which the company becomes a
banking entity or a subsidiary or affiliate of a banking entity.
(3) Extended conformance period. The Board may extend the two-year
period under paragraph (a)(1) or (2) of this section by not more than
three separate one-year periods, if, in the judgment of the Board, each
such one-year extension is consistent with the purposes of section 13
of the Bank Holding Company Act (12 U.S.C. 1851)
[[Page 8277]]
and this subpart and would not be detrimental to the public interest.
(b) Illiquid funds--(1) Extended transition period. The Board may
further extend the period provided by paragraph (a) of this section
during which a banking entity may acquire or retain an equity,
partnership, or other ownership interest in, or otherwise provide
additional capital to, a private equity fund or hedge fund if--
(i) The fund is an illiquid fund; and
(ii) The acquisition or retention of such interest, or provision of
additional capital, is necessary to fulfill a contractual obligation of
the banking entity that was in effect on May 1, 2010.
(2) Duration limited. The Board may grant a banking entity only one
extension under paragraph (b)(1) of this section and such extension--
(i) May not exceed 5 years beyond any conformance period granted
under paragraph (a)(3) of this section; and
(ii) Shall terminate automatically on the date during any such
extension on which the banking entity is no longer under a contractual
obligation described in paragraph (b)(1)(ii).
(3) Contractual obligation. For purposes of this paragraph (b)--
(i) A banking entity has a contractual obligation to take or retain
an equity, partnership, or other ownership interest in an illiquid fund
if the banking entity is prohibited from redeeming all of its equity,
partnership, or other ownership interests in the fund, and from selling
or otherwise transferring all such ownership interests to a person that
is not an affiliate of the banking entity--
(A) Under the terms of the banking entity's equity, partnership, or
other ownership interest in the fund or the banking entity's other
contractual arrangements with the fund or unaffiliated investors in the
fund; or
(B) If the banking entity is the sponsor of the fund, under the
terms of a written representation made by the banking entity in the
fund's offering materials distributed to potential investors;
(ii) A banking entity has a contractual obligation to provide
additional capital to an illiquid fund if the banking entity is
required to provide additional capital to such fund--
(A) Under the terms of its equity, partnership or other ownership
interest in the fund or the banking entity's other contractual
arrangements with the fund or unaffiliated investors in the fund; or
(B) If the banking entity is the sponsor of the fund, under the
terms of a written representation made by the banking entity in the
fund's offering materials distributed to potential investors; and
(iii) A banking entity shall be considered to have a contractual
obligation for purposes of paragraph (b)(3)(i) or (ii) of this section
only if--
(A) The obligation may not be terminated by the banking entity or
any of its subsidiaries or affiliates under the terms of its agreement
with the fund; and
(B) In the case of an obligation that may be terminated with the
consent of other persons, the banking entity and its subsidiaries and
affiliates have used their reasonable best efforts to obtain such
consent and such consent has been denied.
(c) Approval Required to Hold Interests in Excess of Time Limit.
The conformance period in paragraph (a) of this section may be extended
in accordance with paragraph (a)(3) or (b) of this section only with
the approval of the Board. A banking entity that seeks the Board's
approval for an extension of the conformance period under paragraph
(a)(3) or for an extended transition period under paragraph (b)(1)
must--
(1) Submit a request in writing to the Board at least 180 days
prior to the expiration of the applicable time period;
(2) Provide the reasons why the banking entity believes the
extension should be granted, including information that addresses the
factors in paragraph (d)(1) of this section; and
(3) Provide a detailed explanation of the banking entity's plan for
divesting or conforming the activity or investment(s).
(d) Factors governing Board determinations--(1) Extension requests
generally. In reviewing any application by a specific company for an
extension under paragraph (a)(3) or (b)(1) of this section, the Board
may consider all the facts and circumstances related to the activity,
investment, or fund, including, to the extent relevant--
(i) Whether the activity or investment--
(A) Involves or results in material conflicts of interest between
the banking entity and its clients, customers or counterparties;
(B) Would result, directly or indirectly, in a material exposure by
the banking entity to high-risk assets or high-risk trading strategies;
(C) Would pose a threat to the safety and soundness of the banking
entity; or
(D) Would pose a threat to the financial stability of the United
States;
(ii) Market conditions;
(iii) The nature of the activity or investment;
(iv) The date that the banking entity's contractual obligation to
make or retain an investment in the fund was incurred and when it
expires;
(v) The contractual terms governing the banking entity's interest
in the fund;
(vi) The degree of control held by the banking entity over
investment decisions of the fund;
(vii) The types of assets held by the fund, including whether any
assets that were illiquid when first acquired by the fund have become
liquid assets, such as, for example, because any statutory, regulatory,
or contractual restrictions on the offer, sale, or transfer of such
assets have expired;
(viii) The date on which the fund is expected to wind up its
activities and liquidate, or its investments may be redeemed or sold;
(ix) The total exposure of the banking entity to the activity or
investment and the risks that disposing of, or maintaining, the
investment or activity may pose to the banking entity or the financial
stability of the United States;
(x) The cost to the banking entity of divesting or disposing of the
activity or investment within the applicable period;
(xi) Whether the divestiture or conformance of the activity or
investment would involve or result in a material conflict of interest
between the banking entity and unaffiliated clients, customers or
counterparties to which it owes a duty;
(xii) The banking entity's prior efforts to divest or conform the
activity or investment(s), including, with respect to an illiquid fund,
the extent to which the banking entity has made efforts to terminate or
obtain a waiver of its contractual obligation to take or retain an
equity, partnership, or other ownership interest in, or provide
additional capital to, the illiquid fund; and
(xiii) Any other factor that the Board believes appropriate.
(2) Timing of Board review. The Board will seek to act on any
request for an extension under paragraph (a)(3) or (b)(1) of this
section no later than 90 calendar days after the receipt of a complete
record with respect to such request.
(3) Consultation. In the case of a banking entity that is primarily
supervised by another Federal banking agency, the Securities and
Exchange Commission, or the Commodity Futures Trading Commission, the
Board will consult with such agency prior to the approval of a request
by the banking entity for an extension under paragraph (a)(3) or (b)(1)
of this section.
(e) Authority to impose restrictions on activities or investments
during any extension period--(1) In general. The Board may impose such
conditions on any extension approved under paragraph (a)(3) or (b)(1)
of this section as the Board determines are necessary or
[[Page 8278]]
appropriate to protect the safety and soundness of the banking entity
or the financial stability of the United States, address material
conflicts of interest or other unsound banking practices, or otherwise
further the purposes of section 13 of the Bank Holding Company Act (12
U.S.C. 1851) and this subpart.
(2) Consultation. In the case of a banking entity that is primarily
supervised by another Federal banking agency, the Securities and
Exchange Commission, or the Commodity Futures Trading Commission, the
Board will consult with such agency prior to imposing conditions on the
approval of a request by the banking entity for an extension under
paragraph (a)(3) or (b)(1) of this section.
Sec. 225.182 Conformance Period for Nonbank Financial Companies
Supervised by the Board Engaged in Proprietary Trading or Private Fund
Activities.
(a) Divestiture Requirement. A nonbank financial company supervised
by the Board shall come into compliance with all applicable
requirements of section 13 of the Bank Holding Company Act (12 U.S.C.
1851) and this subpart, including any capital requirements or
quantitative limitations adopted thereunder and applicable to the
company, not later than 2 years after the date the company becomes a
nonbank financial company supervised by the Board.
(b) Extensions. The Board may, by rule or order, extend the two-
year period under paragraph (a) by not more than three separate one-
year periods, if, in the judgment of the Board, each such one-year
extension is consistent with the purposes of section 13 of the Bank
Holding Company Act (12 U.S.C. 1851) and this subpart and would not be
detrimental to the public interest.
(c) Approval Required to Hold Interests in Excess of Time Limit. A
nonbank financial company supervised by the Board that seeks the
Board's approval for an extension of the conformance period under
paragraph (b) of this section must--
(1) Submit a request in writing to the Board at least 180 days
prior to the expiration of the applicable time period;
(2) Provide the reasons why the nonbank financial company
supervised by the Board believes the extension should be granted; and
(3) Provide a detailed explanation of the company's plan for
conforming the activity or investment(s) to any applicable requirements
established under section 13(a)(2) or (f)(4) of the Bank Holding
Company Act (12 U.S.C. 1851(a)(2) and (f)(4)).
(d) Factors governing Board determinations--(1) In general. In
reviewing any application for an extension under paragraph (b) of this
section, the Board may consider all the facts and circumstances related
to the nonbank financial company and the request including, to the
extent determined relevant by the Board, the factors described in Sec.
225.181(d)(1).
(2) Timing. The Board will seek to act on any request for an
extension under paragraph (b) of this section no later than 90 calendar
days after the receipt of a complete record with respect to such
request.
(f) Authority to impose restrictions on activities or investments
during any extension period. The Board may impose conditions on any
extension approved under paragraph (b) of this section as the Board
determines are necessary or appropriate to protect the safety and
soundness of the nonbank financial company or the financial stability
of the United States, address material conflicts of interest or other
unsound practices, or otherwise further the purposes of section 13 of
the Bank Holding Company Act (12 U.S.C. 1851) and this subpart.
Subpart L--Conditions to Orders
0
4. Add subpart L with a heading as set forth above, and consisting of
existing Sec. 225.200.
By order of the Board of Governors of the Federal Reserve
System, February 8, 2011.
Jennifer J. Johnson,
Secretary of the Board.
[FR Doc. 2011-3199 Filed 2-11-11; 8:45 am]
BILLING CODE 6210-01-P