The Jan. 30 decision by five federal agencies to propose changes to the Volcker rule that would allow banks, in certain circumstances, to invest in or sponsor hedge funds or private equity funds prompted some immediate opposition, even from some in leadership positions at the agencies themselves.
“We continue the march toward effective repeal of the Volcker rule,” maintained SEC Commissioner Allison Herren Lee, voicing her opposition to the proposed changes. The revision “ignores … risk-reducing public policy” and “is driven by complaints from the very banks the rule is intended to make safer,” asserted CFTC Commissioner Dan Berkovitz in a dissenting statement. House Financial Services Committee Chair Maxine Waters (D-Calif.) accused regulators of “working overtime to weaken a regulation” that will allow “banks to gamble with taxpayer money.”
This latest initiative by the Office of the Comptroller of the Currency (OCC), the Federal Reserve Board (FRB), the Federal Deposit Insurance Corporation (FDIC), the Securities and Exchange Commission (SEC), and the Commodity Futures Trading Commission (CFTC) is not the first time the executive branch has revisited the Volcker rule. Last year, for example, the five agencies responsible for implementing the rule eased restrictions on proprietary trading by banks.
The current round of changes proposed Jan. 30 modify the ban preventing banks from investing in or sponsoring hedge funds or private equity funds, known in regulatory parlance as “covered funds.” The proposed revisions “basically allow banking entities to invest in or sponsor types of funds which regulators believe do not present a substantially elevated risk of the sort the Volcker rule was designed to prevent,” explained Charles Horn, a partner at Morgan Lewis.
This regulatory rollback was not a step taken lightly. “There was a fair amount of discussion at the time the Volcker rule was first adopted about whether or not it should extend to funds such as venture capital funds,” Horn recalled. A 2011 Financial Stability Oversight Council study “suggested that the agencies responsible for administering the Volcker rule consider whether funds such as venture capital funds should be excluded” from the rule, Horn said. Although regulators “opted not to adopt that position” when they finalized the Volcker rule in 2013, they are “now considering a possible change of course with respect to investment funds such as venture capital companies and family wealth management companies,” Horn explained.
The proposed changes could enhance capital formation, SEC Chair Jay Clayton said in a statement. Allowing banks “to extend financing to start-ups and small and medium-sized businesses through qualifying venture capital funds could benefit the broader financial system by improving the flow of financing to these businesses, while allowing banking entities to compete more effectively with non-bank sources of financing,” he explained.
Flyover states may reap particular benefits. Banks in regions “where venture capital and other types of financing are less readily available—i.e., ‘between the coasts’” will be able to provide financing to businesses in those areas, Clayton said.
Weakening vs. right-sizing
Although critics of the proposal generally express concern about increased risk, some see the proposed change as a tempered one. SEC Commissioners Elad Roisman and Hester Peirce described the action as “right-sizing” the regulation in a statement issued on the proposed changes. “Our preference in amending the Volcker rule might have been simply to lean on the ‘DELETE key,’” they acknowledged. Instead, the revisions as proposed “tailor the aspects of the Volcker rule covered-fund regulations that have been most disruptive to legitimate and beneficial business activities by banks,” Roisman and Peirce maintained. Those activities were “not even tenuously responsible for the financial crisis that led to the conception of this rule,” they said.
“It seems the agencies have considered risk mitigation” even as they have expanded bank activities, observed Arthur Long, a partner at the law firm Gibson, Dunn & Crutcher and co-chair of its Financial Institutions Practice Group. Under the proposal, the ability of banks to invest in covered funds is not unfettered. “Even where the proposal has expanded certain potential bank activities, such as for credit funds or venture capital funds, it includes such conditions as the prohibition on banking entity bailouts and no material conflicts of interest,” Long explained.
Indeed, the proposed revisions might be seen as a viable response given the impact of the original rule in the first place. The proposed changes “take into account market realities and lessons learned over time to soften, at least somewhat, a harsher, knee-jerk reaction during the initial rulemaking process” circa 2013, observed Christopher Steelman, a partner at the law firm DLA Piper.
For compliance teams
Comments on the proposal are due April 1, 2020. If adopted as proposed, chief compliance officers “will need to tweak their systems to reflect the revised conditions,” explained David Harris, a partner at the law firm Dechert. While a “wholesale reworking” of compliance procedures for covered funds is not likely to be necessary, “changes at the margins to accommodate the revisions” likely will be needed, Harris said.
Lori Tripoli is a writer based in the greater New York City area who focuses on legal and regulatory issues.