Alert November 23, 2010

FRB Releases Proposed Rule to Implement Volcker Rule Conformance Periods

The FRB released a proposed rule (the “Proposed Rule”) to implement the conformance periods during which banking entities and nonbank financial companies supervised by the FRB 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, commonly known as the “Volcker Rule.”

General Conformance Period.  The Volcker Rule takes effect on the earlier of July 21, 2012 or 12 months after issuance of final regulations implementing the Volcker Rule.  In order to allow the markets and firms to adjust to the Volcker Rule’s prohibitions and restrictions, the Volcker Rule provides banking entities and nonbank financial companies supervised by the FRB with an additional conformance period after the Volcker Rule takes effect 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.  The Proposed Rule implements the Volcker Rule’s conformance period provisions and 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 Proposed Rule 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: (1) the date the Volcker Rule’s prohibitions would otherwise become effective with respect to the company, and (2) 2 years after the date on which the company first becomes a banking entity.  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 the Volcker Rule and its implementing regulations.

Extension of Conformance Period.  The FRB may extend the generally available two-year conformance period by up to three additional one-year periods for an aggregate conformance period of up to 5 years.  Under the Proposed Rule, a banking entity seeking an extension of the conformance period must submit a request to the FRB.  Any such request for an extension must: (1) be submitted in writing to the FRB at least 90 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).  The Proposed Rule lays out several matters that must be addressed in such requests and the factors the FRB will evaluate in considering a request.  The factors provided are not exclusive.  The Proposed Rule would allow the FRB to impose conditions on any extension granted.

Extended Transition Period for Illiquid Funds.  The Volcker Rule permits a banking entity to request in writing the FRB’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 21, 2010 to a hedge fund or private equity fund that qualifies as an “illiquid fund,” defined as a hedge fund or private equity fund that: (1) 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 (2) makes all investments pursuant to, and consistent with, an investment strategy to principally invest in illiquid assets.  The Proposed Rule defines several important terms, including “illiquid asset,” “principally invested” in illiquid assets, “contractually committed to principally invest” in illiquid assets, and “investment strategy to principally invest” in illiquid assets.  Any extended transition period with respect to an illiquid fund may not exceed 5 years and may be in addition to the conformance period available under other provisions of the Volcker Rule.  Such extended transition period 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.  With respect to the extended conformance period for illiquid funds, it is important to note that a banking entity will only be considered to have a contractual obligation to take or retain an equity, partnership or other interest in an illiquid fund or to provide capital to an illiquid fund if the banking entity’s 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, 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 reasonable best efforts to obtain such consent and such consent has been denied. 

Nonbank Financial Companies.  The Proposed Rule also implements the conformance period for nonbank financial companies supervised by the FRB.  Like banking entities, the Volcker Rule provides a nonbank financial company supervised by the FRB two years after the date the company becomes a nonbank financial company supervised by the FRB to conform its activities to any applicable requirements of the Volcker Rule, which also provides the FRB the ability to extend this two-year conformance period by up to three additional one-year periods.  Such entities seeking an extension must submit a request to the FRB under the same time frame as required for banking entities.

The FRB requests comment on all aspects of the Proposed Rule.  Comments should be submitted within 45 days of publication of the Proposed Rule in the Federal Register, which is expected shortly.