Volcker Rule implementation and its impact on European asset managers




FW moderates a discussion on Volcker Rule implementation and its impact on European asset managers between Barry E. Breen and Carolyn H. Jackson, partners at Katten Muchin Rosenman UK LLP.

FW: Could you provide a brief overview of the key objectives of the Volcker Rule?

Breen: One of the primary objectives of the Rule is to promote stability in our financial markets by reducing imprudent risk taking activities conducted by banks, and their affiliates, which were perceived to have a high impact on our markets. While it is clear that the financial crises was caused by the credit activities taking place in the market, once under public scrutiny, all banking activities were placed in the line of fire and subject to scrutiny, and at that time both proprietary trading activities and private fund market activities were also being scrutinised. Thus, the Volcker Rule now prohibits certain banks and bank affiliates from engaging in proprietary trading activities and limits the ability of these entities from sponsoring, acquiring or investing in hedge funds and private equity funds.

FW: In your experience, how are banks responding to the forthcoming implementation of the Volcker Rule?

Jackson: The banks have been gathering voluminous data and conducting extensive analyses. Behind that, they have been investing significant resources in building the systems to collate and interpret the data, as well as to monitor ongoing compliance with the Rule. Additionally, the banks are developing internal controls, instituting management accountability, implementing independent auditing functions, and training employees, as well as developing effective record retention polices. The primary challenge facing the banking industry is determining what exactly is expected of them. Five US federal regulators collaborated on the Rule. Even the regulators themselves are struggling to interpret the Rule, which is complicated by the fact that they need to develop consensus on implementation, which includes resolving the cross-border implications. Additionally, because the US Commodity Futures Trading Commission has asserted authority to act as a primary Volcker Rule supervisory authority over banks that are swap dealers, such banks will be tasked with answering to multiple regulators, each with a different agenda.

The primary challenge facing the banking industry is determining what exactly is expected of them.
— Carolyn H. Jackson

FW: How do you expect regulators to enforce the Volcker Rule?

Jackson: Given the newness of the Volcker Rule and the breadth of its impact, regulators will most likely adopt a reasoned approach to compliance. Any bank, however, that has blatantly disregarded its compliance obligations, will likely have a rude awakening. The banks have been on notice about the primary principles of the Volcker Rule, if not its implementing detail, for nearly five years. Additionally, and not surprisingly, the largest banks, including affected non-US banking organisations, will face the greatest scrutiny. A large issue for enforcement is that no single agency is responsible, but rather, all five agencies collectively, to the extent practicable. Banks should remember, however, that the federal banking agencies can impose civil monetary penalties as well as impose cease and desist proceedings for any violation of any law by a banking entity.

FW: What challenges are likely to surface as the Volcker Rule is rolled out and enforced?

Jackson: The largest challenge, we believe, will be working through the extraterritorial reach of the Volcker Rule, especially for non-US banks. The Volcker Rule undermines the essential tenet of international banking regulation, which is that it is the home country and not the host country that sets investment and activity limitations. The Volcker Rule’s reach over the non-US operations of foreign banking organisations, therefore, presents significant policy issues. Although exemptions exist for activity that is conducted solely outside of the United States, in a global marketplace, being able to provide such a definitive situs of financial services activity may ultimately prove to be impossible. Another challenge is that in addition to the banks, the agencies themselves will need time and further resources, including additional staffing and training, to be able to effectively monitor banks’ compliance with the Volcker Rule. All the regulatory agencies have been spread extremely thin with the enactment of Dodd-Frank.

FW: What are the penalties for noncompliance with the Volcker Rule?

Breen: Interestingly, the Rule does not contain any specific penalties. The agencies tasked with enforcing the Rule, however, have stated that they will use their existing examination and enforcement powers to monitor compliance and bring appropriately measured responses when a violation has occurred. As the Rule requires banking entities to develop, implement and maintain a compliance programme, we anticipate that many of the initial enforcement actions will be around minor non-compliance issues. However, given the current environment where high monetary fines are being imposed for regulatory violations, then banks should be wary and concerned about any compliance violations.

FW: What advice would you offer banks in terms of establishing their Volcker Rule compliance programmes?

Jackson: Banks must develop a robust compliance programme and develop the requisite technological infrastructures. The largest banks should have already had this in place several months ago. All systems should be developed to include flexibility design features, such that they can be easily adapted as the agencies provide more precision on what effective compliance entails. All affected banks must develop a culture of compliance across the entire organisation. The Rule is intricate with many complexities, which will require extensive training to bring the line business managers up to speed. Additionally, resources must be devoted to the risk, accounting, legal and compliance departments for them to be the next backstop of compliance. Finally, banks’ chief executive officers and boards must understand that they are the ones ultimately responsible for compliance with the Rule.

FW: To what extent has the recent expansion of the ‘SOTUS’ exemption and the narrowing of the covered fund definition impacted on banks?

Breen: On 27 February 2015, the agencies updated their list of Frequently Asked Questions (FAQs). The new guidance clarified the circumstances in which a non-US banking entity can continue to hold, or make, investments in a third-party covered fund and limit the need for managers to restructure their existing funds to accommodate investments by non-US banking entities. Prior to the clarification there was a concern that a non-US banking entity could not invest in a covered fund even if the fund was not sponsored, organised, offered or advised by the non-US banking entity. This led to a concern that non-US banking entities would be forced to sell their interests in these third-party sponsored funds. The new FAQ confirms that a non-US bank may invest in a covered fund in reliance on the SOTUS exemption so long as it is truly a third-party covered fund and the other provisions of the SOTUS exemption are complied with. Following the guidance, it is clear that a third-party covered fund established as a master/feeder fund does not need to restructure to retain investments from a non-US banking entity.

FW: Are you confident that banks will have fully complied with the Volcker Rule by 21 July 2015?

Jackson: Expecting any bank, let alone all banks, to have fully complied with the Volcker Rule by 21 July 2015 is highly unrealistic. The Volcker Rule is a major new rule, inflicting a sea change on the industry. Complying with the main obligations of the Rule, let alone its nuances, is a complete unknown. Only with the passage of time, as the regulators provide more guidance and the banks gain more experience, can we even expect 80 percent compliance. We do not expect, however, that there will be extensive applications for an exemption, and we expect it unlikely that any such requests would be granted. The Rule has been five years in coming, and a line in the sand needs to be drawn for effectively demonstrating compliance.

What is clear now is that banking entities involved in sponsoring existing investment funds and looking to bring new investment products to market must re-evaluate these products in order to comply with the Rule.
— Barry E. Breen

FW: How have European asset managers reacted to the requirements set out in the Volcker Rule?

Breen: European asset managers have had to conduct a thorough review of the impact of the Rule on their existing products and relationships with the banks and their affiliates. While some of these evaluations have led to increased costs related to evaluating compliant products, it has also led and, we believe, will continue to lead, to opportunities. In addition to potential opportunities when banks divest themselves of certain assets, European asset managers have been exploring other opportunities to provide investments and investment products to the banks packaged in a manner that falls outside the scope of the Rule. For instance, we have seen a renewed focus on separate accounts, co-investments, and joint ventures over the course of the past few years, as well as an increased level of interest in liquid alternatives and other vehicles that do not rely on the Sections 3(c)(1) or 3(c)(7) exemptions under the Investment Company Act, such as commercial financing vehicles, lending and factoring vehicles, real estate funds and oil and gas funds.

FW: What do you believe is the long-term outlook for European fund managers, following the introduction of the Volcker Rule?

Breen: It is far too early to be making predictions about the long-term effects of the Rule on European fund managers. What is clear now is that banking entities involved in sponsoring existing investment funds and looking to bring new investment products to market must re-evaluate these products in order to comply with the Rule. Given the expansion of the SOTUS exemption there has been a renewed focus on structuring private funds that are offered outside of the US. It is important for the agencies to monitor the impact that the Rule will have on the financial markets and the private funds market in particular to ensure that the scope of the unintended consequences are monitored and managed appropriately.


Barry E. Breen is a partner at Katten Muchin Rosenman UK LLP. He advises clients on all aspects of asset management with a particular focus on hedge fund structuring and operations including single investor funds and managed accounts. In addition to mainstream hedge funds, he counsels start-up managers and established managers regarding hybrid and private equity structuring and operation across a broad spectrum of asset classes. Having practiced in both the United States and United Kingdom, Mr Breen is skilled in addressing the cross-border issues faced by international clients. He can be contacted on +44 (0)20 7776 7635 or by email: barry.breen@kattenlaw.co.uk.

Carolyn H. Jackson is a partner at Katten Muchin Rosenman UK LLP. She provides US financial regulatory legal advice to a broad range of market participants, including commercial banks, investment banks, investment managers, broker-dealers, electronic trading platforms, clearinghouses, trade associations and over-the-counter derivatives service providers Prior to joining Katten, Ms Jackson was the European head of Allen & Overy LLP’s US Regulatory Practice. Before becoming a lawyer, she was the executive director and a board member of the International Swaps and Derivatives Association, Inc. (ISDA). She can be contacted on +44 (0)20 7776 7625 or by email: carolyn.jackson@kattenlaw.co.uk.

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Barry E. Breen

Carolyn H. Jackson

Katten Muchin Rosenman UK LLP

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