Challenges of Volcker Rule compliance for non-US banks


Financier Worldwide Magazine

October 2015 Issue

October 2015 Issue

The US regulation known as the Volcker Rule (the Rule) reaches far and wide, restricting the activities of ‘banking entities’ as defined in the Rule, a term that includes non-US banking organisations (FBOs) that become subject to the Rule as a result of having a US branch or agency. Many banks in Asia, Europe and elsewhere have made faithful efforts to comply with the Rule, and worked hard to put together compliance programs by the 21 July 2015 conformance date. For FBOs that take compliance seriously, the costs can be high. Non-US banks face obstacles such as language barriers and the difficulty of understanding complicated US regulation that may seem strange to non-US lawyers, making it cumbersome for a non-US bank to assess its operations and develop a compliance program. FBOs incur internal costs in the form of man-hours spent on compliance, while also paying for US counsel and probably local counsel to assist with developing and implementing an effective compliance program.

Developing a compliance program

The Rule prohibits banking entities from: (i) engaging in proprietary trading; and (ii) investing in, or sponsoring, certain hedge funds and private equity funds (covered funds). For foreign banks subject to the Rule, establishing a compliance program should probably first involve a diagnostic stage, where the bank reviews its current activities for compliance with the Rule and identifies potential problem areas.

During the diagnostic stage, an FBO should identify entities that it sponsors or invests in and determine if these entities are covered funds. Making this determination probably requires the assistance of expert US counsel who are experienced in Volcker Rule matters. The FBO should inform US counsel of all relevant information about the funds that it sponsors or invests in. For entities that are covered funds, the FBO would then need to determine whether an exception or exemption exists allowing the FBO to sponsor or invest in such covered fund, and if not, consider divesting its interest in such covered fund. During this diagnostic process, in addition to coordinating with US counsel, the FBO may receive on-site assistance from local counsel to fully evaluate its records and organise its reports for US counsel.

Regarding proprietary trading analysis, the FBO should analyse compliance at the level of the smallest discrete unit that engages in trading, often called a ‘trading desk’. Outside counsel or in-house compliance professionals should inform personnel from each trading desk of the necessity to comply with the Rule and provide training on the basics of the Rule. Whether trading constitutes proprietary trading usually depends on a purpose test, which is a fact-specific inquiry, with the Rule providing some guidance but no bright line rule. Generally, if a banking entity holds a financial instrument for less than 60 days, the purchase and sale of such financial instruments will be deemed to be proprietary trading. Relevant personnel need to be made aware of the 60-day guideline.

After the diagnostic stage, the bank will have to develop a compliance manual and implement a compliance program. For the standard program, applicable to bank entities with between $10bn and $50bn of total consolidated assets (total US assets for FBOs), the Rule lists six elements of an effective compliance program: (i) written policies and procedures; (ii) a system of internal controls; (iii) a management framework; (iv) independent testing and audit of compliance program; (v) training for traders, managers and other relevant personnel; and (vi) recordkeeping. Unfortunately neither the Rule nor its preamble provide detailed guidance on the six elements, and therefore internal compliance personnel will have to exercise their own judgment on how to meet the six elements.

Strategy for compliance – SOTUS

For foreign banks subject to the Rule that wish to engage in proprietary trading or covered fund activity, they may seek to rely on the solely outside the United States (SOTUS) exemption. The Rule provides separate SOTUS exemptions for proprietary trading and covered funds activities, respectively.

FBOs that engage in proprietary trading will probably want to make use of the SOTUS exemption. Generally, to qualify for the SOTUS exemption, proprietary trading of an FBO must, among other things, not be conducted with or through any entity that is organised or located in the US. Therefore, each trading desk should identify its US trading counterparties and report to internal compliance personnel or outside counsel. An FBO may rely on SOTUS for trades conducted with the foreign operations of a US entity if no personnel of that US entity located in the US are involved in the trade. For this reason, FBOs should require their counterparties to represent that no US personnel were involved in the trade.

The SOTUS exemption for covered funds permits FBOs to invest in and sponsor covered funds solely outside of the United States. Separately from the SOTUS exemption, FBOs can also rely on the ‘foreign fund exclusion’ under the Rule, which allows FBOs to invest in or sponsor funds organised outside the US and offered and sold outside the US. There is some overlap between the concepts of exempted covered funds (under SOTUS) and foreign excluded funds (which are not covered funds). Adding to the complexity, covered funds are excluded from the definition of ‘banking entity’ but foreign excluded funds are not – which means that a foreign excluded fund controlled by an FBO may be deemed to itself be a banking entity, and therefore become subject to the Rule’s prohibitions on proprietary trading and investing in covered funds. FBOs must consider these issues, among many other provisions of the Rule, when tailoring their compliance strategies to meet their business needs and the requirements of the Rule.

US regulators should limit extraterritorial effect of the Rule

The Rule imposes substantial costs on FBOs, with uncertain benefits to the stability of the US financial system. As a practical matter, it is unlikely that the day-to-day ordinary proprietary trading and covered funds activities of FBOs would significantly impact the US economy. The most likely scenario in which the activities of an FBO would pose a substantial risk to the US financial system is a rogue trader or London whale type situation, and enforcement of the Rule abroad will hopefully be conducted with that in mind. In the meantime, FBOs should be careful to make a good faith effort to comply with the Volcker Rule.


Ben B. Hur is a partner and Andrew Keller is a foreign attorney at Yulchon. Mr Hur can be contacted on +82 2 528 5045 or by email: Mr Keller can be contacted on +82 2 528 5041 or by email:

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Ben B. Hur and Andrew Keller


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