The Volcker Rule’s (foreseeable) impact on foreign markets and institutions: a bit too much?


Financier Worldwide Magazine

May 2013 Issue

May 2013 Issue

We have a saying in Portugal: “pior a emenda do que o soneto”. It is hard to translate into English, but it is generally used to mean that, sometimes, correcting a faulty situation actually renders it worse than it was before. The phrase allegedly originated in the 1700s, when a poet used it to justify not editing the lacklustre work of a would-be disciple. Today, a person involved in the financial services sector may be led to think similar thoughts when looking at some of the legislative and regulatory responses to the 2008 crisis. 

Pressured by hostile constituencies, legislators in Western countries have displayed a tendency to respond aggressively to the (often justified) public demand for financial regulation. The US Volcker Rule, an attempt to deal with excessive risk-taking by banking entities by banning proprietary trading and certain ownership and sponsorship relationships with hedge funds and private equity funds, threatens to be one such case. It is still too early to be sure, as the final draft of its extensive implementing regulation, providing substance to the wide provisions of a relatively short legislative text (enacted as Section 619 of the 2010 Dodd-Frank Act), is still under preparation. But the currently known draft paints some clouds on the horizon, not only for purely US operators, but also for international financial services groups. 

Without going into much detail, the Volcker Rule may be explained as follows: banking entities (a mild version of the rule may also apply to certain nonbanking companies) will be banned from entering into transactions which are categorised as ‘proprietary trading’, as well as from having certain interests (which include, not only ownership, but also many other forms of risk exposure which are often assumed in a sponsorship context) in ‘covered funds’. The concept of ‘proprietary trading’ includes most of what one might reasonably identify with the term. ‘Covered funds’, as defined in the current draft of the implementing regulation, comprises many types of US investment vehicles, as well as their foreign equivalents. Any European UCITS fund is likely to be included. 

There are, of course, some carve-outs to the general prohibitions. However, these are narrowly built, and not entirely exempt from the Volcker Rule. These so-called ‘permitted activities’ may only be carried out subject to certain overriding provisions, which prohibit conflicts of interest, exposure to ‘high-risk’ assets and trading strategies (a concept into which the current draft of the implementing regulation sheds very little light), as well as threats to the safety and soundness of the relevant entity and to US financial stability. They also require the relevant entity to comply with detailed reporting and compliance requirements aimed at ensuring that US regulators are kept informed of business carried under the cover of a ‘permitted activity’. 

At this point in this article, a non-US reader may be tempted to discard it as addressing a mere issue of US law, or considering it only in terms of the ripple effect that the Volcker Rule may have on its dealings with US counterparties. But this is where it gets tricky: considering the current form of the implementing regulation, the Volcker Rule may affect virtually any financial services group with ties to the US, not only in relation to those ties, but to the entire group. Some grasp of what the Volcker Rule might mean for international financial services groups may be reached by looking at three features of the current draft of the implementing regulation. 

In the first place, the aforementioned concept of banking entity has been designed to include many entities with no connection to the US other than controlling a US banking entity, or even being controlled by an entity that controls a US banking entity. So, if a European banking conglomerate owns (or otherwise controls) a US subsidiary, the Volcker Rule will apply not only to that US subsidiary but also to the holding company and to any entity anywhere in the world which is controlled by that holding company. It should be noted that, for the purposes of the Volcker Rule, to control means: (i) to hold 25 percent or more of a class of voting securities; (ii) to control the election of a majority of the directors or trustees of a company; or (iii) to otherwise exercise a controlling influence over management or policies.

Secondly, although the Volcker Rule exempts activities performed by non-US entities that are not (directly or indirectly) controlled by a US-entity, that exemption only applies if the transaction is carried out ‘solely outside the US’. Under the current draft of the implementing regulation, this effectively bans the use of US-based personnel (except in a clerical role), as well as of US-based trading, payment, clearing or settlement facilities, and any other risk retained in the US. 

The third significant aspect is the treatment of activities occurring solely outside of the United States (i.e., activities of entities covered by the first feature under the conditions permitted under the second feature) as ‘permitted activities’. As explained above, this means that they are not entirely excluded from the scope of the Volcker Rule, being required to comply with the overriding provisions described above and to adopt additional (and potentially very expensive) reporting and compliance obligations on a consolidated, worldwide basis.

If all three of these features of the current draft of the implementing regulation pass into the final draft, significant adverse effects could be in store for international financial conglomerates. This is still far from certain, as a lot of negative feedback was received by US regulators in relation to the draft implementing regulation’s rules on the extraterritorial application of the Volcker Rule. The comments made by Barclays Capital make for particularly interesting reading material, but the fact that even two of the US Senators (Sen.Merkley and Sen. Levin) responsible for promoting Section 619 of the Dodd-Frank Act show some reserves as to the implementing regulation’s effects on institutions and activities based abroad gives us a sense of the controversy still surrounding this issue. Some foreign (particularly European) regulators are also reported to have expressed concern. 

In its current form, the implementing regulation represents, in our view, an overreach by US regulators. Even if we leave aside the issue of prohibited transactions for a moment, the steep increase in reporting and compliance costs brought about by the Volcker Rule creates significant indirect constraints on activities with little (or no) connection to the US. Regardless of whether the Volcker Rule is a proportional response to any inadequacies surrounding proprietary risk taking in US financial markets (a discussion into which this article has no intention to enter), or merely curing one’s headache by cutting off the head, the issue of extraterritorial application is another matter. It seems more like wanting to cure one’s headache by making everyone else take a load of aspirin.


Pedro Simões Coelho is a partner and Pedro Bizarro is a lawyer at Vieira de Almeida & Associados. Mr Coelho can be contacted on +351 21 311 3447 or by email: Mr Bizarro can be contacted on +351 21 311 3447 or by email:

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Pedro Simões Coelho and Pedro Bizarro

Vieira de Almeida & Associados

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