20 January 2014

SLT: Question of Volcker Rule foreign coverage answered

Frank Mayer, Timothy McTaggart and Jonathan Levin of law firm Pepper Hamilton LLP have asserted that location is the most important aspect of the Volcker Rule's requirements on foreign banking entities.

The US regulation, which prohibits banking entities and nonbank financial companies from engaging in proprietary trading and restricts their relationships with hedge funds and private equity funds, will also have a direct impact on foreign banking organisations and foreign operations of US banking entities.

The firm stated that banking entities covered by the Volcker Rule include companies that are treated as bank holding companies (BHCs) under the International Banking Act. These include any foreign bank that maintains a US branch or agency, any foreign bank or company that controls a US commercial lending company, and the parent company of any foreign bank or company. In addition, by covering all insured US depository institutions and bank holding companies, the regulations reach all foreign operations of those entities.

But there is hope regarding the core ban on proprietary trading. Mayer, McTaggart and Levin asserted that foreign banking entities are accorded special treatment under carefully delineated circumstances. The prohibition does not apply to purchases or sales of financial instruments by a qualified foreign banking organisation (FBO) under Federal Reserve Regulation K that is not organised or controlled by a US banking entity and conducts the majority of its business outside the US.

The prohibition, they added, similarly is inapplicable to a banking entity that is not a FBO, as long as it is not organised under US law and possesses two of the following three characteristics: more assets outside the US than inside, more foreign revenue than US revenue, and more total net income outside the US than inside.

However, the lawyers made the important caveat that a foreign banking entity may not rely on any proprietary trading exemption if the activity would result in a material conflict of interest with its clients, customers, or counterparties (unless clear advance disclosures are made or information barriers are erected), result in exposure to high-risk assets or trading strategies, or threaten the safety and soundness of the entity or the financial stability of the US.

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