Banking agencies propose looser Volcker rule restrictions for ‘covered funds’

Rules on investments in venture capital funds by banks – imposed under the Volcker rule – would be loosened under a proposed regulation issued by the three federal banking agencies Thursday; two regulators on the agency boards opposed making the proposal.

In separate actions, the Federal Reserve Board, the Federal Deposit Insurance Corp. (FDIC), and the Office of the Comptroller of the Currency (OCC) issued the proposal that would remove a 3% limit on the investment banks can make in venture funds that they offer to their clients and customers. However, limits on investments in hedge funds and private equity funds remained in place.

The Federal Reserve Board considers the ‘covered funds’ proposal in meeting Thursday (Jan. 30)

Under the proposal – referred to as the “Volcker rule covered funds proposal” (or covered funds, for short) – banks could invest more capital in funds they already offer clients as long as the funds invest in startups and small businesses.

In voting for the proposal, Federal Reserve Vice Chair of Supervision Randal Quarles said it aims to simplify the Volcker rule “in light of our experience with the rule over six years of implementation.” He pointed to three “buckets” of changes in the proposal intended for:

  • Permitting banking entities to engage in additional fund-related activities, which do not present the risks that the Volcker rule was intended to address;
  • Improving and clarifying treatment of foreign funds;
  • Simplifying and clarifying operation and compliance requirements of the rule.

Regarding the provision on engagement in additional fund-related activities, Quarles said it allows bank to engage in already permitted activities, such as venture capital investment, through a fund structure. “And to mitigate any risks present with activity through a fund, the proposal does not allow banks to engage in proprietary trading through a fund structure, restricts a banking entity from bailing out the funds it sponsors, limits conflicts of interest between the banking entity and fund, and of course, the activity remains subject to the same strict capital charges even if it is conducted through a fund structure,” he said.

Fed Gov. Lael Brainard, however, said she opposed parts of the proposal and voted against its issuance. “I am concerned that several of the proposed changes will weaken core protections in the Volcker rule and enable banking firms again to engage in high-risk activities related to covered funds,” she said.

In particular, she said, the proposal would give banking firms the green light to exclude parallel investments from the statutory limits on covered fund investments and would also “explicitly allow them to market the covered fund on the basis of the parallel investments.”

Meanwhile, at the FDIC, Board Member Martin Gruenberg also voted against the proposal.

The three agencies approved issuing the proposal for a 60-day comment period (with comments due by April 1). The Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) joined the banking agencies in proposing the rule.

Proposed Revisions to Prohibitions and Restrictions on Proprietary Trading and Certain Interests in, and Relationships With, Hedge Funds and Private Equity Funds

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