With split vote by FDIC, Volcker rule’s ‘covered funds’ provision modified in effort to streamline, clarify

The Volcker rule’s prohibition on banking entities investing in or sponsoring hedge funds or private equity funds is modified under a rule made final Thursday by all three federal banking agencies, plus two securities market regulators.

The rule became final, with an effective date of Oct. 1, after a split vote for approval by the Federal Deposit Insurance Corp. (FDIC) Board at its meeting Thursday. Board Member Martin Gruenberg was the lone vote against the final rule.

The final rule, according to the Federal Reserve, modifies three areas of the Volcker rule (which bars banking entities from engaging in proprietary trading and from acquiring or retaining ownership interests in, sponsoring, or having certain relationships with a hedge fund or private equity fund, or “covered funds”) by:

  • Streamlining the covered funds portion of rule;
  • Addressing the extraterritorial treatment of certain foreign funds; and
  • Permitting banking entities to offer financial services and engage in other activities that do not raise concerns that the Volcker rule was intended to address.

In voting against the changes, Gruenberg charged that the changes would “severely weaken” the Volcker rule’s restrictions on bank investments.

“Today’s final rule would allow the largest, most systemically important banks and bank holding companies once again to engage in investments and relationships with high risk funds that resulted in large losses, and contributed to the failure or near failure of large financial firms in the 2008-2009 financial crisis,” Gruenberg said in a statement he read before the board’s vote. “Weakening this important prudential protection at the present time, given the economic and financial uncertainty caused by COVID-19, risks repeating the mistakes of the last crisis.”

In addition to the FDIC and the other banking agencies, the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) have also adopted the rule.

The FDIC, in a fact sheet about the final rule, said since the Volcker rule’s implementation in 2014, the “covered fund” provisions have generated considerable market uncertainty and hindered capital formation, particularly for small businesses in areas where financing may not be readily available.

The agency said the modified rule would:

  • facilitate capital formation by providing banks with greater flexibility in sponsoring funds that provide loans to companies (such as allowing investments in qualifying venture capital funds) so banks can “allocate resources to a more diverse array of long-term investments in a broader range of geographic areas, industries, and sectors than they may be able to access directly.”
  • Protect safety and soundness and financial stability by preventing banks from engaging in any activity not currently permissible if conducted on their balance sheets, and limiting banks’ exposures to potential risks by including protections that restrict the ability to conduct certain transactions with covered funds.
  • Provide more “clarity and certainty” about what activities are permitted, which will “improve supervision and implementation of the Volcker Rule (such as clarifying the existing foreign public fund exclusion, which the FDIC said “is intended to provide consistent treatment between U.S. registered investment companies and their foreign equivalents”).

Financial regulators modify Volcker rule

FDIC fact sheet