In October 2019, the Federal Reserve, U.S. Commodities Futures Trading Commission, FDIC Federal Deposit Insurance Corporation, Office of the Comptroller of the Currency and U.S. Securities and Exchange Commission (collectively, “Agencies”) all adopted amendments to Section 13 of the Bank Holding Company Act – colloquially known as the “Volcker Rule (Rule). Arising out of the Dodd-Frank Act, the Rule prohibits banking entities from engaging in certain proprietary trading activities. The 2019 amendments do not purport to loosen these restrictions but rather revise how the Rule is policed. The revisions clarify how above identified Agencies will evaluate certain activities under the Rule. Practically, greater certainty will decrease compliance costs associated with certain activities and services. Knowing with greater certainty what is and is not prohibited will enable banks to make quicker, better and more confident decisions in how they offer certain services to their customers. Counterintuitively, the amendments that provide the most concrete safe harbors may not necessarily provide the biggest decrease in compliance risk going forward.

Methodology explained
One significant change is that the amendments reorient the short-term intent prong for in the definition of a “trading account.” Post amendment, the Rule includes a short-term intent test. A financial instrument held for 60 or more days is now presumed not to have “short-term intent.” Previously, financial instruments held less than 60 days were subject to a rebuttable presumption that they were held with “short-term intent.” This reversal provides certainty as to what positions definitively lack short-term intent and are compliant. Inverting the presumption makes certain which instruments will need to be addressed and shown to be compliant rather than leaving all instruments subject to possible scrutiny under this prong – albeit some more than others. Through amending the presumption, the Agencies articulated what they look for when examining “short-term intent” rather than identifying specific items that are compliant. On its face, this is somewhat ambiguous – as any instrument held for less than 60 days could be either compliant or non-compliant. However, by limiting the pool of what instruments will be considered, banks will have certainty that tangibly decreases their compliance burden.

Exemption expanded

Conversely, where the amendments update which financial instruments fit within the Rule's liquidity management exclusion, the benefit to banks is more limited. Among the additions to this exemption are foreign exchange swaps and non-deliverable cross-currency swaps. Expanding the options available to banking entities under this exemption underscores the Agencies’ desire to modernize a six-year-old rule. While adding products to the exemption is logical, it continues to limit banks’ flexibility to use emerging products for liquidity management. For example, as electronic and cryptocurrencies grow in importance, their prevalence as tools for managing liquidity will also increase. Given the structure of the liquidity management exemption, Agencies will need to revisit this exemption to include new liquidity management products in the electronic and crypto spaces as they gain popularity. Had the amendments described how Agencies would determine whether an instrument was used for liquidity management rather than proprietary trading, banks would have been able to understand that logic and apply it prospectively to new products as they emerge.

One takeaway is that while the amendments do decrease the compliance burden, the purpose of the Rule remains, prohibiting certain activities. Each of the Agencies is more concerned with identifying violations than easing examination mechanisms. The amendments are a byproduct of the Agencies’ experience in administering the Rule rather than a legislative salve intended to cut compliance costs for banks. As the Agencies are under no obligation to make amendments, any increased certainty and corresponding decrease in cost is a welcome bonus.

Chuhak & Tecson Banking attorneys are ready to answer questions regarding the amendment to Volcker Rule and will be happy to assist with compliance measures.

Client Alert authored by: Christopher A. Pellegrini, Associate