The proposed Volcker Rule of the Dodd Frank Forum Act is scheduled to be implemented on July 21, 2012.  The Rule prohibits a bank or institution that owns a bank from engaging in proprietary trading that is not at the behest of its clients, and from owning or investing in a hedge fund or private equity fund, as well as limiting the liabilities that the largest banks could hold. 

Foreign banks and regulators are voicing concern over the Rule’s implications.  In an international reach, the Volcker Rule applies to non-US Banks with US branches, agencies or bank subsidiaries; there is no US territorial limit on prohibitions. Exemptions are available for: activity conducted by non-US banks “solely outside of the US” (SOTUS) and for US government securities, but none for non-US government debt.

Industry experts from Debevoise & Plimpton and Ernst & Young, discussed in-depth, the proposed Volcker Rule and its cross-border implications to a crowd of over one hundred  representatives from large international banks, March 26, 2012, in NYC.  Highlights from the Volcker Rule discussion included proprietary trading applicability to foreign banks, compliance program requirements and implementation, and fund applicability to foreign banks. 

Proprietary Trading Applicability to Foreign Banks
The basic restriction on proprietary trading under Volcker is that banks may not buy or sell covered financial positions (securities, derivatives, commodity futures; excluding loans, FX, currencies) for a trading account unless a permitted activity exception applies. Trading accounts are defined as: accounts used for short-term re-sales; benefitting from short-term price movements; realizing short-term arbitrage profits; and acquires and hold positions for 60 days or less.

The permitted activities under Volcker include the following exemptions: SOTUS (“solely outside of the US”), underwriting, market making, hedging, trading in US government securities (but not foreign debt).  Also included under permitted activities are purchases or sales “on behalf of customers”.

There was a lot of discussion around the SOTUS Exemption.  For this exemption to apply, the banking entity may not be, and may not be controlled (directly or indirectly) by, a US banking entity.  Therefore, it is not available to US headquartered banks or US affiliates of foreign banks.  It is available to non-US affiliates of foreign banks.  For SOTUS to apply under transactional requirements the counterparty cannot be a “resident of the US”; no foreign bank personnel involved in trade can be US-based; and the execution of the transaction must be outside of the US.

Compliance Program
The discussion turned to compliance, where strong documentation was emphasized.  The documentation should be frequent, transaction by transaction, and show high levels of detail.  Under Volcker, an institution will be required to document permitted and prohibited covered fund activities and investments and covered trading activities, including identification of risks, strategies, products and investments.

Strong documentation falls under the policies and procedures requirement of the Volcker Rule.  Other components that should be included in a compliance program framework include: internal controls, employee training, independent testing, record keeping, and accountability. 

Once the framework was identified, an in-depth look was provided on how to build an institution’s compliance program under Volcker, focusing on the following:
Establishing project governance: who are the compliance owners and business representatives;
Define target state for July 2012: define key assumptions related to management framework and develop a target compliance program to be in place by July 2012;
Assessment of current compliance program: assess current state of activities in relation to management framework and identify gaps to remediate by July 2012; ,
Line of Business Assessment: Survey/assess the impact of Volcker on the LOB. 
The good news is, according to the industry experts, most institutions probably already have most of these components in their compliance programs today that can be leveraged for the July 2012 requirement. 

Implementation
Once the current state of an institution’s existing compliance program versus proposed Volcker Rule requirements have been assessed and the gaps prioritized, then an implementation plan can be developed, executed and reviewed.  Some of the key factors discussed for a successful implementation are:

Business management and key resource alignment: Management must actively participate in the change process to identify and support the new structure to enhance business value.
Well-defined work stream ownership and governance model: Effective work stream governance and oversight is essential.  Decisions will need to be made over proposed rule implementations; complexity of the potential organizational change will impact most areas across the bank; clearly defined work stream plan through July 2012 is key.
Systematic approach to assessing the proposed rule: The broad functional scope of the proposed rule requires a systematic and consistent assessment approach to be applied across numerous trading desks and fund investments.
Technology coordination: Significant technology development may be required during a period of an increasing number of technology initiatives, thus stressing resources and requiring prioritizations and sequencing.

Fund Applicability to Foreign Banks
The basic restrictions of private equity and hedge funds under Volcker are:
Banks can’t invest in or sponsor private equity or hedge funds; Banks that act as investment advisers or sponsors to private equity/hedge funds cannot engage in covered transactions (loans, guarantees, and credit exposures) with such funds (“Super 23A”). Private equity/hedge funds are defined as: funds that would be investment companies under US law but for 3(c)(1) and 3(c)(7) of the Investment Company Act; and any “foreign equivalent” of such funds.

The permitted activities under Volcker include: Asset management funds (3% investment, naming and other restrictions); Offshore funds: SOTUS applies, not offered to US investors, no foreign bank US personnel involved in offer or sale of ownership interest; Certain loan securitization vehicles; Certain hedging purposes.  But in all cases, Super 23A applies.

The Fund SOTUS Exemption: May invest in covered funds offered solely to non-US residents.  No US affiliate or employee of the bank is involved in offering or sale of the funds.  These covered funds may include: advised or sub-advised by US or non-US advisers, organized in or outside of the US, invested in or outside the US, parallel or feeder funds.

For more information on the Implications of the Volcker Rule and other Dodd-Frank Burdens, please contact Greg Lyons, Partner, Debevoise&Plimpton LLP at gjlyons@debevoise.com.