'Solely Outside the United States' Volcker Rule Exemption
In my May 9, 2012, column,1 I wrote about a proposed rule implementing one of the most controversial provisions in the Dodd-Frank Wall Street Reform and Consumer Protection Act.2 Section 619 of Dodd-Frank, the so-called "Volcker Rule," contains prohibitions and restrictions on the ability of banking organizations and systemically significant non-bank financial companies to engage in proprietary trading or investing in or sponsoring a hedge or private equity fund.3 The rule was aimed at protecting taxpayers from losses at banking institutions protected by the "federal safety net" (e.g., FDIC deposit insurance) and at reducing risk by furthering the safety and soundness of banking institutions and lessening possible threats to the financial stability of the United States.4
On Nov. 7, 2011, the U.S. federal banking agencies and the Securities and Exchange Commission issued for comment proposed regulations to implement the Volcker Rule.5 Over two years later, after review of several thousand comments, the federal banking agencies, the Securities and Exchange Commission and the Commodity Futures Trading Commission announced approval of the final version of the Volcker Rule regulations on Dec. 10, 2013.6
One of the exemptions from the Volcker Rule restrictions on proprietary trading is for transactions taking place "solely outside the United States." This month's column will discuss the final regulations' treatment of this exemption from the proprietary trading rules.7
By way of a brief review, under the Volcker Rule, a "banking entity," which includes a non-U.S. bank that is treated under the International Banking Act of 1978 (IBA) as if it were a U.S. bank holding company, and any affiliate or subsidiary of such a non-U.S. bank,8 generally is prohibited from engaging in proprietary trading or acquiring or retaining an equity, partnership, or other ownership interest in, or sponsor, a hedge fund or a private equity fund, subject to certain exemptions.
The statutory definition of "proprietary trading" is "engaging as a principal for the trading account of the banking entity…in any transaction to purchase or sell, or otherwise acquire or dispose of, any security, any derivative, any contract of sale of a commodity for future delivery, any option on any such security, derivative, or contract, or any other security or financial instrument that the appropriate [regulators]…determine."9 One of the several exemptions to the general ban on proprietary trading is for:
[p]roprietary trading conducted by a banking entity pursuant to paragraphs (9) or (13) of section 4(c) [of the BHC Act], provided that the trading occurs solely outside of the United States and that the banking entity is not directly or indirectly controlled by a banking entity that is organized under the laws of the United States or of one or more States.10
Sections 4(c)(9) and 4(c)(13) are the primary statutory bases for the regulations issued by the Federal Reserve Board regulating a non-U.S. bank's non-banking activities in the United States.11
The legislative history is clear that the exemption was meant to acknowledge "international comity" and allow non-U.S. banks to engage in activities outside the United States that were permissible for that non-U.S. bank under its home country laws.12 A Jan. 18, 2010, Financial Stability Oversight Council report making recommendations on implementing the Volcker Rule also stated that the purpose of the statute was not to impose extraterritorial jurisdiction over non-U.S. banks' proprietary trading outside the United States.13
The November 2011 proposed regulations set out four conditions that would need to be satisfied in order for a purchase or sale to be deemed to have occurred "solely outside the United States":14
(i) The covered banking entity conducting the purchase or sale is not organized under the laws of the United States or of one or more states;
(ii) No party to the purchase or sale is a resident of the United States;
(iii) No personnel of the covered banking entity who is directly involved in the purchase or sale is physically located in the United States; and
(iv) The purchase or sale is executed wholly outside of the United States. (Emphasis added).