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Volcker Rule Implementation: the operational challenges of covered funds management

The 21st of July 2015 will mark a major change in the way American financial institutions and their worldwide affiliates interact with their clients and with one another, as Volcker Rule compliance programs “go live.” 

The complex and large scale requirements described in the Volcker Rule are some of the most involved and detailed-oriented of the Dodd-Frank Act. Furthermore, Subpart C alone, which outlines the requirements with which banking entities must comply in order to bring their ownership interests and relationships with “covered funds” into conformance, is among the most complicated and far-reaching of the Final Rule. 

Subpart C prohibits and restricts activities involving covered funds, which include most hedge funds, private equity investment structures, certain special placement vehicles and in general any investment structure with less than one thousand notes or any fund or investment vehicle limited to one thousand investors or less. Depending on the internal structure and operating model of a given bank, the mere identification of potential covered funds is quite complicated, not to mention the tasks that follow in the analysis and potential restructuring phases. While proprietary trading regulation under Volcker is limited to trading activities, covered funds on the other hand have proven to be “hidden” in areas of the bank that one would never expect.

The impact on financial institutions is therefore quite far from insignificant, given the plethora of activities that could be considered as falling under the scope of covered fund prohibitions and restrictions. An ownership interest in, a sponsorship of or a relationship with a covered fund can occur in virtually every business unit of the bank. From trading desks to private equity advisory practices, from retail banking to private wealth management, even going sometimes so far as the corporate treasury, banks are fully aware of their obligation to prove to regulators that no rock has been left unturned in their quests to uncover covered funds. 

Furthermore, major players in the international banking sector are paying a heavy price for the implementation of covered funds management programs. When implementing covered funds management programs, one must not only consider the costs in terms of additional resources and external legal counsel, but also those associated with retaining permitted covered funds, which if not managed correctly can significantly reduce the value of the organization’s Tier 1 Capital. In addition, many banks are finding themselves forced to restructure investment vehicles or to terminate relationships with covered funds in ways that are oftentimes neither beneficial for the bank nor its clients. 

Baring all of this in mind, it is of the utmost importance that financial institutions can ensure the Volcker-readiness of their covered fund management programs by the implementation deadline. Ensuring this condition is much easier said than done, especially when one accounts for the operational challenges associated with doing so, as well as the sophisticated internal infrastructure that will allow such programs to be sustainable in the long term.

The attached briefing note will provide a synthetic overview of the requirements outlined by the Rule with respect to covered funds, as well as a translation of several portions of the Rule’s text into operational terms.  It will focus specifically on several phases of the covered funds management cycle including, the identification and classification of covered funds, the resulting need for a suitable governance to protect the framework as well as a description of the major players involved.

Can banks expect any relief from the complex interpretative questions Subpart C forces them to ask themselves? Only time will tell. 

This note provides a brief overview of the regulatory context and the resulting operational challenges major financial institutions must overcome in order to implement Sub Part C of the Volcker Rule, which prohibits owning, sponsoring, or having certain relationships with “covered funds.”


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Sia Partners

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