United States

Is there any legislation or proposed legislation in your jurisdiction under which financial institutions are prohibited from dealing in investments as a principal?

The Dodd–Frank Wall Street Reform and Consumer Protection Act (Pub.L. 111–203, H.R. 4173) (the Dodd-Frank Act) was signed into federal law on July 21, 2010, and, among other things, prohibits banking entities from: (i) engaging in proprietary trading; and (ii) certain investment and sponsorship activities relating to certain private funds. The Dodd-Frank Act directed the U.S. financial services regulators to issue detailed rules implementing these restrictions, which they completed on December 10, 2013 (79 Fed. Reg. 5536 (January 31, 2014)) (the Final Rule).

Pursuant to the Final Rule, the Bank Holding Company Act of 1956 (the BHCA) was amended to generally prohibit any banking entity from engaging as principal in proprietary trading for the purpose of selling financial instruments in the near term or otherwise with the intent to resell in order to profit from short-term price movements (the Volcker Rule).1 As noted below, the Volcker Rule is subject to certain limited exemptions.

For additional information regarding the Volcker Rule, please see our article “Implications of the Volcker Rule for Foreign Banking Entities”. We provide a basic summary of the Volcker Rule below.

To which financial institutions do the prohibitions relate?

The Volcker Rule applies to “banking entities”, meaning any:

  1. bank or savings association, the deposits of which are insured by the Federal Deposit Insurance Corporation (an insured depository institution);
  2. company that controls2 an insured depository institution;
  3. company that is treated as a bank holding company for the purposes of section 8 of the International Banking Act of 1978 – this includes: (i) any foreign bank that maintains a branch or agency in the United States; (ii) any foreign bank or foreign company controlling a foreign bank that controls a commercial lending company organized under the law of any U.S. state; and (iii) any company of which any foreign bank referred to in (i) and (iii) is a subsidiary; and
  4. affiliate or subsidiary of any entity described in (1), (2) or (3) above.

In other words, the Volcker Rule applies to every foreign entity that directly or indirectly maintains a bank branch or agency in the United States, or controls a commercial lending company. It also applies to an entity’s affiliates and subsidiaries. On the other hand, the Volcker Rule does not apply to entities whose contacts with the United States do not require licensed agencies or branches. For example, foreign banks that maintain only representative offices in the United States are not subject to the Volcker Rule.

What exceptions to the ban on proprietary trading are contemplated by the legislation?

The proprietary trading prohibition in the Volcker Rule relates to trading as “principal” for the “trading account” of a “banking entity” in any purchase or sale of one or more “financial instruments3”. Thus, any trading activity falling outside this scope is not subject to the restriction. For example, loan syndications, highly-rated short term commercial paper, and spot transactions in physical commodities such as gold, among other non-securities, are not “financial instruments” and are therefore not subject to the Volcker Rule. In addition, subject to certain conditions, the Volcker Rule contains a number of exemptions permitting otherwise prohibited transactions, including:

  1. the purchase and sale of financial instruments consisting of sovereign debt obligations;
  2. proprietary trading activities of foreign banking entities conducted “solely outside of the United States”;
  3. repos and securities lending, on the basis that such transactions resemble secured loans;
  4. transactions effected as agent, broker or custodian;
  5. underwriting and market-making activities;
  6. risk-mitigating hedging activities; and
  7. riskless principal transactions, on the basis that if an offsetting order is in hand, such transactions resemble agency transactions.

Notwithstanding the exemptions described above, transactions will be deemed to be impermissible if they:

  1. involve or result in a material conflict of interest with the entity’s clients, customers or counterparties and such conflict has not been mitigated by timely and effective disclosure and/or information barriers;
  2. result, directly or indirectly, in a material exposure to a high-risk asset or a high-risk trading strategy; or
  3. pose a threat to the safety and soundness of the banking entity or to the financial stability of the United States.

Can any other entity within the relevant financial institution’s group of companies carry on the prohibited activity?

Assuming that a financial entity falls within the definition of a “banking entity”, the Volcker Rule’s proscription on proprietary trading will extend to such entity’s affiliates and subsidiaries. The term “affiliate” means any company that controls, is controlled by, or is under common control with another company. Meanwhile, a “subsidiary” is an entity controlled through ownership or control of 25% or greater, direct or indirect, voting power of any class of voting securities of the company or through other indicia of “control”, as defined in the BHCA.

Thus, if an entity in the relevant financial institution’s group of companies is not an affiliate or subsidiary of the banking entity, and such entity does not otherwise fall within the definition of a “banking entity”, it would be permitted to engage in proprietary trading. However, given the Volcker Rule’s broad interpretation of the concept of “control”, any entity within a financial institution’s group that includes a “banking entity” would likely be subject to the Volcker Rule’s restrictions.

When will the proposed legislation come into effect?

The Final Rule becomes effective on April 1, 2014, with a conformance period until July 21, 2015, to enable banking entities to come into compliance with the Final Rule’s prohibitions on proprietary trading and on covered fund ownership and sponsorship. Certain requirements of the Volcker Rule, however, begin to apply prior to the end of the conformance period, such as the reporting obligations under the Volcker Rule. Although the text of the Volcker Rule somewhat ambiguously provides that the recording and reporting obligations under the Volcker Rule take effect June 30, 2014, in our recent discussions, the staff of the Securities and Exchange Commission stated that it intended this to mean that the first reports will be due September 2, 2014 (since August 31, 2014 falls on a Sunday and September 1, 2014 is a federal holiday) with respect to the monthly period ending July 31, 2014.


1 The Volcker Rule also prohibits banking entities from acquiring or retaining an ownership interest in, sponsoring or having certain relationships with a hedge fund or private equity fund, though this aspect of the Volcker Rule is outside  the scope of this article.


Control” by a company for these purposes means instances in which:

  1. the company directly or indirectly or acting through one or more persons owns, controls or has power to vote 25 per centum or more of any class of voting securities of the bank or company;
  2. the company controls in any manner the election of a majority of the directors of the bank or company; or
  3. the Federal Reserve Board determines, after notice and opportunity for hearing, that the company directly or indirectly exercises a controlling influence over management or policies of the bank.


As used in the Volcker Rule, financial instruments consist of the following:

  1. securities, including options on securities;
  2. derivatives (including swaps and security-based swaps), including options on derivatives and forwards; or
  3. commodity futures, or commodity futures options.