Volcker: Mission impossible

More questions were raised than answered when earlier this month US regulators released long-anticipated proposals that will ban banks from owning or sponsoring private equity funds. 

More commonly known as the Volcker rule, regulators are currently seeking feedback on how to fine-tune Section 619 of the Dodd-Frank Act, which restricts banks from trading off their own accounts as well as limiting their investments in private investment funds to no more than 3 percent of any one fund’s capital.

The 298-page proposals provide only a silhouette of the final rule, instead listing an astounding 394 questions to stakeholders who will have until 13 January to provide their comments. Given the importance of the issue to banks and thus the lengthy comments they are likely to provide, it may take weeks, maybe months, following that date for regulators to absorb the consultation responses and finally unveil the rule’s final details, reckons Greg Lyons, a financial institutions lawyer at Debevoise & Plimpton.

That could be a problem. Regulators still insist banks reach compliance with the final rule by next July, leaving banks with only months to make the necessary in-house changes and craft compliance programs  (though the 3 percent rule may not need to be met until as far out as 2022). As a result some predict the July deadline to be pushed back, but even so banks have been left with a tall order.  

Regulators estimate banks will need to spend some 6.6 million hours to implement Volcker, and roughly 1.8 million hours to meet compliance every year thereafter. “How can banks comply with a rule that complicated? And how can regulators effectively administer it in a way that doesn't make it harder for banks to serve their customers and further weaken the broader economy?” decried American Banker Association head Frank Keating in response to the proposal.

For those banks that do see restricted private equity fund sponsorship as worth the compliance burdens, and some undoubtedly will, a number of policies and procedures will need to be put in place by next year. This includes various internal controls that delineate responsibility and monitoring of compliance, staff training, and maintenance of records demonstrating compliance which must be held for a minimum of five years, to highlight a few of the requirements. It’s likely some of these costs will be passed down to GPs.

More worrying for banks working ahead of the deadline is the inability to implement comprehensive compliance systems until final rules are published. Questions still surround how banks can convert their in-house funds into compliant customer funds (under the proposal banks can sponsor funds for both new and existing customers where the fund’s underlying risk are fully borne by the customers themselves). Other questions relate to whether or not venture capital funds will be exempted from the rule’s scope; the proposal does not exempt them but asks if that’s the right decision.

Consequently expect more lobbying from banks as Volcker moves forward. You can also expect the herculean compliance challenge banks have been handed by regulators to further encourage their disentanglement from the private equity industry.