Make No Bonds about It: Exempting Foreign Government Obligations from the Volcker Rule
McElroy, Matthew S., Fordham Journal of Corporate & Financial Law
U.S. financial regulators are considering exempting foreign government obligations from the Volcker Rule's prohibition on proprietary trading. Bank Holding Company Act § 13(d)(1)(J), added by Section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, governs such exemptions and sets a very high standard for regulators seeking to utilize them. This provision requires that four regulatory agencies unanimously agree to the exemption and determine that it satisfies a strict substantive standard-that it "promote[s] and protect[s] the safety and soundness of the banking entity and the financial stability of the United States."
Regulators may jointly agree to make such an exemption for sovereign debt because they are facing intense political pressure to do so. Foreign governments, including several close allies of the United States, have spoken out publicly against the Volcker Rule. These governments are asking U.S. regulators to exempt sovereign debt from the trading prohibitions of the Volcker Rule because of the adverse effects it will have on their debt markets. Their concerns support the case that the substantive standard in § 13(d)(1)(J) is satisfied.
Congress enacted the Volcker Rule in § 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank").2 The Volcker Rule prohibits proprietary trading by federally-insured depository institutions and sets capital and quantitative limits on proprietary trading by nonbank financial companies supervised by the Federal Reserve Board.3 It also contains limited exceptions to the ban on proprietary trading, permitting trading in government securities, trading in connection with market-making activities, and trading on behalf of customers.4 Importantly, Congress did not include foreign government obligations in the government securities exemption.5 As a result, U.S. banks may not proprietarily trade in foreign sovereign debt. Foreign governments, worried that the rule will restrict their ability to raise capital in public markets, are asking regulators to make an exception for sovereign debt. One possible avenue for creating this exception is a provision within the Volcker Rule allowing regulators to exempt additional activities from the prohibition on proprietary trading, if the activities meet certain requirements.6
Congress granted regulators the authority to exempt activities from the Volcker Rule in subsection 13(d)(l)(J) of the Bank Holding Company Act of 1956.7 In order for regulators - the Commodities Futures Trading Commission ("CFTC"), Securities and Exchange Commission ("SEC" or "Commission"), Office of the Comptroller of the Currency ("OCC"), and Federal Reserve Board (collectively, the "Agencies") - to exempt an activity, they must first agree on what activity to exempt.8 Further, that activity must be one that "would promote and protect the safety and soundness of the banking entity and the financial stability of the United States."9 Many foreign governments have submitted public comment letters asking the Agencies to exercise their authority under § 13(d)(l)(J) to exempt foreign government obligations. The statute itself does not explicitly say when the Agencies should use their exemptive power, nor does it distinguish between banned and permitted activities. As a result, the Agencies face the difficult task of writing rules that fill these voids. The Agencies are now struggling to determine if Congress really intended to include foreign government obligations in the ban on proprietary trading.
In October 2011, the Agencies released Prohibitions and Restrictions on Proprietary Trading and Certain Interests in, and Relationships with, Hedge Funds and Private Equity Funds ("Proposed Rule"), containing proposed regulations for implementing the Volcker Rule.10 The Proposed Rule seeks comments on certain questions, including whether the § 13(d)(l)(J) exemptive authority should be applied to foreign government obligations. …