January 9, 2019
Authored by: Robert Klingler
The Economic Growth, Regulatory Relief and Consumer Protection Act (EGRRCPA) provided significant regulatory relief for community banks, including broad relief from the Volcker Rule’s prohibition on proprietary trading and investments in covered funds. As previously discussed, Section 203 of EGRRCPA provided an exemption from the Volcker Rule for institutions that are less than $10 billion and whose total trading assets and liabilities are not more than 5% of total consolidated assets. The exemption provides complete relief from the Volcker Rule by exempting such depository institutions from the definition of “banking entity” for purposes of the Volcker Rule.
On December 21, 2018, the financial regulatory agencies invited public comments on a proposal to implement the EGRRCPA changes to the Volcker Rule. The proposed rule provides that an insured depository institution is exempt from the Volcker Rule if “it has, and every company that controls it has, total consolidated assets of $10 billion or less and total trading assets and trading liabilities, on a consolidated basis, that are 5% or less of total consolidated assets.” While the proposed rule is not yet effective, the Federal Reserve has previously confirmed that it would not enforce the Volcker Rule in a manner inconsistent with EGRRCPA, so the proposed rule is effectively already in place.
Based on September 30, 2018 call report data, this change to the Volcker Rule exempted approximately 97.5% of the 5,486 U.S. depository institutions. (The actual number is probably slightly less, as some of those exempted depository institutions are affiliated with larger and/or foreign banks, each of which would remain subject to the Volcker Rule.) Of note, the $10 billion asset threshold is by far the most relevant determinant of the eligible relief. Based on that call report data (which necessarily excludes any trading assets and liabilities held by a parent company), only 0.15% of depository institutions had trading assets equal to at least 5% of their total assets (and only 0.16% of the institutions had trading assets equal to 3% or more of their total assets).
While few community banks ever engaged in proprietary trading before the Volcker Rule, EGRRCPA still provides meaningful relief from the compliance obligations of the Volcker Rule, the risk of inadvertently being deemed to engage in proprietary trading, or the prohibition from investing in covered funds (or the need to ensure that vehicles that were invested in qualified for an exemption from the covered fund definition).
Simply given the landscape of the U.S. banking market, it is easy to confirm that Congress, when adopting, EGRRCPA, released nearly all banks from the Volcker Rule. Relief from the Volcker Rule for over 97% of the institutions in the industry is certainly welcome relief. (And for those concerned that too much regulatory relief has been provided, I would note that over 83% of the assets held by U.S. depository institutions are still held by institutions that will remain subject to the Volcker Rule.)
But did Congress do even more than that?
In December 2018, Yahoo Finance and the American Banker each ran short stories questioning whether, in adopting EGRRCPA, Congress inadvertently exempted nearly all banks from the limitations of the Volcker Rule. The headline of the Yahoo Finance article read “Congress may have accidentally freed nearly all banks from the Volcker Rule.” The basic gist of the article was that the statutory language included in EGRRCPA actually exempted all banks that either has less than $10 billion in assets or whose trading assets constituted less than 5% of their total assets. As only a handful of institutions have trading assets that constituted more than 5% of their total assets, this interpretation would confine the Volcker Rule to only a handful of the largest institutions.
The headline of the American Banker story was a more focused on the impact on banks over $10 billion and a lot more pessimistic, “A big-bank loophole to escape Volcker Rule? Not so fast.” As reflected in the American Banker story, regardless of a literal reading of EGRRCPA, at the end of the day, institutions over $10 billion in assets will be unlikely to escape the Volcker Rule.
But that ignores the fun that be had with detailed statutory interpretation and examining the actual language used in the statute.
As reflected above and in the Yahoo Finance article, there are certainly a lot of negatives in the EGRCCPA provision.
Boiling down to the operative provisions at stake (and ignoring the “controlled by” prong), EGRCCPA provides that the Volcker Rule does not apply to an institution that does not have (A) more than $10 billion in assets and (B) trading assets of more than 5%. Put more succinctly, there is an exemption for an institution that is “NOT (A and B).”
The proposed rule, as noted above, provides that the Volcker Rule does not apply to an institution that has $10 billion or less in assets and trading assets of 5% or less. Thus, in proposing the rule, the regulators eliminated one not and expressed the two prongs in the opposite construction (more than $10 billion vs. $10 billion or less and “more than 5% vs 5% or less). Using the same succinct framework, there is an exemption for an institution that is “NOT A and NOT B.”
Under the statute, failing either A or B would appear to be sufficient to qualify for the exemption, as (A and B) is not true if either A or B is false. However, under the regulation, both A and B have to be false in order to qualify for the exemption. This could provide grounds for an institution that has more than $10 billion in assets, but trading assets of less than 5% of their assets, to challenge the statutory authority for applying the Volcker Rule to them.
As noted by the American Banker story, beyond the statutory language, any court would likely look to congressional intent and also take into consideration the regulators’ perception of that intent.
At the time of the legislative debate, the Congressional Research Services summarized the applicable EGRRCPA provision as amending “the Bank Holding Company Act of 1956 to exempt from the “Volcker Rule” banks with: (1) total assets valued at less than $10 billion, and (2) trading assets and liabilities comprising not more than 5% of total assets.” While the proposing release does not mention the underlying statutory language, I would note that the proposed rule is worded almost identically to the Congressional Research Services Summary of the provision.
With the regulatory interpretation of the EGRRCPA Volcker Rule position matching the Congressional Research Services Summary, any bank seeking to expand the Volcker Rule exemption based on the statutory language is likely to ultimately be dissatisfied.
Note 1: This is really a lesson as to why one should try to avoid double negatives at all times. Interpreting them never makes anyone feel better about the world.
Note 2: I was a policy debate geek throughout college (and then coached parliamentary debate throughout graduate and law school). One frequent (usually throw-away) argument in policy debate is that the other side is not being “topical.” Usually this type of topicality argument is based on similar grammatical/logical constructions. Rarely are they pursued and even more rarely are they successful. In my last round as a debater (in a semi-final of a regional tournament), my partner and I attempted to only make topicality arguments. We lost on a 2-1 decision. I would be surprised if a court decision on this issuer were that close.