Under the Economic Growth, Regulatory Reform and Consumer Protection Act, depository institutions and their holding companies with less than $10 billion in assets are excluded from the prohibitions of the Volcker Rule. Accordingly, institutions under $10 billion may, so long as consistent with general safety and soundness concerns, engage once again in proprietary trading and in making investments in covered funds.
On December 21, 2018, the federal regulatory agencies proposed rules implementing this EGRRCPA provision. However, as previously noted, even pending finalization of these regulations, the regulatory agencies have also noted that they will not enforce the Volcker Rule in a manner inconsistent with EGRRCPA.
EGRRCPA, and the proposed rule, effect the exclusion of smaller institutions from the Volcker Rule by modifying the scope of the term “banking entity” for purposes of the Volcker Rule. The proposed rule excludes from being a “banking entity” any institution that has (i) $10 billion or less in assets and (ii) trading assets of 5% or less.
Neither EGRRCPA nor the proposed rule, however, addresses the impact on an institution when it goes over $10 billion in assets, either as a result of organic growth or via merger. The proposed rule does not even apply the tests on a quarter-end or other reporting period basis, much less an average balance or consecutive quarter requirement. The proposing release notes that they believe that insured depository institutions “regularly monitor their total consolidated assets” for other purposes, and therefore do not believe this ongoing test requirement would impose any new burden.
Accordingly, it would appear that once an institution crosses the $10 billion asset threshold (even, arguably, on an intraday basis), that it must immediately cease any proprietary trading and divest ownership of any covered funds. For proprietary trading, this is potentially annoying and inconvenient, but ultimately doable. But covered funds are inherently illiquid and the institution may not be in position to quickly, expeditiously, or cost-effectively exit such positions on a short-term basis, if at all.
However, the existing conformance period rules would appear to provide relief. 12 CFR 225.181(a)(2) provides relief for a “company that was not a banking entity … as of July 21, 2010, and becomes a banking entity … after that date.” Given the redefinition of banking entity under EGRRCPA and the proposed rule, this would appear to capture an institution that, at least for the first time, grew above $10 billion in assets. Under the conformance period rules, such institutions would then have two years from the date of becoming a banking entity (i.e. exceeding $10 billion in assets) to bring its activities and investments into compliance with the requirements of the Volcker Rule. The two year requirement would appear to be a hard deadline, as the ability of the regulators to grant up to a five year extension on a case-by-case basis for illiquid funds is limited to contractual obligations that were in effect on May 1, 2010.
The Volcker Rule relief granted by EGRRCPA for institutions under $10 billion remains useful and valid for the vast majority of U.S. banks, but as institutions grow over $10 billion (or are acquired by other institutions that either are, or intend to go, over $10 billion), Volcker Rule compliance will remain an important element of due diligence. It is important to note that representations regarding compliance with law, and even targeted representations regarding Volcker Rule compliance, may be insufficient in definitive agreements, as the target’s size will mean that the target’s compliance is based on an exemption that will be unavailable to the acquirer.