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Implementation of The Volcker Rule Conformance Period: A Primer

February 11, 2011

The Federal Reserve Board (“the Board”) has adopted the final rule implementing the conformance period during which banking entities and nonbank financial companies supervised by the Board must bring their activities and investments into compliance with the “Volcker Rule,” the Dodd-Frank Act’s prohibitions and restrictions on proprietary trading and relationships with hedge funds and private equity funds.

The General Conformance Period.

The Volcker Rule will take effect on the earlier of July 21, 2012, or 12 months after the issuance of final regulations by the rule writing agencies. In order to allow the markets and firms to adjust to the Volcker Rule, affected firms have a conformance period in which they can wind down, sell, or otherwise conform their activities to the Act. This conformance period generally extends through the date that is two years after the date on which the prohibitions become effective or, in the case of a nonbank financial company supervised by the Board, two years after the company is designated by the Financial Stability Oversight Council (FSOC) for supervision by the Board, if that period is later.

General Extensions of The Conformance Period.

In accordance with the Act, the Board may grant up to three separate one-year extensions of the general conformance period. It will not grant all three one-year extensions at a single time.

Extended Conformance Period for Illiquid Funds.

The Act permits the Board to extend the period during which a banking entity may take or retain an ownership interest in, or otherwise provide additional capital to, an illiquid fund, but only if the extension is necessary to allow the banking entity to fulfill a contractual obligation that was in effect on May 1, 2010. Although only one five-year extension is permitted, it may be added to an extension granted under a different provision. To be considered illiquid, a fund must meet two sets of criteria. The first focuses on the nature, assets, and investment strategy of the fund itself. The second focuses on the terms of the banking entity’s investment in the fund.

Addressing the nature of the assets, the rule specifically provides that an asset may be considered illiquid if a fund is restricted from transferring the asset for three or more years. However, an asset is not illiquid simply because of market conditions or because the size of the holding makes it difficult to transfer. A fund will be considered to be “principally invested” in illiquid assets if at least 75 percent of the fund’s consolidated total assets are, or were expected to be, composed of illiquid assets.

Addressing the second criteria, the terms of the investment, an extension will not be granted if a contract permits a firm to terminate its obligations because they would violate the Volcker Rule.

The final rule is effective April 1, 2011. View the release and text of the new rule here.

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