November 01, 2019

Volcker Rule 2.0: An Overview of Recent Changes and Preview of What’s to Come

Zachary L. Baum and Julia A. Knight


As of October 8, 2019, the five agencies responsible for administering the Volcker Rule– the Commodity Futures Trading Commission (CFTC), the Federal Deposit Insurance Corporation (FDIC), the Federal Reserve Board (FRB), the Office of the Comptroller of the Currency (OCC) and the Securities and Exchange Commission (SEC) –  have approved a final rule that revises aspects of the Volcker Rule implementing regulations.  The final rule represents the first revisions to the Volcker Rule since the original final rule was adopted in late 2013.  The final rule includes some notable departures from the proposal issued in 2018 by the five agencies with responsibility for Volcker Rule implementation.  While the final rule largely addresses the proprietary trading and compliance program changes in the 2018 proposal, the Agencies deferred the most significant covered funds questions, stating that those issues would be addressed in a new notice of proposed rulemaking.  Below, we highlight some of the final rule’s most significant changes in the areas of proprietary trading, compliance programs, metrics reporting and covered funds.

Proprietary Trading

We discuss below five areas of changes to the proprietary trading provisions that are significant for banking entities:  the trading account definition, exclusions from the proprietary trading definition, permitted trading for foreign banking organizations (FBOs), a presumption of compliance with the underwriting and market-making exemptions, and the requirements of the risk-mitigating hedging exemption.  Overall, the final rule provides a simpler proprietary trading prohibition that appears to be better tailored to the activities that the Volcker Rule statute intended to restrict.

First, the final rule resolves the issue of greatest concern to the banking industry by removing the new accounting prong that the Agencies proposed last year to replace the purpose test in the trading account definition.  The Agencies had intended the accounting prong to provide a simpler, objective test to address industry concerns about the scope of the subjective purpose test and related 60-day rebuttable presumption.  However, it quickly became apparent after the 2018 proposal that the accounting prong would expand the proprietary trading prohibition’s scope to sweep in many positions not intended to be prohibited, including some long-term investments.  The Agencies ultimately adopted a simple solution by dropping the proposed prong, simplifying the short-term intent prong and placing increased reliance on the market-risk capital prong.

With regard to the short-term purpose prong of the trading account definition, the final rule reverses the presumption in the short-term purpose prong so that instruments held for 60 days or longer are presumed not covered.  The Agencies cited several activities that they believe should not be included in the definition of proprietary trading, but that they found were often captured by the 60-day rebuttable presumption, including asset-liability management activities, certain liquidity management activities, transactions to correct error trades, loan-related swaps and certain matched derivative transactions.

With regard to the market risk capital prong of the trading account definition, under the final rule, institutions subject to the U.S. market risk capital rule are only required to look to the market risk capital prong and the dealer prong, and need not apply the short-term purpose prong.  Other banking entities (which may include entities controlled but not consolidated with a market risk capital parent) will be subject to the short-term purpose prong, but these entities may elect to apply the market risk capital prong instead, provided the election is made with regard to a banking entity and all of its wholly-owned subsidiaries.  The opt-in approach is designed to provide parity between smaller banking entities that are not subject to the market risk capital rule and larger entities with active trading businesses that are subject to the market risk capital rule.  By not requiring that banking entities apply both the market risk capital prong and the short-term purpose prong, the Agencies have removed a significant source of ambiguity and “scope creep” arising out of the need to review separately any non-market risk capital positions under the subjective purpose prong and to apply its accompanying 60-day rebuttable presumption.

Second, the final rule provides a number of additional exclusions from the proprietary trading definition for various types of financial instruments that may be used for particular purposes that are not intended to be prohibited, but that nonetheless may involve short-term trading by a banking entity as principal.  Most notably, the final rule expands the instruments that may fall within the liquidity management exclusion beyond securities to include foreign exchange forwards, foreign exchange swaps and cross-currency swaps, so long as the other elements of the liquidity management exclusion are met.  The expansion of the list of products that now may qualify for the exclusion is an acknowledgement that cross-border liquidity management is prevalent among banking entities subject to the Volcker Rule and that the original liquidity management exclusion may have addressed stores of liquidity (securities) without truly addressing “liquidity management”.  In addition, the final rule adopts a limited exclusion for matched derivatives transactions conducted by non-dealer banks that is intended to pick up the proposed exclusion for loan-related swaps, but in practice will apply to a broader array of swaps with customers.

Third, the final rule revises the exemption for foreign banks’ trading outside the United States to remove the restriction on trading with or through U.S. counterparties and the prohibition on using U.S. personnel to arrange, negotiate or execute a transaction.  This finally resolves one of most significant objections of foreign banks to the extraterritorial scope of original 2013 rule.

Fourth, the Agencies finalized largely as proposed a presumption that a trading desk operating within internally-set risk and other limits satisfies the reasonably expected near-term demand (RENTD) requirement, which requires that permitted underwriting and market-making activities not exceed the RENTD of clients, customers and counterparties.  Banking entities would be permitted to base risk and other desk limits on internal models and analyses rather than any mandatory analysis.  Internal limits, however, are required to be designed not to exceed the RENTD of clients, customers or counterparties, based on the nature and amount of a trading desk’s underwriting/market-making-related activities.  Therefore, the Final Rule does not eliminate RENTD as a requirement or a parameter; rather, the key innovation is in the presumption of compliance, which is expected to alleviate transaction- and inventory-level review in favor of more general supervisory monitoring of a desk’s risk management.

Fifth, the Agencies eliminated two requirements of the 2013 Rule’s risk-mitigating hedging exemption.  Banking entities no longer must conduct a correlation analysis.  The Agencies determined this was not mandated by the statute and that banking entities should have flexibility to apply analysis that is appropriate to assess particular hedging activity.  In addition, banking entities no longer must show that a hedge “demonstrably” reduces or otherwise significantly mitigates an identifiable risk.  A banking entity must still “design” or “reasonably expect” its hedging activity to reduce or significantly mitigate one or more risks.

Compliance Programs

Three-tiered Compliance Framework

The final rule creates three tiers of compliance program requirements that correspond to banking entities’ level of gross trading assets and liabilities (TAL).  Under the final rule, this metric excludes transactions in U.S. government or agency securities.

The most extensive compliance program requirements will apply to “significant” TAL entities, which are those with TAL of $20 billion or more.  These institutions must comply with the six-pillar compliance program set out in Section __.20 of the 2013 rule, as well as metrics reporting requirements and the CEO attestation requirement.  The $20 billion threshold is a notable increase from the $10 billion TAL threshold in the 2018 proposal, as well as from the existing rule, which applied metrics reporting and the CEO attestation to entities with $10 billion or more in TAL (and also applied the CEO attestation to entities with total consolidated assets of $50 billion or more). The more prescriptive compliance program requirements set out in Appendix B of the 2013 rule have been removed for all banking entities.

“Moderate” TAL entities are those with TAL between $1 billion and $20 billion, and can satisfy the compliance program requirement by including in existing compliance policies and procedures references to the Volcker Rule requirements as appropriate given the activities, size, scope and complexity of the organization.  “Limited” TAL entities are those with less than $1 billion in TAL.  These institutions have no compliance program requirement and benefit from a rebuttable presumption of compliance.

The final rule reserves authority for the agencies to determine that any of the requirements applicable only to a significant TAL banking entity could be applied to a moderate or limited TAL entity.

Notably, in a change from the 2018 proposal, the final rule applies all of the TAL thresholds to FBOs based on the TAL of their U.S. operations, rather than global TAL.  This avoids scoping in FBOs with only limited U.S. operations to requirements such as the CEO attestation.

Metrics Reporting

In addition to raising the threshold for metrics reporting, the final rule has reduced the reporting requirements themselves, eliminating some quantitative metrics from both the 2013 final rule and the 2018 proposed rule.  The narrative reporting requirements proposed in 2018 also have been narrowed.

The revised metrics reporting requirements are expected to reduce the number of required data items by 67 percent and the total volume of data by 94 percent, according to the Agencies’ estimates and relative to the status quo.

Reporting frequency under the final rule will be quarterly; previously, entities with over $50 billion in gross trading assets and liabilities were subject to a monthly reporting schedule.

Covered Funds

The final rule’s changes to the covered funds provisions are limited to a handful of changes that were specifically proposed in the 2018 proposal.  For many of the most significant covered fund issues – such as the definition of covered funds, the addition or expansion of exclusions from that definition, and changes to the so-called “Super 23A” prohibition – the 2018 proposal only posed questions for comment.  Rather than using the comments received as a basis for a final rule, the Agencies opted to put those covered funds issues onto a separate, slower track through a new notice of proposed rulemaking covering those and other topics.

The final rule makes three notable changes to the covered funds rules, related to the market making and underwriting exemptions, the exemption for FBOs’ funds activities outside the United States, and the ability to acquire covered funds to hedge customer-driven transactions.

Interests in third-party covered funds acquired by banking entities in reliance on the market making and underwriting exemptions no longer will be subject to the 3% limits and Volcker Rule capital deduction requirement.  This will effectively eliminate the need for banking entities relying on these exemptions to undertake intensive compliance exercises to determine whether a third-party fund is a covered fund.  The 3% limits and capital deduction will continue to apply to banking entities’ investments in sponsored covered funds.

The second set of changes relate to the “SOTUS exemption” for FBOs’ funds activities conducted solely outside the United States.  The final rule removes the restriction prohibiting an FBO from relying on that exemption if the purchase or sale of ownership interests in covered funds is financed by a U.S. branch or agency of the FBO.  This restriction also was eliminated in the exemption for non-U.S. trading activities.  In addition, the final rule adopts the interpretation of the U.S. marketing restriction set forth by the Agencies in their Frequently Asked Question #13.  FAQ #13 confirms that the marketing restriction will not prevent an FBO from investing in third-party funds with U.S. investors as long as the FBO itself does not participate in an offering of the fund to U.S. persons (including serving as sponsor or investment adviser to the fund if it is offered to U.S. persons).

Third, the final rule allows a banking entity to hold a covered fund interest as a risk-mitigating hedge when acting as an intermediary on behalf of a customer (that is not itself a banking entity) to facilitate the customer’s exposure to the fund.  While this exemption initially was proposed in 2011, the 2013 final rule changed course and removed it, and in the preamble to that rule the Agencies made reference to such hedging transactions potentially representing a “high-risk trading strategy” (which would make such transactions potentially ineligible to rely on another exemption, such as market-making).  In addition to reinstating an exemption for such transactions, the Agencies also disavowed this view.

Compliance Date

The effective date of the final rule is January 1, 2020.  Compliance is not required until January 1, 2021, but institutions may “opt in” to elements of the final rule after the effective date if they so choose.  It appears this should permit institutions that provided a CEO attestation in March 2020 but will no longer be subject to an attestation requirement under the final rule to suspend such attestations beginning with the March 2020 cycle, although this was not explicitly confirmed by the Agencies.


While the final rule did not change the fundamental scope of the Volcker Rule’s prohibition on proprietary trading, it made specific adjustments to the scope of the prohibition in an effort to more effectively focus it on those activities intended to be prohibited, in addition to removing some compliance burdens that in retrospect appeared unjustified.  A similar effort to clarify and focus the covered funds prohibitions has now been put on a longer track, and progress may be slow there given the complex issues involved and a lessening of pressure on the Agencies now that the first round of amendments has been successfully completed.


Zachary L. Baum

Zachary L. Baum is an associate in Cleary Gottlieb Steen & Hamilton LLP’s Washington DC office and be reached at (202) 974-1873 or by email at

Julia A. Knight

Julia A. Knight is an associate in Cleary Gottlieb Steen & Hamilton LLP’s New York office and be reached at (212) 225-2304 or by email at