Wednesday, February 29, 2012

US Senator Concerned about Impact of Volcker Regulations on Market Making and Venture Capital Funds

Senator Michael Bennet (D-CO) is concerned that the proposed regulations implementing the Volcker Rule provisions of Dodd-Frank could unintentionally chill basic market making activities, which are explicitly permitted under the Volcker Rule. In a letter to the SEC and banking agencies, he also noted that Congress never intended for venture capital funds to be swept into the embrace of the Volcker regulations.

The Senator pointed out that the proposed regulations highlight seventeen measurements that a financial institution must calculate regarding its market making activities. It also contains a list of qualitative criteria that an institution must satisfy. He pointed out that some aspects of the proposed regulations could potentially work to place an institution at risk of an enforcement action for undertaking proprietary trading even if it satisfies both the metrics and the qualitative criteria.

He urged that the final regulations provide a greater degree of certainty as to what constitutes permissible market making activities. This is particularly important for institutions that are making a good faith attempt to comply with the Volcker Rule. The Senator fears that, without greater clarity on questions of compliance, a final rule may unintentionally disrupt traditional hedging and market making activities.

Similarly, he asked the SEC and other regulators to implement consistent supervisory procedures when enforcing the Volcker Rule. If one regulator determines that a set of transactions constitutes permissible market making, he emphasized, another regulator should not be able to characterize the same set of transactions as improper proprietary trading. The Senator views this kind of coordination as critical for the proper functioning of the financial markets.

On a separate point, he asked the regulators to refine the breadth of the covered fund definition as it pertains to joint ventures and other acquisition vehicles that occur commonly in commercial transactions. The proposal notes that the definition of a covered fund could potentially include within its scope many entities and corporate structures that would not usually be thought of as a hedge fund or private equity fund. The proposal goes on to acknowledge that joint ventures, acquisition vehicles and other widely-utilized corporate structures are generally not used to engage in investment or trading activities.

If the final regulations prohibit companies that are somehow affiliated with insured depository institutions from forming joint ventures or other acquisition vehicles, reasoned the Senator, it may become substantially more expensive and complicated to engage in an otherwise common merger or acquisition. All the while, such a prohibition would have little, if any, bearing on Congress' intended goals of the Volcker Rule.

In his view, the final regulations should also permit financial institutions to invest in venture capital funds. He emphasized that venture capital funds lack the size and interconnectedness of the type of investment vehicles that Congress contemplated in crafting the Volcker Rule. They also play an important role in the economy at a time when it has become increasingly difficult for smaller and mid-size companies to obtain access to capital.

Finally, Senator Bennet said that final regulations should permit insurance companies to obtain ownership interests in certain covered funds for their general accounts. Under various state laws, insurance companies are already required to diversify their investments and are restricted in the categories of investments that they may hold. These various state laws are aimed at minimizing excessive risk taking, which overlap with the goals of the Volcker Rule.

Without such an ability to invest in certain covered funds, noted the Senator, insurance companies may have difficulty finding alternative investment vehicles to fund their products. Such a prohibition may also run counter to the intent of Congress, which sought to exempt insurance companies from the restrictions set forth in the Volcker Rule.

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