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Regulators propose Volcker Rule changes to allow VC stakes

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WASHINGTON — Banking regulators are proposing to update a portion of the Volcker Rule and allow banks to take stakes in certain investment funds, which was originally prohibited under the 2013 rule enacted after the financial crisis.

The proposal — which the Office of the Comptroller of the Currency, Federal Reserve and Federal Deposit Insurance Corp. all approved Thursday — would revise the definition of a so-called covered fund. The plan would allow financial institutions to invest in funds that many stakeholders say were not meant to be the target of the Volcker Rule.

The original rule, mandated by the Dodd-Frank Act and first conceived by former Fed Chairman Paul Volcker, allowed banks to take direct stakes in individual startup companies but not funds containing multiple investments.

The proposal would ease that provision by allowing banks to invest in instruments such as credit funds, venture capital funds, customer facilitation funds and family wealth management vehicles — even if those funds contained multiple investments.

The 2013 rule not only banned proprietary trading but also limited bank stakes in private-equity and hedge funds to prevent the type of short-term risky bets that helped precipitate the financial crisis.

The five regulatory agencies that oversee the Volcker Rule — including the Fed, FDIC and OCC — proposed revamping the rule in 2018, and finalized high-level changes to the covered funds provision in August.

But the agencies are now tackling the more granular definition of a “covered fund,” which dictates what kinds of investments banks can make.

“We now have considerable supervisory experience putting that common sense prohibition into practice, and we have learned that a simpler, clearer approach to implementing the rule makes it easier for both banks and regulators to carry out the intent of the rule,” Fed Chair Jerome Powell said in a statement Thursday. (The Fed and FDIC both approved the proposal at board meetings on Thursday.)

Yet the proposal immediately drew mixed reactions, with industry groups saying the changes would represent a prudent refinement of the post-crisis regime and Dodd-Frank supporters charging that the regulators were going too far.

“Today’s proposal will allow banks to get back to some important traditional commercial banking and asset management activities that the current rule prohibits, helping businesses grow and consumers build savings," Greg Baer, president and CEO of the Bank Policy Institute, said in a statement. "These are client-focused, non-proprietary activities that the Dodd-Frank Act didn’t intend to prohibit, so this proposal is all gain and no pain.”

But Dennis Kelleher, CEO of Better Markets, said the proposal "will allow banks to do indirectly what they are prohibited from doing directly."

“Today’s proposal undermines the Volcker Rule prohibition and its objectives by opening more loopholes that will allow Wall Street’s biggest taxpayer-backed banks to again engage in substantial proprietary trading," Kelleher said.

Yet FDIC Chairman Jelena McWilliams took aim at those who have criticized both the proposal as well as the previous revision of the proprietary trading ban, suggesting that they were being reactionary.

"Any adjustments to the Volcker Rule seem to elicit criticism that just about any change, no matter how many guardrails are in place, would somehow create a gaping hole in our regulatory framework. Such criticism is simply unfounded," she said at the agency's board meeting.

Allowing banks to invest in a fund structure rather than taking more direct stakes in companies would help them to diversify risk, which could in turn bolster safety and soundness, agency officials said in a press briefing.

The decision to propose permitting these activities is bolstered by the congressional record, agency officials added. Former Sen. Chris Dodd, D-Conn., a principal author of Dodd-Frank, said himself in 2010 that “properly conducted venture capital investment will not cause the harms at which the Volcker Rule is directed.”

The proposal would also simplify parts of the “covered funds” provision seen as overly restrictive, according to the proposal, including how foreign public funds, loan securitizations and small-business investment companies are treated. If finalized, the rule would also allow for certain low-risk transactions, like intraday credit and payment, clearing and settlement transactions.

The banking regulators are also proposing to exclude foreign public funds from the definition of a covered fund, because they are sufficiently similar to U.S. investment funds, the agencies said.

However, the proposal maintains the original rule’s restriction on allowing a bank to engage in proprietary trading through a fund structure, restricts banks from bailing out any funds it sponsors and limits conflicts of interest between a bank and a fund, Randal Quarles, vice chair for supervision at the Fed, said in a statement.

“Of course, the activity remains subject to the same strict capital charges even if it is conducted through a fund structure,” Quarles added.

But Fed Gov. Lael Brainard objected to the proposal, saying she did not see the basis for excluding venture capital funds from the ban.

“The proposal opens the door for firms to invest without limit in venture capital funds and credit funds,” she said in a statement. “The proposal suggests that these funds do not raise concerns about banks’ involvement in risky activity that the Volcker Rule was intended to address. To the contrary, it is clear why Congress legislated the Volcker Rule to limit these activities.”

FDIC board member Martin Gruenberg, the agency's former chairman appointed by former President Barack Obama, also opposed the plan, saying it would “severely weaken” the Volcker Rule.

The proposal “would allow the largest, most systemically important banks again to engage in investment and relationships with the high-risk funds that resulted in large losses and contributed to the failure and near failure of large financial firms in the financial crisis,” Gruenberg said.

But Comptroller of the Currency Joseph Otting, who sits on the FDIC board, said the changes would "sharpen the focus of the Volcker Rule on those activities that presented risk to the federal banking system."

"The proposal would help provide additional options for capital that is critical to the growth of small businesses across the country," he said.

In a jab clearly directed at Gruenberg, Otting said, "And unlike my colleague on the board who has a tendency to cry wolf whenever we modify these rules to ensure that capital reaches American consumers and businesses, I feel these changes help to focus on the activities that present, really, the greatest dangers to our financial system."

Brendan Pedersen contributed to this article.

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Volcker Rule Regulatory relief Regulatory reform Venture capital Private equity Jerome Powell Randal Quarles Lael Brainard FDIC Federal Reserve
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