How does the Volcker Rule define "covered funds"?
Examine the specific definition and criteria for "covered funds" as outlined in the Volcker Rule, including entities subject to regulation.
The Volcker Rule defines "covered funds" as a specific category of entities and investments that are subject to certain restrictions and prohibitions under the rule. Covered funds are typically investment vehicles that are exempt from certain regulatory requirements but are considered by the Volcker Rule to pose risks that are similar to those associated with proprietary trading. The rule aims to restrict banking entities' involvement with these funds to prevent excessive risk-taking with customer deposits. Here are some key elements of how the Volcker Rule defines covered funds:
Hedge Funds and Private Equity Funds: The Volcker Rule specifically includes hedge funds and private equity funds within the definition of covered funds. These are commonly known investment vehicles that pool capital from multiple investors to make various types of investments.
Venture Capital Funds: The rule exempts venture capital funds from the definition of covered funds. Venture capital funds are typically focused on investing in startup companies and are considered less risky compared to other types of funds.
Foreign Public Funds: Foreign public funds that are publicly offered and operated outside the United States are generally excluded from the definition of covered funds. This exclusion recognizes that these funds are subject to regulatory oversight in their home jurisdictions.
Ownership and Sponsorship Restrictions: The Volcker Rule generally prohibits banking entities from acquiring or retaining an ownership interest in, or sponsoring, covered funds. This prohibition is designed to prevent banks from engaging in proprietary trading through these funds.
Permitted Activities: While there are restrictions on ownership and sponsorship, the Volcker Rule allows banking entities to provide certain limited services to covered funds. These services include underwriting, market-making, and organizing and offering the covered fund.
It's important to note that the Volcker Rule contains detailed provisions and exceptions related to covered funds, and the definition of covered funds can be complex. The rule is subject to regulatory interpretations and guidance, and its application may vary depending on specific circumstances and the nature of the fund in question.
Overall, the Volcker Rule's treatment of covered funds is aimed at reducing the risks associated with proprietary trading and certain high-risk investments while still permitting some activities that are considered less risky and consistent with traditional banking services.
Defining "Covered Funds" in the Volcker Rule.
Under the Volcker Rule, a covered fund is an entity that:
- Is an investment company under the Investment Company Act of 1940 but for section 3(c)(1) or 3(c)(7) of that Act;
- Is a commodity pool under the Commodity Exchange Act (CEA) whose operator relies on CFTC Rule 4.7; or
- Is a foreign fund that either relies on section 3(c)(1) or 3(c)(7) of the Investment Company Act with respect to US investors or satisfies other criteria.
Section 3(c)(1) of the Investment Company Act exempts from regulation certain investment companies that have fewer than 100 beneficial owners and are not making a public offering of their securities. Section 3(c)(7) of the Investment Company Act exempts from regulation certain private equity funds. CFTC Rule 4.7 exempts from regulation certain commodity pools that are operated by registered commodity pool operators and that have fewer than 15 participants.
The Volcker Rule also defines a covered fund as any fund that is sponsored by a banking entity. A sponsor of a fund is an entity that:
- Serves as a general partner, managing member, trustee, or commodity pool operator of a covered fund;
- In any manner selects or controls (or has employees, officers, directors, or agents who constitute) a majority of the directors, trustees, or management of a covered fund; or
- Provides more than 3% of the financing of a covered fund.
The Volcker Rule prohibits banking entities from acquiring or retaining an ownership interest in, sponsoring, or having certain relationships with covered funds. However, there are a number of exemptions to these prohibitions. For example, banking entities are permitted to invest in covered funds that are managed by their affiliates, as long as the investments are made through a blind pool and the banking entity has no control over the investment decisions of the fund.
The Volcker Rule definition of covered funds is broad and encompasses a wide range of entities, including private equity funds, hedge funds, and commodity pools. If you are unsure whether a particular entity is a covered fund, you should consult with an attorney or other qualified professional.