The Federal Reserve Board has adopted guidelines for banks seeking an extension to conform certain “seeding” investments in hedge funds or private equity funds (covered funds) to the requirements of the Volcker Rule. The Fed’s guidelines provide that firms seeking a seeding period extension should submit information “including the reasons for the extension and an explanation of the entity’s plan to conform the investment ... to the requirements of the Dodd-Frank Act.”
As observed by the Fed, a “seeding” refers to the period during which a banking entity provides a new fund with initial equity to permit the fund to attract investors. While there are some exemptions and limitations, the Volcker Rule generally prohibits insured depository institutions and their affiliates from engaging in proprietary trading and from owning, sponsoring, or having certain relationships with a covered fund. Accordingly, the Dodd-Frank Act permits the Fed to review an application from a bank to provide additional time—up to two additional years—for the bank to conform its seeding investments in covered funds to the Volcker Rule if the Fed finds that the extension “would be consistent with safety and soundness and in the public interest.”
Fed guidelines. In its letter to all banking entities holding $10 billion or less in consolidated assets and subject to section 13 of the Bank Holding Company Act—the Volcker Rule—the Fed sets forth the guidelines for submitting requests for an extension of the seeding period.
Under the guidelines, titled “Procedures for a Banking Entity to Request an Extension of the One-Year Seeding Period for a Covered Fund (SR 17-5),” a bank must explain its plan for reducing the permitted investment in each covered fund through redemption, sale, dilution, or other methods, to the per-fund limitation by the end of the extended seeding period. Further, the bank is to submit, in writing, its request for an extension of the seeding period to the “Applications Unit of the Federal Reserve Bank in the district where the top-tier banking entity is headquartered.” Notably, the bank’s request should be submitted “at least 90 days prior to the expiration of the applicable time period.”
In reviewing whether a bank’s application meets all of the pertinent requirements under the laws and regulations covering the Volcker Rule, the Fed will consider the “facts and circumstances related to the permitted investment in a covered fund,” including, among other things:
- whether the investment would result, directly or indirectly, in a material exposure by the bank to high-risk assets or high-risk trading strategies;
- the contractual terms governing the bank’s interest in the covered fund;
- the date on which the covered fund is expected to have attracted sufficient investments from investors unaffiliated with the bank to enable the bank to comply with the limitations in the rule;
- the total exposure of the covered bank to the investment and the risks that disposing of, or maintaining, the investment in the covered fund may pose to the bank and to the financial stability of the nation;
- the cost to the bank of divesting or disposing of the investment within the applicable period;
- whether the investment, divestiture, or conformance of the investment would involve, or result in, a material conflict of interest between the bank and unaffiliated parties—including clients, customers, or counterparties to whom the bank owes a duty;
- the bank’s prior efforts to reduce through redemption, sale, dilution, or other methods its ownership interests in the covered fund—including the marketing of interests in the fund;
- the conditions of the market; and
- any other factor the Fed deems appropriate.
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