When Congress passed the Volcker Rule in a package of sweeping financial reform legislation in 2010, its aim was to minimize systemic risk by prohibiting banks from engaging in proprietary trading—a form of trading that allows banks to profit by investing their own money instead of trading on behalf of clients. To prevent banks from skirting this prohibition, the Volcker Rule also generally prohibits banks from sponsoring, acquiring or retaining an ownership interest in so-called “covered funds,” defined to include hedge funds and private equity funds, a blanket restriction that has impacted sources of capital for the middle market.
Five years after regulations implementing the Volcker Rule were finalized, the five joint agencies with authority over the Volcker Rule released a notice of proposed rulemaking (NPRM) to simplify and tailor compliance requirements, including potential changes to the definition of a covered fund.
ACG filed a comment letter last week in response to the NPRM to advocate that certain middle-market private funds do not pose a threat to systemic risk and should therefore be excluded from the definition of a covered fund under the Volcker Rule.
In the comment letter, ACG argued that the current one-size-fits-all approach to the definition of a covered fund has deprived banking entities from investing in middle-market private funds that pose no systemic risk, do not share the characteristics of the types of investment vehicles the Volcker Rule was primarily designed to protect against, and provide much-needed investment capital to growing U.S. businesses.
Certain middle-market private funds do not pose a threat to systemic risk and should therefore be excluded from the definition of a covered fund under the Volcker Rule.
ACG asserted that middle-market private funds make long-term investments in privately held businesses, do not employ significant leverage at the fund level or engage in risky derivatives, generally disallow redemption rights for investors, and are already heavily regulated. Because these factors provide inherent fund-level stability for middle-market private funds, there is no reason that banks should be prohibited from investing in them by the Volcker Rule.
To implement this exclusion, ACG urged the joint agencies to leverage the already-existing regulatory framework of the Securities and Exchange Commission’s Form PF as a bright-line basis for identifying the covered-fund status of a “middle-market private fund.”
Specifically, ACG advocated that if a private equity fund is not advised by a firm that reported most recently as a “large private equity adviser”—meaning the adviser does not have at least $2 billion in private equity fund assets under management—then the fund should not be considered a covered fund under the Volcker Rule. ACG also asserted that banks would be able to easily identify whether a fund meets this criterion by simply checking the publicly available Form ADV on the SEC’s website, which lists AUM amounts, and then, if necessary, verifying it by requesting a redacted Form PF.
ACG’s solution fulfills several important conditions designed to increase the chance for success: It relies on definitions already found within the current regulatory framework, it uses a bright-line threshold that banks can easily verify, and it can be implemented with minimal cost or burden to banks.
Furthermore, ACG’s position fulfills its mission to drive middle-market growth. By advocating to allow banks to invest in middle-market private funds, ACG is laying the groundwork to open up a valuable source of capital that can be injected into U.S. middle-market businesses, helping these economy-boosting companies to grow and expand.
Maria Wolvin is ACG Global’s vice president and senior counsel, public policy.