Kathleen A. Scott
Kathleen A. Scott ()

In my May 9, 2012, column,1 I wrote about a proposed rule implementing one of the most controversial provisions in the Dodd-Frank Wall Street Reform and Consumer Protection Act.2 Section 619 of Dodd-Frank, the so-called “Volcker Rule,” contains prohibitions and restrictions on the ability of banking organizations and systemically significant non-bank financial companies to engage in proprietary trading or investing in or sponsoring a hedge or private equity fund.3 The rule was aimed at protecting taxpayers from losses at banking institutions protected by the “federal safety net” (e.g., FDIC deposit insurance) and at reducing risk by furthering the safety and soundness of banking institutions and lessening possible threats to the financial stability of the United States.4

On Nov. 7, 2011, the U.S. federal banking agencies and the Securities and Exchange Commission issued for comment proposed regulations to implement the Volcker Rule.5 Over two years later, after review of several thousand comments, the federal banking agencies, the Securities and Exchange Commission and the Commodity Futures Trading Commission announced approval of the final version of the Volcker Rule regulations on Dec. 10, 2013.6

One of the exemptions from the Volcker Rule restrictions on proprietary trading is for transactions taking place “solely outside the United States.” This month’s column will discuss the final regulations’ treatment of this exemption from the proprietary trading rules.7


By way of a brief review, under the Volcker Rule, a “banking entity,” which includes a non-U.S. bank that is treated under the International Banking Act of 1978 (IBA) as if it were a U.S. bank holding company, and any affiliate or subsidiary of such a non-U.S. bank,8 generally is prohibited from engaging in proprietary trading or acquiring or retaining an equity, partnership, or other ownership interest in, or sponsor, a hedge fund or a private equity fund, subject to certain exemptions.

The statutory definition of “proprietary trading” is “engaging as a principal for the trading account of the banking entity…in any transaction to purchase or sell, or otherwise acquire or dispose of, any security, any derivative, any contract of sale of a commodity for future delivery, any option on any such security, derivative, or contract, or any other security or financial instrument that the appropriate [regulators]…determine.”9 One of the several exemptions to the general ban on proprietary trading is for:

[p]roprietary trading conducted by a banking entity pursuant to paragraphs (9) or (13) of section 4(c) [of the BHC Act], provided that the trading occurs solely outside of the United States and that the banking entity is not directly or indirectly controlled by a banking entity that is organized under the laws of the United States or of one or more States.10

Sections 4(c)(9) and 4(c)(13) are the primary statutory bases for the regulations issued by the Federal Reserve Board regulating a non-U.S. bank’s non-banking activities in the United States.11

Legislative History

The legislative history is clear that the exemption was meant to acknowledge “international comity” and allow non-U.S. banks to engage in activities outside the United States that were permissible for that non-U.S. bank under its home country laws.12 A Jan. 18, 2010, Financial Stability Oversight Council report making recommendations on implementing the Volcker Rule also stated that the purpose of the statute was not to impose extraterritorial jurisdiction over non-U.S. banks’ proprietary trading outside the United States.13

Proposed Regulations

The November 2011 proposed regulations set out four conditions that would need to be satisfied in order for a purchase or sale to be deemed to have occurred “solely outside the United States”:14

(i) The covered banking entity conducting the purchase or sale is not organized under the laws of the United States or of one or more states;

(ii) No party to the purchase or sale is a resident of the United States;

(iii) No personnel of the covered banking entity who is directly involved in the purchase or sale is physically located in the United States; and

(iv) The purchase or sale is executed wholly outside of the United States. (Emphasis added).

The regulators’ stated purpose in proposing these conditions was to “ensure that a transaction executed in reliance on the exemption does not involve U.S. counterparties, U.S. trading personnel, U.S. execution facilities, or risks retained in the United States. The presence of any of these factors would appear to constitute a sufficient locus of activity in the U.S. marketplace so as to preclude availability of the exemption.”15


Many of the comments from the major non-U.S. banks, their trade associations and in some cases, their regulators, sharply criticized this proposed exemption, noting that:

• The proposal went beyond the plain language of the statute.

• The proposal did not take sufficient note of the purpose of the Volcker Rule.

• There would be unintended consequences if the proposal were adopted as proposed.

• There are better alternatives to meet the purpose of Volcker.

• The proposal is not in keeping with the principles of international comity.

The Final Rule

That the regulators took those comments to heart in drafting the final rule language is clear from a review of the final regulation implementing the “solely outside the United States” exemption.16

As a threshold matter, the final rule clarifies exactly what is a “U.S. banking entity,” resolving an inconsistency among various federal laws. Under the IBA, banks located in or organized under the laws of a commonwealth, territory or possession of the United States are considered non-U.S. banks, whereas U.S. securities laws and certain banking laws treat those locations as being in the United States. The final regulation came down on the side of ruling that banks from those locations (e.g., Puerto Rico and Guam) are U.S. banks, thus explicitly subjecting these entities to the full effect of the Volcker Rule.17

When it comes to the substance of the “solely outside the United States” exemption, the regulators significantly revised the proposed exemption in order to focus on the activity taking place in the United States and for what entity such activity is being conducted, taking a risk-based approach rather than the rather mechanical transaction-based approach utilized in the proposed regulations. The key concepts are the location of the risk of the transaction, and which entities have assumed that risk in the transaction.18 The risk of the transaction must be outside the United States.

Under the final rule, in order for a transaction to fall within the “solely outside the United States” exemption from the ban on proprietary trading:

• The banking entity engaging as principal in the purchase or sale (including any personnel of the banking entity or its affiliate that arrange, negotiate or execute such purchase or sale) cannot be located in the United States or organized under the laws of the United States or of any state;

• The banking entity (including relevant personnel) that makes the decision to purchase or sell as principal cannot be located in the United States or organized under the laws of the United States or of any state;

• The purchase or sale, including any transaction arising from risk-mitigating hedging related to the instruments purchased or sold, cannot be accounted for as principal directly or on a consolidated basis by any branch or affiliate that is located in the United States or organized under the laws of the United States or of any state;

• Financing for the banking entity’s purchases or sales cannot be provided, directly or indirectly, by any branch or affiliate that is located in the United States or organized under the laws of the United States or of any state; and

• The purchase or sale is not conducted with or through any U.S. entity, other than:

• A purchase or sale with the foreign operations of a U.S. entity if no personnel of such U.S. entity that are located in the United States are involved in the arrangement, negotiation, or execution of such purchase or sale;

• A purchase or sale with an unaffiliated market intermediary19 acting as principal, provided the purchase or sale is promptly cleared and settled through a clearing agency or derivatives clearing organization acting as a central counterparty; or

• A purchase or sale through an unaffiliated market intermediary acting as agent, provided the purchase or sale is conducted anonymously on an exchange or similar trading facility and is promptly cleared and settled through a clearing agency or derivatives clearing organization acting as a central counterparty.20

Personnel located in the United States acting for the non-U.S. banking entity cannot be involved in soliciting, arranging, negotiating, making the decision to transact, or executing a transaction. However, personnel performing back office functions, such as clearing and settlement, would be able to do so in the United States. The final rule also confirms that a non-U.S. bank that operates or controls a U.S. branch, agency, or subsidiary is not considered to be “located in the United States” for purposes of the exemption solely by virtue of operating or controlling such U.S. branch, agency, or subsidiary.21

Competitive Concerns

The preamble to the final rule contains a detailed discussion of the reasons behind changes that were made and requested changes that were not made. In addition to moving to a risk-based approach in crafting the final rule, the regulators also noted that certain changes were made to maintain the competitiveness of U.S. markets and the stability of the U.S. financial system.

For example, in order to comply with the exemption as originally proposed, a U.S. resident could not be a party to a transaction with a non-U.S. bank. Commenters pointed out that such a requirement could deter non-U.S. banking entities from conducting such transactions with foreign subsidiaries or branches of U.S. firms, and possibly lead to U.S. parties being limited in their participation on non-U.S. exchanges. Moreover, non-U.S. banking entities might be unable to determine whether a counterparty was a U.S. resident, and might avoid U.S. trading platforms entirely, adversely affecting the competitiveness of U.S. trading platforms. In addition, such a requirement could in effect drive non-U.S. banking entities to move their trading operations and personnel outside the United States, thus reducing U.S. trading activity and moving jobs outside the United States, a consequence that is clearly not the intention of the drafters of the Volcker Rule.

Thus, in order to preserve the competitiveness of the U.S. financial markets while at the same time requiring the risk of the transaction under the exemption to stay outside the United States, the regulators added exemptions to permit non-U.S. banks to engage in proprietary trading transactions from outside the United States with a limited number of U.S. counterparties and not lose the ability to rely on the “solely outside the United States” exemption. The Volcker Rule allows additional exemptions that would promote financial stability, and regulators used that authority in adopting these two narrow exemptions.

The two additional exemptions allow for transactions by a non-U.S. bank with an unaffiliated market intermediary (such as a registered broker-dealer), thus preserving the prohibition on entering into a proprietary trading transaction with an affiliated U.S. banking entity. Whether such unaffiliated market intermediary is acting as principal or agent, the transaction must be promptly cleared and settled through a clearing agency or a derivatives clearing organization that is acting as a central counterparty. If the market intermediary is acting as agent, then the transaction also must be conducted anonymously on an exchange or trading facility. The regulators have acknowledged that an anonymous trade could result in a transaction between a non-U.S. bank and its U.S. affiliate, but they have concluded that this is an acceptable consequence so long as the trade is indeed anonymous.

The regulators declined, however, to extend the exemption to allow the non-U.S. offices and affiliates of U.S. banking entities to engage in transactions with non-U.S. bank entities pursuant to the “solely outside the United States” exemption, finding that the wording of the statute is so explicit as to preclude the ability of the regulators to enlarge the scope of the exemption in that manner.22


In promulgating the final rule, the regulators went back to the text of, and reason for, the Volcker Rule, and crafted an exemption that the regulators believe should enable a non-U.S. bank to continue its non-U.S. proprietary trading activities without endangering its exemption for transactions taking place “solely outside the United States.” The challenge now facing non-U.S. banks is how best to revise their global operations in order to comply by the July 2015 effective date. As non-U.S. banks develop their compliance plans, they should immediately alert the regulators as to any problems that arise in order to discuss possible alternative methods of compliance that would enable non-U.S. banks to continue to engage in non-U.S. transactions without running afoul of the Volcker Rule.

Kathleen A. Scott is senior counsel in the New York office of Norton Rose Fulbright.


1. “Non-U.S. Banks, ‘Volcker’ and ‘Solely Outside the United States,’” New York Law Journal, May 9, 2012.

2. Pub. L. 111-203, July 21, 2010.

3. Section 619 is now codified as 12 U.S.C. §1851.

4. Senate Report 111-176, April 30, 210, p.8.

5. 76 Fed. Reg.68846 (Nov. 7, 2011). The Commodity Futures Trading Commission did not join in that notice and instead published its own proposed rule implementing Volcker (the text of which conformed to the proposal issued in November 2011), in the Federal Register on Feb. 14, 2012. See 77 Fed. Reg. 8332.

6. See, for example, http://www.federalreserve.gov/newsevents/press/bcreg/20131210a.htm.

7. Similar changes were made with respect to the same exemption to the ban on investing in or sponsoring private equity funds, for similar reasons, but this column focuses solely on the proprietary trading exemptions.

8. A “banking entity” is defined as an insured depository institution, any company that controls an insured depository institution, a company that is treated as a bank holding company under the International Banking Act of 1978 because it is a non-U.S. bank engaged in banking activities in the United States through a U.S. branch or agency, and any affiliate or subsidiary of the foregoing. 12 U.S.C. §1851(h)(1).

9. 12 U.S.C. §1851(h)(4).

10. Section 619(d)(1)(H).

11. See 12 C.F.R. Part 211, Subpart B.

12. On July 15, 2010, when debating final passage of Dodd-Frank in the Senate, Jeff Merkley (D-Ore.) explained the reason for the “solely outside the United States” exemption: “Subparagraphs (H) and (I) recognize rules of international regulatory comity by permitting foreign banks, regulated and backed by foreign taxpayers, in the course of operating outside of the United States to engage in activities permitted under relevant foreign law.” 156 Cong. Rec. 5897, July 15, 2010. Paragraph (I) deals with the offshore exemption to the prohibition on investing in or sponsoring private equity funds.

13. Financial Stability Oversight Council, “Study & Recommendations on Prohibitions on Proprietary Trading & Certain Relationships With Hedge Funds & Private Equity Funds,” (FSOC Study), p. 46. The FSOC study can be accessed at http://www.treasury.gov/initiatives/fsoc/Pages/default.aspx.

14. Proposed §__.6(d)(3).

15. 76 Fed. Reg. 68881.

16. See §__.6(e).

17. See §__.2(c).

18. Dec. 9, 2013, Memorandum from board staff to the board, “Draft final rule implementing the proprietary trading and hedge fund and private equity fund prohibitions and restrictions of section 13 of the Bank Holding Company Act.”

19. An “unaffiliated market intermediary” means an unaffiliated entity, acting as an intermediary, that is a broker, dealer, swap dealer or futures commission merchant either registered with the SEC or the CFTC under the appropriate federal securities or commodities statute, or exempted by statute or regulation. See §__.6(e)(6).

20. See §__.6(e)(3).

21. See §__.6(e)(5).

22. See Preamble to final rule, pages 424-425.