Last updated: October 15, 2019
The Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the Federal Reserve, Commodity Futures Trading Commission, and U.S. Securities and Exchange Commission have all announced their approval of final revisions to the Volcker Rule. Chatham Financial is pleased that the published final rule reflects many of the modifications that have been central to our advocacy efforts and those of our financial institution clients. The comment letter that Chatham, along with 27 clients, submitted last year was referenced throughout the final rule.
Financial institutions with less than $10 billion in total assets and limited trading assets and liabilities were previously removed from the scope of the Volcker Rule; however, these revisions will greatly increase regulatory certainty and reduce compliance burdens and inefficiency for larger institutions. The intricacies of the final rule are extensive, but highlights that may be applicable to your program are summarized below.
Particularly for financial institutions that currently have or are considering loan-level hedging programs, the revisions are overwhelmingly positive. Recognizing that such derivatives are not intended to create profit from short-term interest rate movement, the regulators are explicitly removing customer back-to-back swaps from the definition of proprietary trading if certain requirements are met. Specifically, a transaction by a non-swap dealer will not be considered to be proprietary trading if: 1) the offset of the customer swap with an equal and opposite dealer trade occurs “contemporaneously” and 2) the financial institution retains no more than “minimal price risk”. It is noteworthy that this exclusion covers not only loan-level swap transactions, but also other derivatives offered in connection with end-user hedging objectives, including back-to-back commodity swaps, that meet the above requirements.
Additionally, in response to strident opposition from Chatham and other industry commenters, the regulators have opted not to include a test based on accounting treatment of an instrument in place of the existing short-term intent prong of the proprietary trading definition. Instead, the final rule contains a rebuttable presumption of compliance if an instrument is held for more than 60 days. The 2013 Volcker Rule contained a rebuttable presumption that a transaction was proprietary trading if an instrument was held for fewer than 60 days, so this revision represents a favorable shift in the burden of rebuttal from the financial institution to its regulators.
The final rule also retains the three compliance tiers — limited, moderate, and significant, based on gross trading assets and liabilities — that were introduced in the proposed rulemaking. Financial institutions with less than $1 billion in gross trading assets and liabilities will be presumed to be in compliance and will generally not be required to implement the six-part compliance program previously imposed under Volcker for banks over $10 billion in assets. Financial institutions with greater than $20 billion in trading assets and liabilities, whose business models and trading activities contribute to systemic risk, will remain subject to the most stringent requirements under the rule.
These revisions take effect on January 1, 2020. Although mandatory compliance is required by January 1, 2021, early adoption is permitted.
Chatham Hedging Advisors, LLC (CHA) is a subsidiary of Chatham Financial Corp. and provides hedge advisory, accounting and execution services related to swap transactions in the United States. CHA is registered with the Commodity Futures Trading Commission (CFTC) as a commodity trading advisor and is a member of the National Futures Association (NFA); however, neither the CFTC nor the NFA have passed upon the merits of participating in any advisory services offered by CHA. For further information, please visit chathamfinancial.com/legal/notices/.
Transactions in over-the-counter derivatives (or “swaps”) have significant risks, including, but not limited to, substantial risk of loss. You should consult your own business, legal, tax and accounting advisers with respect to proposed swap transaction and you should refrain from entering into any swap transaction unless you have fully understood the terms and risks of the transaction, including the extent of your potential risk of loss. This material has been prepared by a sales or trading employee or agent of Chatham Hedging Advisors and could be deemed a solicitation for entering into a derivatives transaction. This material is not a research report prepared by Chatham Hedging Advisors. If you are not an experienced user of the derivatives markets, capable of making independent trading decisions, then you should not rely solely on this communication in making trading decisions. All rights reserved. 19-0208