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Balance-Sheet Risk Management Hedging Programs under the Volcker Rule

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Balance-Sheet Risk Management Hedging Programs under the Volcker Rule With the implementation of the Volcker Rule, the question arises as to the impact of the rule on balance- sheet risk management ("BSRM") hedging programs. The Volcker Rule's proprietary trading ban is a prohibition on certain short-term speculative trading. It generally bans using derivatives principally for the purpose of: (1) short-term resale; (2) benefitting from short-term price movements; (3) realizing short-term arbitrage profits; or (4) hedging positions relating to any of the above. If a banking entity is using derivatives for these purposes, the Volcker Rule only permits certain types of trading activity if a compliance program is implemented. As explained in this white paper, trades executed in BSRM hedging programs are not executed for the above purposes prohibited by the Volcker Rule. As a result, BSRM hedging transactions are typically not "proprietary trading" nor should the BSRM programs themselves be required to implement a compliance regime. Background The Volcker Rule was enacted as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank"). 1 Although the Volcker Rule is complex, it generally prohibits or limits banking entities from making certain types of speculative investments, specifically: • engaging in short-term proprietary trading of securities, derivatives, commodity futures and options on these instruments for their own account; or • owning, sponsoring, or having certain relationships with hedge funds or private equity funds, referred to as "covered funds." 2 Although short-term proprietary trading is generally forbidden, the Volcker Rule contains exceptions for certain types of "permitted activities," including market making, underwriting, hedging and trading in certain government obligations. 3 Banking entities engaging in permitted types of proprietary trading must implement a compliance program to ensure compliance with the regulations. 4 The nature and scope of a financial institution's compliance obligations vary according to several factors, including the absolute size of a financial institution's assets and the size of its trading assets and liabilities. All entities are required to be compliant by July 21, 2015. 1 12 U.S.C. § 1851 2 12 U.S.C. § 1851; 12 CFR Part 44 3 12 U.S.C. § 1851(d); 12 CFR Part 44 4 12 CFR Part 44

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