Volcker Agencies Issue FAQ Clarifying SOTUS Exemption
Commentary by Scott Cammarn
The Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the SEC and the CFTC (collectively, the "Volcker Agencies") issued an FAQ that clarifies the exemption under the Volcker Rule for certain covered fund activities conducted by foreign banking entities; i.e., solely outside the United States (the "SOTUS Exemption").
Under Section 248.13(b) of the final Volcker Rule, as now clarified by the Volcker Agencies in the FAQ, a foreign banking entity may (through its non-U.S. affiliates only) rely on the SOTUS Exemption to acquire an ownership interest in a covered fund that is open to U.S. investors, provided that the foreign banking entity (including its affiliates) is not the adviser, manager, sponsor, CPO, or organizer and offerer of the fund and otherwise is not involved in marketing the fund's ownership to U.S. investors.
See: Updated Volcker FAQ.
Commentary
This FAQ changes fundamentally how the industry views the SOTUS exemption applicable to covered fund investing. Language in the final regulation's Preamble seemed to indicate that the Volcker Rule's covered fund SOTUS exemption would be unavailable if a fund were open to U.S. investors; thus, the only method of ensuring the availability of the SOTUS exemption would be if the fund had a Reg. S-type clause that barred investment in the fund by U.S. persons. As a result, many foreign banks had concluded that, absent a Reg. S clause, the SOTUS exemption would be unavailable; therefore, the foreign bank could not acquire an ownership interest in the fund under the Volcker Rule. At the same time, foreign banks continued to urge the Volcker Agencies that the language in the Preamble was erroneous, and that limiting the SOTUS exemption to funds with Reg. S clauses essentially read the SOTUS exemption out of existence (because funds with Reg. S clauses generally do not fall under the definition of "covered fund" to begin with).
The FAQ is a welcome relief. It makes clear that a foreign banking entity may acquire an ownership interest in a third-party fund even if that fund is (or has been) marketed to U.S. persons by the fund or by its third-party adviser – and even if the fund is domiciled in the United States – as long as the foreign banking entity itself is not involved in marketing to U.S. persons. The FAQ also will be welcomed by fund families that will be required no longer to create separate Reg. S-only funds (including so-called "foreign parallel funds") in order to accommodate investments by foreign banks. Thus, the FAQ restores the common understanding of the SOTUS exemption as it existed in the statutory language and was advocated by foreign banks in the 2011 comment letter process (including in numerous comment letters submitted by Cadwalader).