The rules and laws surrounding financial institutions and investment allowances are often vague with long histories of changes. One such rule is the Volcker Rule, which determines the definition of covered funds and which institutions can own them. What is a covered fund, anyway? 

As a proprietary trading firm in NYC, Black Eagle Financial Group decodes the rule and the asset below. This deep dive can inform you about following the Volcker Rule and why the federal government put it in place. 

What Is the Volcker Rule?

The Volcker Rule is a complex governmental control placed on banking entities and other financial institutions to protect the establishment’s customers from losing funds due to excessive trading. Like many other regulatory acts, it has gained some controversy due to its lack of distinction between international and national funds. This leaves room for loopholes. 

Origins

The 2008 financial crisis struck panic in countless Americans, especially those working in the financial sectors. Many banks made speculative investments using their customers’ deposited funds, which played an influential role in fueling the crisis. Speculative investments come with high risks and volatile changes that quickly shift an asset’s value. 

The federal agencies responsible for governing the country’s economic well-being drafted the Volcker Rule to respond to these occurrences. It is part of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which was introduced in 2010. 

It went into full effect in early 2014 with a compliance requirement by the following year. Since then, the rule and its overarching act have undergone numerous amendments. For instance, federal board members pushed changes in 2018 that would ease restrictions and lessen costs for participating banks. 

Purpose

What is a covered fund and what does it have to do with the Volcker Rule? First, let’s dive deeper into the rule’s purpose. As described above, part of the reason behind the 2008 financial crisis was banking entities using customer funds for risky investments. High-risk assets go one of two ways. They either turn a fairly significant profit or they tank the investor’s funds.

Too many risky investments across the nation tanked national funds, leaving regular citizens with bank accounts to pick up the pieces. The first enactment of the Volkner Rule placed hefty constraints on banking entities, significantly limiting how and what they could invest in financial markets. After 2018’s amendments, the banks have a little more leeway in what they can do:

• Offering and building hedge funds: Entities can build hedges by collecting financial investments and distributing them across various assets, using the profits to structure the fund. 
• Providing private equity funds: Like hedges, private equity funds involve pooling financial resources together. However, a private equity fund comes with fewer risks. 
• Participate in insurance sectors: Banks may partner with insurance providers to supply unique coverage options. 
• Act as financial agents and brokers: Qualified bank staff can advise and assist their customers in investment efforts, earning commission for profits.

While the restrictions aren’t as staunch as they once were, they still aim to protect consumers and prevent future financial disasters. 

What Is a Covered Fund?

Now, what is a covered fund? According to the Volcker Rule, a covered fund meets one or more of the following qualifications:

1. It depends on section 3(c)(1) of the Investment Company Act. In a nutshell, this section exempts private funds of all sizes from registration as long as they have fewer than 100 accredited beneficial owners.  
2. It depends on section 3(c)(7) of the Investment Company Act. This section significantly increases the permissible number of owners to 2,000. However, all owners must qualify as purchasers. 
3. It is a foreign fund that relies on the above sections of the Investment Company Act. Otherwise called international funds, foreign funds allow you to invest money in other countries. If the foreign account meets the above section requirements, it may be exempt from registration, too. 
4. The fund is a commodity pool with an operator that depends on CFTC Rule 4.7. Commodity pools allow numerous investors to purchase, sell, and trade options, swaps, and futures. They are typically headed by a commodity pool operator. The Commodity Futures Trading Commission explains the rules further. 

Essentially, the Volcker Rule keeps banking entities from fully overtaking or singularly building extensive investment funds by themselves or using their customers’ deposits. 

What Should You Know About the Volcker Rule?

The Volcker Rule’s final iteration was published in 2020. This amended draft clarifies definitions regarding what does and does not qualify as a covered fund.  

#1 Clarification on Ownership Interest

One of the Volcker Rule’s final iterations further defines what “ownership interest” means. Generally, ownership interest refers to a party’s rights to an asset when it made a significant investment. The rule separates creditor rights, such as debt interests and loans, from ownership rights. 

#2 Parallel Investments and Co-Investments

Parallel investments involve two funds existing in the same portfolio while co-investments involve multiple parties simultaneously making small investments. The final Volcker Rule separates covered funds from parallel and co-investments. Banking entities don’t have to include or restrict these investments as long as they comply with the specific laws regulating them.  

#3 Covered Fund Exemptions

The Volcker Rule offers a few exemptions from the previous cover fund definition. These exemptions include:

• Allowing loaners to keep and maintain a few debt securities
• Further defining which cash equivalents loaners can keep or hold
• Permitting loaners to own or hold market assets outside of loan securities

This gives loan securitizations more flexibility, especially in the mortgage and insurance sectors. 

#4 Regulatory Exemptions

The rule also expands exempted regulator areas that banking entities can exclude from covered fund disclosure. These areas include:

• Customer facilitation vehicles: If a customer specifically requests investment services or assistance, their bank can meet their request by acting as a facilitation vehicle. Customers can use banking services at their own risk and benefit. 
• Credit funds: Many banks supply or extend loans. They build those loan pools through credit funds. The loans ultimately benefit consumers looking to purchase property, buildings, cars, and other material assets. 
• Family wealth management vehicles: Families often pool their capital to manage their wealth together. They might choose banks as vehicles to facilitate their financial management strategies. Like with customer facilitation vehicles, the bank can offer these services since it acts on behalf of the customers. 
• Venture capital funds: Some banks help small businesses get their start through investments from venture capital funds. These funds ultimately stimulate the economy and benefit customers.  

Get Investment Guidance With Black Eagle Financial Group

What is a covered fund? Our proprietary trading firm can help you determine whether your fund counts. We offer:

• Custom rates
• Top-notch security
• Solid trading platforms
• Flexible routing options
• A mentorship program
• NIGHTVISION, our unique proprietary tool
• Custom reports
• Ongoing support

 Contact us to reap Black Eagle Financial Group’s advantages.