Applying the Volcker Rule’s Covered Fund Definition Separately to Individual Asset Pools within Multi-Issuance Special-Purpose Vehicles

Abstract

The Dodd–Frank Act was signed into law in July 2010 in response to what is generally considered one of the worst financial crises in modern history. One of its more controversial provisions is the “Volcker Rule,” which prohibits banks from engaging in proprietary trading and from investing in and sponsoring private equity and hedge funds. Such funds are defined largely by reference to the concept of an “investment company” under the Investment Company Act of 1940, as amended, and certain exemptions from that definition. Although applying the Volcker Rule generally can be extraordinarily complex, additional complexity arises in the context of certain types of vehicles that issue on multiple occasions separate series of notes backed by separate collateral pools. Such vehicles are frequently used for “repackaging” transactions. Although they share the same corporate issuer, each series of notes issued is completely separate from each other series, and only the collateral underlying that particular series is available to creditors relating to that series. However, under the Investment Company Act of 1940, and thus under the Volcker Rule, the definition of investment company goes beyond the normal corporate boundaries such that things like insurance company separate accounts or analogous constructs, even within the same corporate entity, will be treated as separate issuers.

Accordingly, the authors argue in this article that two of the more significant portions of the Volcker Rule (relating to determining what constitutes a prohibited hedge fund or private equity fund) must be applied, in the context of such multi-issuance vehicles issuing separate series of notes, on a collateral pool by collateral pool (i.e., a series by series) basis and not more generically to the nominal corporate issuer and/or all its issued series in aggregate. In other words, for a banking entity considering whether the Volcker Rule is implicated by a particular contractually ring-fenced (CR) series under an multi-issuance special-purpose vehicle (MSPV) program, it would generally look only to that particular CR series and how it fits into the MSPV program. Conversely, where a banking entity is considering whether the Volcker Rule is implicated by an MSPV program in general, it would need to analyze each CR series separately thereunder (in the context of that MSPV program). The status of one or more such CR series as covered funds is not in itself dispositive as to the status of any one or more other CR series issued by the same MSPV program. Of course, the desirability of intentionally being involved in an MSPV program that has some CR series that are covered funds and others that are not is highly questionable. Nevertheless, in circumstances where many non-covered funds exist under the same umbrella as a handful of covered funds, this approach may obviate the need to expend vast resources to build new structures or to restructure existing platforms.