Confidential Working Draft: NovDecember 2511, 2015
SUBJECT TO DISCUSSION AND REVISION

Institute of International Bankers
Volcker Rule Compliance Approach to TOTUS Trading with Non-U.S. Counterparties

This outline describespaper summarizes the consensus view of the members of the Institute of International Bankers (“IIB”) with regard toan approach to compliance with an exemption to the Volcker Rule’s prohibition on proprietary trading that permits certain trading conducted solely outside the United States (“TOTUS Trading” under the “TOTUS Exemption”). Specifically, it addresses approaches that foreign banking organizations (“FBOs”) could take to comply with certain aspects ofthe requirement that FBOs generally not trade “with or through” a U.S. entity when relying on the TOTUSExemption.

I. Background

A.Issue Presented.

  • The non-U.S. operations of FBOs may, in the ordinary course of their trading activities outside the United States, face counterparties that are: (1) non-U.S. offices or subsidiaries of U.S. entities, or (2) non-U.S. offices or subsidiaries of non-U.S. entities. An issue has arisen regarding approaches to compliance with relevant requirements of the TOTUS Exemption, and whether these two types of counterparties can be distinguished from a compliance perspective.
  • In particular, when facing the non-U.S. operations of a U.S. entity, FBOs have in certain cases elected to obtain a representation from the counterparty that the U.S. entity’s U.S. personnel are not involved in arranging, negotiating or executing the transaction. The question that has arisen is whether similar representations are necessary when an FBO outside the United States faces a non-U.S. office or subsidiary of a non-U.S. entity.[1]

B.Purpose of, and policy behind, the TOTUS Exemption.

  • The TOTUS Exemption, as implemented in the final Volcker Rule regulations, focuses primarily on the location of entities that will bear the risk of TOTUS Trading. Risk borne outside the U.S. by non-U.S. entities presents limited or no risk to the U.S. financial system.
  • In implementing the TOTUS Exemption, the agencies sought to avoid giving FBOs an undue competitive advantage over U.S. banking entities subject to the Volcker Rule. Yet, the agencies acknowledged that the statute itself recognized that transactions between two non-U.S. entities should not raise such effects on competition.
  • There is no evidence that the TOTUS Exemption was intended to limit transactions between non-U.S. entity counterparties. Indeed, the Volcker Rule agencies sought, in modifying the final rule, to increase the range of potential customers and transactions for U.S. entities.

AC.TheTo effect these purposes and policies, theTOTUS Exemption imposes certain requirements relating to the non-U.S. location of the relevant trading activity.

From the perspective of the FBO complying with the TOTUS Exemption, in B.In addition to requiring that the trades be booked, hedged and financed outside the United States by the FBO, the TOTUS Exemption includes requirements that the FBO’s relevant entities and personnel be located outside the United States.

  • For example, the FBO entity “engaging as principal in the purchase or sale (including any personnel of the banking entity or its affiliate that arrange, negotiate or execute such purchase or sale)” may not be “located in the United States or organized under the laws of the United States or of any State.”

CD.Other non-U.S. location requirements relate to the counterparty of the FBO.

  • For example, theTheVolcker Rule provides that an FBO entity relying on the TOTUS Exemption may not trade “with or through any U.S. entity” other than in certain specifically enumerated circumstances.
  • Consistent with this requirement, an FBO affiliate should be able to trade “with or through”non-U.S. entities, such as the non-U.S. offices and affiliates of banking organizations and other financial institutions (e.g., other FBOs) headquartered and organized outside the United States.[1]
  • In contrast, trades conducted by an FBO entity with or through a U.S. entity, including a U.S. entity’s foreign operations (such as non-U.S. branches and subsidiaries), generally would not be permitted under the TOTUS Exemption unless the trades fall within certain categories of permitted TOTUS Trading with U.S. entities.
  • One of these generally permits an FBO entity to trade “with the foreign operations of a U.S. entity if no personnel of such U.S. entity that are located in the United States are involved in the arrangement, negotiation, or execution of such purchase or sale.”

E.There are thus two different standards that could apply to an FBO’s TOTUS Trading with a non-U.S. counterparty. Which standard applies will depend on whether the non-U.S. counterparty is an office or affiliate outside the United States of (a) a non-U.S. entity, such as another FBO, or (b) a U.S. entity.

1.When facing a non-U.S. office or affiliate of a non-U.S. organization (e.g., the London branch of a European bank or a U.K. subsidiary of a South American bank), the TOTUS Exemption directsan FBO should follow procedures designed to ensure that it is not trading “with or through” a U.S. entity.

  • This limitation focuses in the first instance on the location of the entity that is the FBO’s counterparty (e.g., the location of the entity named in any trade confirmation or other relevant documentation).

2.In contrast, when facing the foreign operations of a U.S. entity (e.g., the London branch of a U.S. bank or a U.K. subsidiary of a U.S. bank holding company), an FBO should follow procedures designed to ensure that its trading complies with thethe TOTUS Exemption imposes anadditional requirement that “no personnel of the U.S. entity located in the United States are involved in the arrangement, negotiation, or execution of the trade.”

  • Compliance with this additional requirement could involve facts that are not immediately apparent to the FBO. As a result, FBOs have developed standard written representation letters to be obtained from the foreign operations of U.S. banksbanking entities(“TOTUS Representation Letters”). The TOTUS Representation Letters are designed to support the determination, in appropriate circumstances, that the U.S. banksbanking entities’ U.S. personnel were not involved in the “arrangement negotiation, or execution” of the trade.

II.Analysis and Proposed Distinctions

A.One issue that has arisen is whether, when an FBO trades with the non-U.S. offices and subsidiaries of a non-U.S. organization, it needs to obtain representations similar to those in the TOTUS Representation Letters, which were originally developed for trading with the foreign operations of U.S. entities.

B.Because of the distinction between the two relevant standards, as described above, it does not appear that such representations should be necessary.

1.Unlike the provision of the TOTUS Exemption in the Volcker Rule that permits FBOs to trade with foreign operations of U.S. entities under defined circumstances, the TOTUS Exemption does not expressly prohibit the involvement of U.S. personnel of a counterparty when an FBO trades with the non-U.S. offices and affiliates of a non-U.S. organization.

  • Instead, the relevant restriction imposes a limitation on conduct by theFBO itself—preventing the FBO from trading with or through a U.S. entity and preventing the FBO from having its U.S. personnel arrange, negotiate or execute the trade.
  • In contrast, the restriction in the context of an FBO trading with the non-U.S. operations of a U.S. entity is also conditioned on conduct bythe U.S. entity (by making the TOTUS Exemption unavailable if U.S. personnel of the U.S. entity arrange, negotiate or execute the trade).

2.The distinction between these two standards is highlighted by the fact that the “arrange, negotiate or execute” limitation appears only twice in the TOTUS Exemption: (1) as a limitation on the location of the FBO’s own personnel involved in TOTUS Trading, and (2) when an FBO trades with the foreign operations of a U.S. entity, as a limitation on the location of a U.S. entity’s personnel. Thein these two requirements, making theomission of a similar limitation inonthe context of an FBO’s TOTUS Trading withconduct ofthe non-U.S. operations of non-U.S. organizations is therefore significant.

3.The TOTUS Exemption’s prohibition on trading “with or through” a U.S.entity, with this absence of a further limitation on the involvement of U.S.personnel of a non-U.S. counterparty, suggests a more straightforward compliance obligation based on facts that should be more readily knowable based on, i.e., compliance can be apparent fromthe location ofand nature ofinteraction withthe FBO’s counterparty. [2]

4.[There may be circumstances in which an FBO could be deemed to be trading “through” a U.S. entity even when the transactional counterparty in a particular trade is a non-U.S. office or subsidiary of a non-U.S. banking organization. The concept of trading “through” an entity, as distinct from trading “with” an entity, is not defined or explained in the Volcker Rule context. If “through” were read broadly, the general prohibition on trading with or through a U.S. entity under the TOTUS Exemption could capture, for example, a circumstance in which an FBO enters into a transaction with the head office of a non-U.S. banking organization intermediated by a U.S. subsidiary of the non-U.S. bank acting as agent. In that circumstance, it is possible that the FBO could be said to have transacted “through” a U.S. entity in a manner that would be inconsistent with the general prohibition in the TOTUS Exemption on trading with or through a U.S. entity (subject to provisions permitting such trading under specified circumstances not addressed in this outline).

However, in those scenarios (in contrast to a need to discern the location of personnel), FBOs would be aware of such intermediation and the location of the U.S. affiliate acting as agent, and the FBO could adopt procedures to prevent its non-U.S. personnel from interacting with a U.S. affiliate of a non-U.S. counterparty in such a way as to constitute trading “through” the U.S. affiliate. The question of an FBO’s compliance obligations with respect to potential unseen involvement by U.S. personnel of the counterparty would not arise in those scenarios.

In other words, in order for an FBO to be trading “through” a U.S. entity (vs. a non-U.S. entity) the FBO would ordinarily be aware that it is trading through a U.S. entity—e.g., if the relevant contact persons at the counterparty communicating with the FBO were located in the United States or if otherwise a U.S. entity were holding itself out to the FBO as acting as agent for the non-U.S. entity.] [To be discussed whether necessary or helpful to include B.4.]

C.For these reasons, it would be reasonable for FBOs to distinguish between these two types of non-U.S. counterparties in designing their compliance approaches to implementing the TOTUS Exemption.

1.When relying on the TOTUS Exemption to trade with the non-U.S. offices and affiliates of U.S. entities, FBOs may obtain representations like those in the TOTUS Representation Letter, or otherwise satisfy themselves through due diligence questions or other information,that no U.S. personnel of the U.S.banking entity were involved in arranging, negotiating or executing the trade.

2.When relying on the TOTUS Exemption to trade with the non-U.S. offices and affiliates of non-U.S. entities, anFBOs would look to readily available information regarding the location of the entity with which (or through which) it is trading (location of counterparty, location of contact persons at the counterparty communicating with the FBO, etc.) to ensure that the FBO is trading “with or through” a non-U.S. entity. The FBO should not need to obtain representations regarding involvement of U.S. personnel in arranging, negotiating or executing the trade, or otherwise seek to obtain such information through due diligence questions, etc.

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[1]This paper is limited to this particular compliance issue under the TOTUS Exemption.

[1]Trading “through” a non-U.S. entity could present separate considerations under the TOTUS Exemption, not addressed in this outline, if the transaction is ultimately “with” a U.S. entity.

[2][This paper does not address the circumstances in which an FBO could be deemed to be trading “through” a U.S. entity even when the transactional counterparty is a non-U.S. office or subsidiary of a non-U.S. banking organization (e.g., trading with a non-U.S. counterparty using a U.S. broker or agent). However, in the foreseeable scenarios in which an FBO outside the United States may trade with a non-U.S. counterparty “through” a U.S. entity, the FBO would be aware of such intermediation and the location of the U.S. entity acting as, e.g., agent and the FBO could adopt procedures to address interacting with a U.S. entity in such a way as to constitute trading “through” the U.S. entity. As a result, the question of an FBO’s compliance obligations with respect to potential unseen involvement by U.S. personnel of the counterparty, and the possible need for representations to address this risk, similarly would not arise.]