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Tax rules for day trading
Regulators presented proposed regulations regarding the Rule on October 11, and gave the public until February 13, to submit comments. Finally, on December 10, , all five regulators approved the final regulations and these were published in the Federal Register in January, as an interim final regulation. Institutions within the scope of the Rule must now begin finalizing strategies related to further involvement with activities regulated under the Rule.
The premise of the Rule is that banking entities 2 should be prohibited from trading or owning "risky assets. Each of these prohibitions contains complex definitions as well as exemptions. The Rule is intended to permit banking entities to continue critical client-oriented financial services, subject to appropriate risk management.
Proprietary Trading Prohibition on Proprietary Trading The Rule prohibits any banking entity from engaging in proprietary trading. The main purpose of this prohibition is to limit the risk-taking by banking entities as they try to profit by trading in "risky assets". The broad prohibition against proprietary trading and the various exemptions to it are each the subject of complex definitional provisions.
Institutions which determine to avail themselves of exemptions must undertake extensive internal compliance programs and the adoption of detailed policies and procedures at the individual trading desk level. Finally, larger banking entities will be obligated under the regulations to capture and calculate transaction and position data on a variety of quantitative metrics on a daily basis and to report such data to regulators.
Definitions "Proprietary trading" is defined as "engaging as principal for the trading account of the banking entity in any purchase or sale of one or more financial instruments. However, the definition excludes loans, most commodities as opposed to commodity futures and foreign exchange or currency. There are three different tests used to determine what constitutes a "trading account.
Trading accounts consist of any one of the following:. Exclusions from the Definition of "Proprietary Trading" Notwithstanding the scope of the definition of proprietary trading outlined above, there are significant exclusions from the definition. These exclusions refer to purchases and sales of financial instruments: Exemptions from the Prohibition on Proprietary Trading In addition to activities which are excluded from the definition of proprietary trading, the Rule sets forth several exemptions from the general prohibition.
These exemptions generally contain significant conditions, including documentation and compliance requirements, and related definitions. Following is a summary of the exemptions: A banking entity is permitted to engage in underwriting activities only if i the banking entity is acting as an underwriter for a distribution of securities 6 and the trading desk's underwriting position is related to such distribution, ii the amount and type of securities in the trading desk's underwriting position are designed not to exceed the reasonably expected near term demands of clients, customers or counterparties, and reasonable efforts are made to sell or otherwise reduce the underwriting position within a reasonable time period, taking into account the liquidity, maturity, and depth of the market for the relevant type of security, iii the banking entity maintains compliance policies and procedures directed to compliance at the trading desk level, 7 iv the compensation arrangements of underwriting personnel are designed not to reward or incentivize prohibited proprietary trading, and v the banking entity is licensed or registered to conduct the underwriting activities.
A banking entity is permitted to engage in hedging activity designed to reduce or otherwise significantly mitigate, and demonstrably reduces or otherwise significantly mitigates one or more specific, identifiable risks, including market risk, counterparty or other credit risk, currency or foreign exchange risk, interest rate risk, commodity price risk, basis risk or similar risks, arising in connection with and related to identified positions, contracts, or other holdings of the banking entity, provided that i the hedge does not give rise to any significant new or additional risk which is not concurrently hedged and ii the hedge is subject to continuing review, monitoring and management by the banking entity.
This exemption is also conditioned upon the maintenance of an effective compliance program, and extensive documentation requirements at the trading desk level. Similar limits on compensation arrangements for hedging personnel are required. Other exemptions from the prohibition on proprietary trading.
The Rule provides certain other exemptions, each with their own conditions and requirements, which pertain to i trading in domestic government obligations, ii trading in foreign government obligations, iii trading on behalf of customers, iv trading by a regulated insurance company and v trading by foreign banking entities.
The exemptions to the proprietary trading prohibition are subject to several broad limitations: Covered Funds Activities and Investments Prohibition on Acquiring or Retaining an Ownership Interest in and Having Certain Relationships with a Covered Fund The Rule provides that "a banking entity may not, as principal, directly or indirectly, acquire or retain any ownership interest in or sponsor a covered fund.
Exclusions The Rule does not apply to banking entities acting:. Definitions A "covered fund" is a private investment company, 9 a private commodity pool, 10 or an offshore entity controlled by a U. This exclusion enables investment advisers to collect some forms of carried interests from funds without application of the Rule. A banking entity which securitizes asset-backed securities and is subject to Dodd-Frank's rules on risk retention for securitizers is granted some relief from the foregoing conditions.
It is not necessary for the banking entity to be engaged in bona fide trust, fiduciary investment advisory or commodity trading advisory services and it is not necessary to limit the offering to the banking entity's customers. A banking entity is also permitted to engage in underwriting and market-making activities involving a covered fund so long as: Exemptions for Permitted Investments in Covered Funds Notwithstanding the Rule's prohibitions on acquiring and retaining ownership interests in covered funds, a banking entity may acquire and retain such ownership interests in a covered fund for the purpose of either i establishing the fund and providing the fund with sufficient initial equity for investment to permit the fund to attract unaffiliated investors or ii making de minimis investments.
Each of these activities is subject to limitations. As noted above, ownership interests in connection with underwriting and market-making activities are included in these calculations.
Although the per fund and aggregate limits apply to the aggregate holdings of the banking entities and their affiliates, the Rule excludes from the determination of holdings the holdings of certain registered investment companies, business development companies and foreign public funds which might be considered affiliates of the banking entity. Exemptions for Permitted Risk-Mitigating Hedging Activities The Rule provides a very narrow exemption for investments in a covered fund which reduce risk to the banking entity arising from an employee compensation arrangement that is tied to the performance of the covered fund.
The hedging activity must demonstrably reduce or significantly mitigate one or more specific risks arising in connection with the compensation arrangement with an employee who directly provides investment advisory, commodity trading advisory or other services to the covered fund. The investment may not give rise to any significant new or additional risk which is not itself contemporaneously hedged. The Rule also requires the banking entity to implement and enforce an internal compliance program that includes reasonably designed policies and procedures, internal controls and ongoing monitoring, management and authorization procedures.
In addition, the compensation arrangement to which the hedge relates must provide that any losses incurred by the banking entity on the hedge be offset by a reduction in the amounts payable to the employee. Exemptions for Certain Permitted Covered Fund Activities and Investments Outside of the United States A banking entity may acquire or retain an ownership interest in, or sponsor, a covered fund if: Exemptions for Permitted Covered Fund Interests and Activities by a Regulated Insurance Company An insurance company may acquire or retain an ownership interest in, or sponsor, a covered fund if: Limitations on Relationships with a Covered Fund Generally, no banking entity that serves as the investment manager, investment adviser, commodity trading advisor or sponsor to a covered fund, that organizes and offers a covered fund as permitted by the Rule or that continues to hold an ownership interest as permitted by the Rule, may enter into a transaction with the covered fund that would be a covered transaction 22 under Section 23A of the Federal Reserve Act, assuming that the banking entity were a member bank and the covered fund were an affiliate.
However, the Rule provides exceptions for the acquisition and retention of ownership interests as permitted by the Rule and also for certain prime brokerage transactions. A banking entity which serves as the investment manager, investment adviser, commodity trading advisor or sponsor to a covered fund must comply with the restrictions on transactions between member banks and affiliates imposed under 23B of the Federal Reserve Act, assuming that the banking entity were a member bank and the covered fund were an affiliate.
In this context, a banking entity can mitigate a conflict of interest, and proceed with the transaction, through timely and effective disclosure of the conflict, or through established, adequate information barriers.
Compliance Each banking entity is required to develop a program reasonably designed to ensure and monitor compliance with the prohibitions on proprietary trading and covered fund activities and investments.
The terms, scope, and detail of the compliance program must be appropriate for the type, size, scope, and complexity of activities and business structure of the entity.
The minimum requirements for all banking entities include:. Certain large banking entities 24 engaged in proprietary trading are subject to "enhanced compliance" requirements. These entities are required to establish, maintain, and enforce a governance and management framework that is reasonably designed to ensure that appropriate personnel are responsible and accountable for the effective implementation and enforcement of the compliance program, a clear reporting line with a chain of responsibility, and the periodic review of the compliance program by senior management.
A significantly broader group 25 of banking entities engaged in proprietary trading will be required to report quantitative metrics on their trading activities. Effective Date and Compliance Dates The Rule became effective April 1, , but affected banking organizations generally will have until July 21, to bring their proprietary trading and private fund activities into conformance with the Rule. This new conformance date is an administrative extension of the original statutory conformance date of July 21, Also, the deadline for conformance by banking entities in connection with loan securitizations will be extended to July 21, with regard to their ownership interests in, and sponsorship of, any loan securitizations that had been in place as of December 31, An important exception to the extension is that banking organizations with significant trading activities will be required to report quantitative metrics on their trading activities beginning in July In addition, banking organizations are expected to engage in "good faith efforts" to bring all of their covered activities into compliance by the July conformance date.
To this end, the Federal Reserve Board has warned that "banking entities should not expand activities and make investments during the conformance period with an expectation that additional time to conform those activities or investments will be granted. Critics of the Rule foresaw a reduction in the efficiency of markets, economic growth and employment as a result of loss of liquidity.
Further negative forecasts included high transition costs as non-banking entities assumed trading activities currently performed by banking entities, a reduction in commercial output and resource exploration due to a lack of hedging counterparties, and reduced access to debt markets.
Supporters of the Rule emphasized that restrictions in proprietary trading may reduce systemic risk and lower the probability of another financial crisis.
The regulators contend that the Rule as promulgated achieves a balance between promoting healthy economic activity and reducing regulatory burdens where appropriate. Time will tell whether the right balance has been achieved. This article summarizes in broad outline the principal provisions of the Volcker Rule. The Rule itself is heavily detailed and qualified, and has been nuanced by substantial commentary submitted by the regulatory agencies responsible for the Rule.
Application of the Rule to specific circumstances will require a review of pertinent provisions of the Rule in greater detail than that present in this article. There are exclusions for "covered funds" as hereinafter defined and certain portfolio companies and portfolio concerns which might be considered affiliates or subsidiaries of banking entities in any of the first three categories above.
There is also an exclusion for the FDIC acting in its corporate capacity or as a conservator or receiver for a banking entity. Ownership interests may not be "predominantly owned" by the banking entity or the issuer or their respective affiliates, directors and employees. A loan securitization generally may not include securities.
Trading accounts consist of any one of the following: No transaction or activity is permissible if it would involve or result in a material conflict of interest between the banking entity and its clients, customers, or counterparties. No transaction or activity is permissible if it would result, directly or indirectly, in a material exposure by the banking entity to a high-risk asset or a high-risk trading strategy.
No transaction or activity is permissible if it would pose a threat to the safety and soundness of the banking entity or to the financial stability of the United States. Exclusions The Rule does not apply to banking entities acting: The minimum requirements for all banking entities include: