Subscription Credit Facilities and the Volcker Rule

On December 10, 2013, the federal financial agencies (the “Agencies”) approved joint final regulations (the “Final Regulation”) implementing section 619 of the Dodd-Frank Act, commonly referred to as the Volcker Rule. Section 619 added a new section 13 to the Bank Holding Company Act of 1956 (the “BHCA”), which generally prohibits any banking entity from engaging in proprietary trading and acquiring or retaining an ownership interest in, sponsoring, or having certain relationships with, a hedge fund or a private equity fund. Banks and other lending institutions (“Lenders”) commonly provide loan facilities to private equity funds (“Funds”) that are secured by, or otherwise look to repayment from, the uncalled capital commitments of the Fund’s limited partner investors (each a “Subscription Facility” or a “Facility”). In the typical Facility, the Lender does not directly sponsor, invest in or manage its Fund borrower, but rather only provides extensions of credit.¹ Lenders frequently inquire to ensure their Facilities are in compliance with the Final Regulation. This Legal Update clarifies why most Facility structures will not run afoul of the Final Regulation’s prohibition against acquiring or retaining an ownership interest in a covered fund and what parameters a Lender should maintain to ensure continuing compliance.²

Covered Funds as Subscription Facility Borrowers

In order to be subject to the Volcker Rule, a Fund must be a “covered fund,” as defined under the Final Regulation. A “covered fund” includes any issuer that relies solely on the section 3(c)(1) or 3(c)(7) exceptions from the definition of “investment company” under the Investment Company Act of 1940 (the “1940 Act”). It also includes any “commodity pool” under the Commodity Exchange Act that shares characteristics of an entity excluded from the 1940 Act under section 3(c)(1) or 3(c)(7). With respect to US...