Today we continue the march toward effective repeal of the Volcker Rule. The rule is premised on the common sense proposition that banks should not be allowed to gamble with taxpayer money and that taxpayers should never again be forced to rescue banks and their highly compensated executives from the consequences of their bad decisions.

The Volcker Rule seeks to protect taxpayers by prohibiting short-term, speculative trading by banks and restricting their investments in high-risk funds (referred to as “covered funds”). Last fall, we significantly weakened the former,[1] and today we propose to undermine the latter.[2]

Today’s proposal would increase banks’ ability to add risk to their balance sheets in two significant ways. It would broaden the categories of private funds in which banks can invest—most notably by including venture capital and credit funds. And, it would allow banks to evade certain investment restrictions by permitting a greater degree of “parallel investment” alongside covered funds, thus allowing exposure to these often high-risk holdings.

As with the rule last fall, this proposal replaces clear, common sense restrictions with just the hope that banks will self-police and remain diligent in identifying and mitigating their own risks—an expectation that flies in the face of experience. The structures of large financial institutions, including bankers’ compensation, still strongly incentivize the kind of risk taking that led to the financial crisis. Hope will not protect investors from banks’ appetite for risk in the pursuit of yield. I cannot support the proposal.[3]

Once again, the proposal has not provided evidence or analysis in support of the proposed changes.[4] The changes are, by and large, not correcting unforeseen complications or making adjustments to reflect changes in circumstances since the rule’s adoption in 2013.[5] In fact, many of the changes proposed today were specifically considered and rejected by the agencies in adopting the final rule in 2013.[6] While I have numerous issues with the ways in which the proposal would erode the basic protections of the Volcker Rule[7], I want to highlight two of my more significant concerns.

Venture Capital Funds

The proposal states, without any supporting evidence, that permitting banks to invest in venture capital funds “could promote and protect the safety and soundness of banking entities and the financial stability of the United States.”[8] The proposal, however, provides no meaningful analysis of the high-risk nature of venture capital. These funds are speculative by design, and yet the proposal illogically concludes that investing in them will make banks safer. The need for the changes is also unclear, especially in light of the historic growth in venture capital over the past two years.[9] In glossing over the risk—a consideration that should be central to any changes in the covered fund provisions—the proposal strays from Congressional intent and ignores recent experience that illustrates the significant hazards in this part of the market.[10]

Prior to the adoption of the final rule in 2013, numerous industry commenters on the proposed rule requested a carve-out for venture capital funds.[11] The agencies determined, however, that the very changes we propose today are inconsistent with the statutory mandate of the Volcker Rule.[12] Specifically, the agencies stated that “the statutory language of [the Volcker Rule] does not support providing an exclusion for venture capital funds from the definition of covered fund.”[13] Despite calls to differentiate venture capital funds from other forms of private equity, the agencies explained that “the activities and risk profiles for banking entities regarding sponsorship of, and investment in, venture capital funds and private equity funds are not readily distinguishable.”[14]

Today, the agencies simply reverse course. The proposal would now adopt the Commission’s definition of “venture capital fund” from an unrelated rule and use that to distinguish venture capital from private equity[15]—an argument that was also considered and rejected by the agencies in 2013.[16] The agencies determined at the time that Congress did not intend to permit banks to invest in speculative private funds, and the contours of the Commission’s venture capital fund definition do not reasonably differentiate these funds for purposes of the Volcker Rule. Congress’ intent in adopting the Volcker Rule in 2010, as interpreted by the agencies in 2013, does not change with the passage of time, nor does today’s proposal support this fundamental reinterpretation.[17] Significantly, had Congress held the view that the 2013 interpretation was wrong or in need of adjustment, it could have addressed this in the legislative changes to the Volcker Rule that it adopted in 2018, but it did not.[18]

The proposal’s reliance on the Commission’s separate definition of “venture capital fund” also raises two additional concerns. First, by incorporating the Commission’s definition into today’s proposal, the agencies give the Commission substantial control over the degree of risk that is acceptable for banks to take with these types of investments. The Commission is not a prudential regulator; our mission is not anchored in principles of safety and soundness for banking institutions. However, to the extent that the Commission makes changes that broaden the current definition of “venture capital fund”—and we are receiving calls to do so[19]—we will concomitantly permit increased risk-taking by banks.

Second, the actions taken today have the potential to increase the level of risk that venture capital funds present to the financial system. When Congress adopted the Volcker Rule—which was intended to keep banks out of speculative private funds such as venture capital—it also adopted a provision relieving advisers to venture capital funds of the requirement to register with the Commission.[20] In providing this exemption, Congress relied heavily on the notion that venture capital funds, because of the nature of their operations, are less likely to present systemic risk than other types of private equity or hedge funds.[21] Congress believed that their “activities are not interconnected with the global financial system” and that the high level of risk inherent in these funds is borne by fund investors and not the broader economy.[22] Today’s proposal would allow banks greater flexibility to invest in venture capital funds. If this proposal is adopted, both Congress and the Commission should consider whether permitting banks to pursue speculative investments in venture capital funds calls into question the rationale for the registration exemption.[23]

Parallel Investments

The proposal would also lift certain restrictions on banks’ investing alongside a covered fund, or “parallel investment,” thus opening the door to evasion of the rule’s investment prohibitions.

The 2013 Adopting Release limited banks’ ability to engage in certain types of investment activity in parallel with covered funds. The agencies stated that if a bank invests in substantially the same positions as a covered fund, “then the value of such investments shall be included for purposes of determining the value of the banking entity’s investment in the covered fund.”[24] The agencies took the same position with respect to commitments by a bank to co-invest with a covered fund in a privately negotiated transaction.[25] The rule limits the value of a bank’s investments in any covered fund to a de minimis amount, and the agencies’ position on these parallel investment activities was meant to ensure that such activity was counted toward that de minimis limitation.[26] After all, substantial investment alongside of a covered fund raises many of the same concerns as direct investments in the fund.

Today’s proposal, however, reverses course and would specifically instruct banks that such parallel investments need not be counted toward the de minimis limitation.[27] Thus, parallel investments could be used to evade the prohibitions on investing in covered funds. [28]

Moreover, a bank may be motivated to make such investments in order to artificially maintain the value of a fund it has sponsored and the underlying assets to which the bank also has direct exposure. While the proposal asserts that banks still could not use parallel investments “for the purpose of artificially maintaining or increasing the value of the fund’s positions,”[29] it goes on to explain that a bank may now “market a covered fund it organizes and offers . . . on the basis of the banking entity’s expectation that it would invest in parallel with the covered funds in some or all of the same investments.”[30] Thus, despite the assertion that banks still may not artificially maintain the value of sponsored covered funds, the proposal specifically suggests that banks pursue the very arrangements that could create market pressure and incentives for them to do just that. It is hard to imagine that this is what Congress intended in adopting the Volcker Rule.

Nothing in today’s proposal would reduce the potential for systemic risk or subject banks to more meaningful oversight of high-risk investment activity. The proposal does not balance competing concerns; it does not seek to enhance protections in some areas while dialing them back because of new evidence in others. Rather, it uniformly allows banks to take on greater risk, especially in the form of investments in venture capital and credit funds, and increases opportunities for evasion of the restrictions that remain. In the case of venture capital funds, this not only imports the risks of such funds into the banking system, but, in doing so, undermines the rationale for exempting advisers to venture capital funds from registration with the Commission.

Although I cannot support the proposal in its current form, I look forward to receiving comment from the public about how the agencies can address the risks inherent in the proposed changes.