Foreign bank cross-border trading under the Volcker Rule: the ‘trading outside the United States’ exemption’s incongruous consequences

Abstract

The Volcker Rule’s proprietary trading provisions prohibit any banking entity from engaging in proprietary trading, which is defined by the Volcker Rule to encompass short-term trading and dealing activities in financial instruments for the banking entity’s own account. Because the term “banking entity” includes all U.S. and non-U.S. affiliates of a foreign banking organization, the extraterritorial reach of the Volcker Rule’s proprietary trading ban is very broad, extending to all of a foreign banking organization’s trading activities worldwide, regardless of the location, place of incorporation of the entity in which they are conducted, or the U.S. nexus of those activities. To limit the broad extraterritorial scope of the proprietary trading prohibition, the Volcker Rule permits a foreign banking organization to engage in otherwise prohibited proprietary trading under a “Trading Outside the United States” or “TOTUS” exemption. This exemption imposes conditions that generally seek to limit the risks to and conduct of the foreign banking organization in the United States. Despite the limitations on U.S. conduct and risk, the TOTUS exemption specifically permits foreign banking organizations to engage in some cross-border transactions involving U.S. counterparties and infrastructure by allowing trading “with or through a U.S. entity.”The requirements of the Volcker Rule’s TOTUS exemption for these cross-border transactions, however, do not sufficiently take into account the existing framework for trading activities under U.S. law and market structure. The article illustrates this disconnect by analyzing two types of securities transactions — trades on U.S. securities exchanges and internalized trades — conducted by a hypothetical bank. These simple examples of common securities transactions highlight the limited utility of the TOTUS exemption for foreign banks and how the regulations lead to results that seem inconstant with the policy objectives of the exemption. The article suggests a few modifications to the TOTUS exemption for regulators to consider to better align the exemption with the stated policy objectives as well as existing regulatory requirements and market structure that govern securities transactions.