We have reached the summer of 2013 and Dodd-Frank's third anniversary, and most foreign banks with U.S. operations remain buffeted by regulatory change. Whether from the threat of imposition of a U.S. intermediate holding company subject to U.S. capital requirements, or from the application of inconsistent cross-border rules governing swap activities, the outlook for foreign banking organizations (FBOs) operating here in the United States is uncertain.

The worst may be yet to come. Hanging over their heads is the forthcoming release of the final Volcker Rule, implementing Section 619 of Dodd-Frank. Delayed now by close to 20 months since the proposal, the final rule threatens to wreak havoc on the operations of FBOs with U.S. operations.

The Volcker Rule will require all covered banks to stop engaging in proprietary trading and to strictly limit their investment in covered funds. The proposed rule, which was issued in October 2011, is exceedingly complex, and would require FBOs to build significant internal compliance functions. The final Volcker Rule is expected to be even more complex. For FBOs, the rule will apply to them in some form so long as they have a branch or subsidiary bank in the United States, regardless of how small their U.S. operations are in comparison to the global bank.

It would be bad enough if the Volcker Rule applied strictly to the U.S. operations of FBOs. However, the proposed rule suggests (and the final rule is expected to mandate) that Volcker would apply anywhere, to any activity, unless it occurred solely outside of the United States, or SOTUS. Unless an FBO does a proprietary trade or makes an investment in a covered fund that meets the regulatory definition of a SOTUS exemption, that trade or investment would have to comply with the Volcker Rule, regardless of how little the individual trade or investment actually involves the United States.

The proposed rule's definition of SOTUS was exceedingly narrow—so much so that many transactions that to the reasonable mind would be considered non-U.S. would, under the proposed rule, fail to be exempt from Volcker. For instance, if a Singaporean branch of a German bank does a trade with a Brazilian firm controlled by U.S. private equity funds, that trade would be covered. If a European fund markets potential investments to U.S. investors, that investment would be covered. If a swap of assets between entirely non-U.S. parties requires settlement in dollars sourced from a U.S. payment source, that trade would be covered. We hope for some relief in the final rule, but as it stands now, the rule has the potential to apply anywhere in the world, and could be triggered by nearly any activity conducted by any business line in any location.

The SOTUS rule is so complex that there is almost no way to predict whether a trade or investment will be covered or exempt without examining most every situation individually. And this is why, for FBOs, the Volcker Rule will be so much worse than any other regulatory initiative on the table—because they will need to create massive compliance and reporting systems to handle it, even if the vast, vast majority of their dealings are done outside Volcker's scope.

Meanwhile, most of the personnel involved in transactions examined for possible SOTUS exemptions will be based in non-U.S. offices (as the U.S. offices will clearly be covered). This means that FBOs must translate extremely complicated U.S. regulatory concepts into every language in which they operate.

Finally, the Volcker Rule will require a significant amount of reporting of financial data from non-U.S. sources. This likely will require the build-out of substantial reporting systems which have the potential to aggravate compliance given the data-transfer and privacy concerns this will raise.

So every covered FBO should be dreading the release of the final Volcker Rule. And it may surprise many people that the rule actually is in effect already.

Section 619 of the Dodd-Frank Act became effective automatically last July. Covered FBOs technically are currently in a "conformance period" and must act in "good faith" to ensure compliance of their covered activities by July 2014. Of course, no final Volcker Rule has been issued yet, so to what standards must an FBO conform?

What a nightmare.



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