Volker Rule and Real Estate Funds


Five regulatory agencies adopted the final rules that implement the Volcker Rule, a provision of the Dodd-Frank Wall Street Reform and Consumer Protection Act. It’s a big, complicated, ugly rule that will drive compliance officers at banks crazy trying to implement. Have fun reading all 964 pages. The text of the regulations themselves only run on for 70 of those pages

From the position of a private fund sponsor there is one section to pay particular attention to. Subpart C of the Volker Rule prohibits banks from owning or sponsoring a “covered fund”. That definition comes from section 13(h)(2) of the Bank Holding Company Act and is any entity that would be an investment company, but for the exclusions under sections 3(c)(1) and 3(c)(7) of the Investment Company Act. That picks up hedge funds and private equity funds. It will also likely pickup real estate funds whose managers registered as investment advisers.

The Rule also explicitly pulls in some commodity pools. There is some fine print there to focus on. Those real estate fund managers that didn’t register as investment advisers, but did file as commodity pool operators may be stuck with the Volker Rule. It’s tough to figure out what the agencies are trying to grab, but my best guess is that the rule applies if the fund relies on a 4.7 exemption, but may not apply if the fund relies on the 4.13 exemption.

The Rule does allow for a small ownership interest, as long as it does not exceed 3% of the total value of the total number or value of the outstanding ownership in the fund. (See Section 12(a)(2)(ii)(A).) From the bank’s perspective, it cannot have more than 3% of its Tier 1 capital in covered funds.

As for a real estate fund, it may still be able to be exempted from the restrictions under the Volcker Rule. It would have to rely on the nebulous section 3(c)(5)(c) exemption under the Investment Company Act. The fund may also have to limit its use of interest rate derivatives to stay outside the definition of a “commodity pool” under the Commodity Exchange Act.

The end result for real estate funds is likely minimal. Clearly the big investment bank-sponsored funds will go away. Bu that has been happening for the past few years. Just look at the PERE Charts to see those funds dropping down and off the list. They will continue to be sellers and not buyers. It does look like separate accounts and other types of real estate investments may be permitted for banks.