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From Banking and Finance Law Daily, February 14, 2014

House Democrats push agencies on Volcker Rule CLO guidance

By John M. Pachkowski, J.D.

Seventeen House Democrats, led by Maxine Waters (D-Calif), the Ranking Member of the Financial Services Committee, and Carolyn Maloney (D-NY), Ranking Member of the Capital Markets, and Government Sponsored Enterprises Subcommittee, have sent a letter to the heads of the Office of the Comptroller of the Currency, Federal Reserve Board, Federal Deposit Insurance Corporation, Securities and Exchange Commission, and Commodity Futures Trading Commission regarding the application of the Volcker Rule to  senior debt securities of collateralized loan obligations (CLOs).

The letter expressed the House members’ support for interpretive guidance on the Volcker Rule's definition of an “ownership interest” that protects the intent of the Volcker Rule, while also recognizing that certain traditional creditor-protective voting rights should not, by themselves, cause senior debt securities of CLOs to be treated as equity interests and thereby subject to the Volcker Rule’s prohibition on banks owning hedge funds and private equity funds.

The House members noted that in the case of CLOs, the senior debt securities issued by the CLO typically include the right to vote to remove the investment manager not just in an event of default, but also “for cause,” which typically includes a material breach of contract, fraud, and criminal activity.

They believe that the right to vote on removing an investment manager in traditional creditor-protective circumstances such as a material breach of contract should not, by itself, trigger an “ownership interest” and that a narrowly-tailored interpretation will align the definition of “ownership interest” with Congressional intent, while also guarding against evasion of the ownership restrictions; and, at the same time, avoid the need for unduly disruptive, market-wide renegotiations of existing CLOs.

The congressional letter is the latest call for the regulators to fix “unintended consequences” of the agencies’ final rule implementing the Volcker Rule.

A Dec. 24, 2013, letter by executives representing the Loan Syndications and Trading Association, the Securities Industry and Financial Markets Association, the Structured Finance Industry Group, the American Bankers Association, and the Financial Services Roundtable to the agencies sought clarification of the ownership interest issue regarding CLOs. In that letter, the trade groups were concerned that without further guidance by the pertinent federal regulators, banking entities “could begin to dispose of these CLO debt securities and stop acquiring new covered fund CLO debt securities, even though we believe that these rights should not be read to constitute an ownership interest.” They added that without the regulators’ clarification of the “ownership interest” definition, unnecessary market disruptions would occur (see Banking and Finance Law Daily, Dec. 27, 2013). In a follow-up letter, the trade groups reiterated their request for guidance from the agencies (see Banking and Finance Law Daily, Jan. 8, 2014).

Finally, legislation has been introduced by Senators Mark Kirk (R-Ill), Mike Crapo (R-Idaho), Pat Toomey (R-Pa), John Barrasso (R-Wyo), Mike Enzi (R-Wyo), Jerry Moran (R-Kan), and Roger Wicker (R-Miss) that would revise the Bank Holding Company Act so that it would not be construed to mandate divestiture of CLOs issued before Dec. 10, 2013—the date the agencies issued the final Volcker Rule. The Independent Community Bankers of America supports this legislation. In a letter to Sens. Kirk and Crapo, the ICBA noted that “S. 1907 would provide immediate and urgently needed relief for hundreds of community banks from an arbitrary and severely damaging provision of the final Volcker Rule which would only hamper our nation’s economic recovery” (see Banking and Finance Law Daily, Jan. 10, 2014, and Banking and Finance Law Daily, Jan. 13, 2014).

Companies: American Bankers Association; Financial Services Roundtable; Independent Community Bankers of America; Loan Syndications and Trading Association; Securities Industry and Financial Markets Association; Structured Finance Industry Group

MainStory: TopStory FinancialStability Loans SecuritiesDerivatives VolckerRule

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