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From Banking and Finance Law Daily, January 15, 2014

Regulators offer relief from Volcker Rule provisions affecting trust preferred securities collateralized debt obligations

By Richard A. Roth, J.D.

The federal bank, thrift, and commodities regulators have adopted an interim final rule responding to financial industry complaints about the effect the Volcker Rule regulations will have on investments in collateralized debt obligations that are backed by trust preferred securities. The interim rule will permit banking entities to retain some investments made before Dec. 10, 2013, the date the final Volcker Rule was issued. It will not permit additional investments to be made.

Broadly described, the Volcker Rule is intended to prevent banking entities from engaging in certain investment activities that are deemed to be too risky. It was mandated by the Dodd-Frank Act. The implementing regulations prohibit banking entities from engaging in proprietary trading and from investing in, sponsoring, or maintaining described relationships with hedge funds and private equity funds.

Genesis of problem. Trust preferred securities are hybrid securities that have some characteristics of preferred stock and some characteristics of subordinated debt. They have been used as a way for community banks to raise capital.

The dispute arose from the inclusion of CDOs backed by trust preferred securities within the investments that are banned by the Volcker Rule regulation. Banks, especially community banks, became concerned that they would be forced to recategorize the CDOs as investments held for sale and eventually to sell the CDOs, both of which could be harmful to the institutions’ capital positions.

Interim rule provisions. To respond to this possibility, and to carry out Congress’s intent to grandfather some older CDOs, the regulatory agencies have adopted an interim final rule that will allow a bank to retain an interest in, or to sponsor, entities that issued affected CDOs, provided that:

  • the issuer was established before May 19, 2010;

  • the bank reasonably believes that the proceeds of the offering were invested primarily in qualifying collateral; and

  • the bank’s investment in the issuer was made before Dec. 10, 2013, or was acquired by a merger or acquisition.

Qualifying collateral is a trust preferred security or subordinated debt instrument issued before May 19, 2010, by a depository institution holding company that had total consolidated assets of less than $15 billion for the reporting period 12 months just before the instrument was issued. A similar instrument issued by a mutual holding company before the same date also qualifies, regardless of the holding company's size.

The interim rule also allows market making activities.

In an effort to ease the compliance burden for banks, the agencies have issued a non-exhaustive list of issuers that meet the interim rule’s requirements.

Effective date and comment deadline. The interim final rule was approved by the Federal Reserve Board, Federal Deposit Insurance Corporation, Office of the Comptroller of the Currency, Commodity Futures Trading Commission, and Securities and Exchange Commission, the same agencies that issued the Volcker Rule regulations. It is effective April 1, 2014, as are the common final rules. The agencies will accept comment on the interim final rule for 30 days following its publication in the Federal Register.

ABA response. The American Bankers Association quickly responded to the agencies’ announcement, commending the regulators’ “speed and judiciousness.” According to the ABA, the change will allow banks to avoid “millions of dollars in unexpected and unnecessary write downs.” The association also praised the inclusion of the qualifying issuer list.

Companies: American Bankers Association

MainStory: TopStory VolckerRule

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