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From Securities Regulation Daily, April 7, 2014

Banks get two more years to conform CLOs to Volcker Rule

By John M. Pachkowski, J.D.

The Federal Reserve Board, exercising its authority under Sec. 13 of the Bank Holding Company Act (BHC Act), will be extending the conformance period for banking entities to conform their ownership interests in, and sponsorship of, some collateralized loan obligations (CLOs) to meet the requirements of the Volcker Rule and its implementing regulations.

Under the BHC Act Sec. 13, the Fed may, by rule or order, extend the conformance period for not more than one year at a time, for a total of no more than three years, if in its judgment, an extension is consistent with the purposes of Sec. 13 and would not be detrimental to the public interest. Following approval of the Volcker Rule’s implementing regulations, the Fed extended the conformance period until July 21, 2015.

In its announcement and statement, the Fed said that it will provide two additional one-year extensions, which together would extend the period until July 21, 2017, to conform their ownership interests in, and sponsorship of, CLOs. These latest extensions will only apply to CLOs in place as of December 31, 2013, that do not qualify for the exclusion in the final rule for loan securitizations.

Divestiture concerns. The Fed is taking this action in light of concerns expressed by a number of banking entities, trade associations, and members of Congress that the Volcker Rule’s implementing regulations would require divestiture by banking entities of ownership interests in CLO vehicles that did not meet the loan securitization exemption for covered funds since the vehicles contained non-conforming non-loan assets.

The Securities Industry and Financial Markets Association (SIFMA), representing a wide swath of securities market participants, said that despite its members’ interest in a “workable” Volcker Rule, it worried that today’s announcement could result in forced sales that may widen CLO spreads. SIFMA said it is still evaluating the Fed’s planned extension, but said there are potential consequences for “Main Street businesses” without more comprehensive CLO relief.

Said SIFMA president and CEO, Kenneth E. Bentsen, Jr., “We are disappointed that the agencies involved did not use their rulemaking authority to provide broad relief from the Volcker Rule to legacy CLOs. SIFMA strongly believes that regulators should have addressed the problem in a comprehensive, coordinated, and conclusive manner yet the statement released today seems to suggest the Agencies have taken a different approach.”

Investment limits and capital. During the conformance period, banks will not have to include ownership interests in CLOs to determine investment limits under the final rule nor will they be required to deduct CLO investments from tier 1 capital as required by the Volcker Rule’s implementing regulations.

Interagency consultation. In taking this action, the Fed consulted with staffs of the other agencies charged with enforcing the requirements of BHC Act Sec. 13, including the Office of the Comptroller of the Currency, FDIC, SEC, and CFTC . In turn, the agencies plan to administer their oversight of banking entities under their respective jurisdictions in accordance with the Fed’s conformance rule, including any extension of the conformance period applicable to CLOs.

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