As regulatory agencies work on implementing regulations designed to enforce the Volcker Rule, banks must consider the impact of the pertinent regulatory requirements on their collateralized loan obligation holdings. In addition, they must develop a strategy to deal with legacy notes to be in compliance with the Volcker Rule as interpreted by the agencies.
What’s Inside?
The final rules issued by the financial services regulatory agencies in December 2013 to enforce the Volcker Rule component of the Dodd–Frank Act go into effect on 21 July 2015, with conformance extended until July 2017. To be in compliance with these regulations, banks will need to divest nonconforming collateralized loan obligations (CLOs) or to amend or refinance them, with potentially significant losses and costs for the banks.
How Is This Research Useful to Practitioners?
The Volcker Rule component of the Dodd–Frank Act, which was passed in July 2010 in response to the financial crisis of 2008–2009, prohibits banks from conducting most proprietary trading with their own accounts and limits their ownership of and relationship with hedge funds and private equity funds, also known as “covered funds.” As interpreted by the regulations issued by the financial services regulatory agencies, the Volcker Rule permits the issuance of new loan-only CLOs but would require banks to divest or restructure a large number of previously issued CLOs that are not in compliance.
The final rules to enforce the Volcker Rule component of Dodd–Frank were approved by the Federal Reserve Board, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, the Securities and Exchange Commission, and the Commodities Futures Trading Commission in December 2013, with compliance mandated by 21 July 2015. Banks potentially face significant losses and high costs in divesting CLO notes or in amending or refinancing them to be in compliance with these regulations.
How Did the Author Conduct This Research?
The author, an executive for the Loan Syndications and Trading Association (LSTA), approaches the Volcker Rule in terms of how it might benefit or harm the banking industry—specifically, how it could potentially affect banks’ holdings of CLOs. He outlines the background of the Volcker Rule and the chronology of the period between the passage of Dodd–Frank in 2010 and the final rules issued by the financial services regulatory agencies in December 2013. During this prolonged period, as the author indicates, LSTA and other trade associations advocated having CLOs exempted in the Volcker Rule, as loans themselves were; these advocacy activities included submitting regulatory text.
Ultimately, conformance was extended until July 2017; newly conforming CLOs can continue to be issued. But the final rules consider debt securities of CLOs that have securities baskets to constitute ownership interests in covered funds that must be divested.
Abstractor’s Viewpoint
The author’s viewpoint is clearly, and solely, that of an industry advocate; his focus is strictly limited to what will benefit the banking industry within a relatively short time frame. I would prefer to see this issue addressed within a wider, more balanced context that takes into consideration the overall safety and soundness of the banking system, as well as the intent of the Dodd–Frank Act to address what is best for the country as a whole over a longer period of time.