Banks and money managers are seeking further guidance on the impact of the Volcker Rule on collateralized loan obligations (CLOs).
The trading ban limits banks’ ability to hold CLOs and other kinds of collateralized debt obligations (CDOs), and at least two banks have said they planned to sell CLOs since it was finalized Dec. 10.
In a letter today to joint federal regulators, the Loan Syndication and Trading Association, the Securities Industry and Financial Markets Association, the Financial Services Roundtable, the Structured Finance Industry Group and the American Bankers Association have asked for clarification on what exactly constitutes ownership of CLOs. These investment vehicles issue multiples classes of securities that convey varying degrees of control over their management. The trade groups want to know if debt securities issued by CLOs that have a contingent right to remove a manager for cause or to vote for a replacement do not constitute an “ownership interest,” under the rule.
“The lack of clarity on this issue could unnecessarily disrupt the CLO market as banks may decide they can no longer acquire or retain debt securities of CLOs that are covered funds,” Bram Smith, executive director of the LSTA, stated in a press release. “If banks are forced to divest their holdings, banks and other investors could be facing material losses as well as a significant reduction of liquidity in the CLO market, which could ultimately threaten the availability and increase the cost of corporate credit.”
The LSTA believes that CLO debt securities that include the right to replace a CLO manager “for cause” or upon its resignation do not constitute “ownership interests” under the Volcker Rule; nevertheless, the trade group notes that there is considerable confusion on the matter, the press release stated. If such rights were deemed to create an ownership interest, banks would be prohibited from acquiring or continuing to hold notes in any CLO that is a covered fund.
“CLO note holders have very limited rights to replace managers in cases involving a significant breach of the managers’ obligations,” said Elliot Ganz, the LSTA’s general counsel and executive vice president> He said that these types of events “pose clear and direct threats to the interests of note holders and their ability to respond to them is properly viewed as an essential creditor’s right and not an ownership interest.”
Banks have already recieved -- and rejected -- guidance on the impact of the Volcker Rule on CDOs backed by trust-preferred securities. Ina release dated Dec. 12, regulators specified that banks iwth trust-preferred CDOs do not have to sell such holdings immediately, but can take time to figure out how they can be permitted under the rule.
Camden Fine, president of the Independent Community Bankers of America, called the clarification a "disaster," saying it did nothing to remove the threat of banks having to take significant charge offs of capital at year end.
The Volcker Rule does not go into effect until July 21, 2015; regulators extended the compliance date by an additional year when they finalized the rule.