The latest regulatory fix to the Volcker Rule has left collateralized loan obligations out in the cold, but banks and money managers continue to push for an exemption for these instruments as well.
Late Tuesday, federal regulators released an interim final regulation designed to allow banks to continue owning collateralized debt obligations backed by trust preferred securities without running afoul of the Volcker Rule.
The agencies' solution would exempt from the Volcker Rule all collateralized debt obligations backed by trust-preferred securities that were issued by banks with less than $15 billion of assets. Under the rules released Dec. 10, banks would have been forced to sell their holdings, at substantial losses by 2015.
But banks may still have to sell their holdings of CLOs, which amount to as much as $70 billion. CLOs are considered “covered funds” under the Volker Rule if they own anything besides loans, and most have significant holdings of corporate loans as well as bonds.
In testimony before the House Financial Services Committee today, Elliot Ganz, the general counsel of the Loan Syndications and Trading Association, said that forcing banks to sell their CLOs would also result in big losses.
If banks are simultaneously forced to sell, the impact of this rule would be felt almost immediately, he said: The act of selling would put downward pressure on CLO prices and could trigger more selling pressure, potentially causing a downward spiral of falling prices and further sales, all despite no fundamental changes in the projected cash flows of the underlying CLO debt security. This would unnecessarily and arbitrarily reduce bank capital levels.
“If the price of CLO debt securities were to drop by only 10%, banks holding CLO debt securities would face potential cumulative losses of up to $7 billion, which losses would be driven solely by imposition of the Final Rule,” said Ganz. “The final rule as written would cause banks to recognize significant losses on otherwise safe, high quality assets, which furthers no regulatory objective.”
The CLO industry is lobbying for a different fix: it wants regulators to confirm that senior debt securities issued by CLOs do not constitute an ownership interest in these deals under the Volcker Rule. Banks typically hold the top-rated tranches of CLOs, and these securities give them the right to remove a manager for cause.
In addition, the LSTA supports introduced legislation that would grandfather existing CLO loans issued before Dec. 10 and allow banks to continue to hold those debt securities.
The Securities Industry and Financial Markets Association is also pushing for an exemption to the Volcker Rule for CLOs.
“While we welcome the relief provided to certain holders of TruPS CDOs, we believe that regulators must address the larger problem of the inclusion of senior debt securities issued by collateralized loan obligations (CLOs) in the Volcker Rule’s prohibitions,” Sifma’s president and chief executive Kenneth E. Bentsen, Jr. said in a statement released late Tuesday.
“If this situation is not remediated, corporate borrowers could face higher credit costs and banks will likely suffer unnecessary losses wholly unrelated to the risk of the CLOs themselves, but rather due to the technical language of the final Volcker Rule. We continue to encourage regulators to issue guidance clarifying that banks may hold CLO debt securities.”