The U.S. House Financial Services Committee today overwhelmingly approved a bill that would grant a two-year extension to the deadline for banks to divest in CLOs that they are prohibited from holding under Volcker Rule.

The Loan Syndications and Trading Association applauded the measure from Rep. Andy Barr (R-KY), saying in a weekly newsletter issued today that the bill’s 55-3 vote “sends a strong bipartisan message to regulators that Congress wants and expects them to address – and fix – the disruption to the CLO market caused by the Volcker rule.”

The extension, which now goes to the full House, also gives banking and securities trade groups, such as the Financial Services Roundtable, LSTA and the Securities Industry and Financial Markets Association, more time to convince regulators and lawmakers to revise a provision in the Volcker Rule that puts CLOs backed by bonds or other securities in addition to loans off limits to banks. CLOs issued before the final version of the rule was published typically allocate between 5% and 10% of assets to corporate bonds,

The bill, which included an amendment by Rep. Carolyn Mosely (D-NY), would extend the period in which banks could hold on to CLOs backed by debt securities until July 2017. Known as the Restoring Proven Financing for American Employers Act, it covers CLOs issued prior to Jan. 31, 2014 and those that would trip the “ownership interests” portion of the Volcker Rule. Banks tend to buy the senior tranches of debt issued by CLOs. While debt is not typically considered to be an ownership interest, the senior debt securities issued by CLOs give holders the right to remove a manager for cause. This would appear to constitute an ownership interest as defined in Volcker.

The LSTA says that the bill would “effectively grandfather” all CLO 1.0s (those assets created before the 2008 financial crisis) since they are all projected to be repaid or refinanced by 2017 anyway. But “while banks would not have to divest CLO 2.0s until 2017 (assuming there would be no intervening regulatory fix or clarification of the rules), they would not be fully protected since some are expected to be around until at least 2020,” the LSTA newsletter states.

The industry groups argue that the Volcker Rule’s prohibitions should not apply to CLOs, since these instruments performed well through the financial crisis, and because a prohibition could roil the CLO markets, and in doing so make it more difficult for below investment grade companies to obtain financing.

An interagency group of regulators from the Federal Reserve, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corp., the Commodities Futures Trading Commission and the Securities and Exchange Commission have been considering an exemption that would grandfather existing CLO holdings on banks’ books, but that working group has resisted making revisions.

Earlier this year regulators did grant banks an exemption for holding trust preferred securities, which also fall afoul of Volcker and are widely held by community banks. But regulators have been reluctant to carve out such a wide exemption for CLOs, which are widely held by large banks.

Dave Preston, a senior analyst at Wells Fargo Securities, published a report today in which he stated that a Volcker fix for CLOs is likely to come via legislation, rather than regulation.

In the report, Preston said that the recent pickup in CLO issuance – some $4.2 billion has been issued in March, bringing volume for the year to date to $15.7 billion – “does not equate to the market shrugging off concerns about the Volcker Rule.” Rather, he said, “we believe primary market volume has increased due to growing optimism that a fix will be found regarding the Volcker Rule’s apparent prohibition on bank holdings of CLO 1.0 and 2.0 tranches.”

In other words, “the thaw in the primary market may be partly driven by investors’ belief that the bipartisan momentum will produce a workable outcome for the CLO market,” Preston wrote. “If investors thought that banks would not be permitted to hold existing CLO 1.0 and 2.0 positions, we believe primary issuance would slow.” 

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