FRB Allows Banking Entities Two Additional One-Year Extensions to Conform CLO Ownerships Covered by Volcker
Commentary by Scott Cammarn
The Board of Governors of the Federal Reserve System ("FRB") announced that it intends to give banking entities two additional one-year extensions to conform their ownership interests in and sponsorship of certain collateralized loan obligations ("CLOs") covered by the Volcker Rule.
The FRB previously extended the conformance period for all activities and investment by one year, to July 21, 2015. To ensure effective compliance, the FRB stated that it intends to grant banking entities two additional one-year extensions, which together would extend the conformance period until July 21, 2017. Only CLOs in place as of December 31, 2013, that do not qualify for the exclusion in the final rule for loan securitizations would be eligible for the extension. The FRB stated that it intends to act on these extensions in August of 2014 and 2015.
A banking entity would not have to include ownership interests in CLOs to determine its investment limits under the final rule, and a banking entity would not be required to deduct CLO investments from tier 1 capital under the final rule until the end of the relevant conformance period.
According to the press release, the FRB consulted with the staff members of other agencies charged with enforcing the requirements of the Volcker Rule, including the OCC, SEC, FDIC and CFTC. The agencies plan to administer their oversight of banking entities under their respective jurisdictions in accordance with the Board's conformance rule, including extensions of the conformance period that are applicable to CLOs.
Reactions
Congressman Scott Garrett, Chairman of the Financial Services Subcommittee on Capital Markets and Government-Sponsored Enterprises, issued a statement urging U.S. financial regulators to "go back to the drawing board." Noting that Congress did not intend for securitizations (including CLOs) to be covered under the Volcker Rule, Congressman Garrett suggested that the banking regulators were "completely unaccountable to Congress" and that they were engaging in a "remarkable" regulatory overreach.
SIFMA issued a statement expressing disappointment, suggesting that regulators should have addressed the problem in a more "coordinated and conclusive manner."
See: FRB Press Release.
See also: Congressman Garret's Statement; SIFMA's Comments.
Related news: House Bill Would Clarify Ownership Interest Definition for CLOs under Volcker Rule (March 7, 2014); Trade Associations Request Further Clarification Regarding Ownership Interests for Debt Securities under New Volcker Rule Regulations (January 7, 2014); Trade Associations Request Clarifications Regarding Holding Debt Securities under New Volcker Rule Regulations (with Lofchie Comment) (December 26, 2013).
Commentary
With respect to CLO sponsorships and ownership interests, the Federal Reserve is delaying the Volcker conformance date for two more years -- until July 21, 2017, the maximum extension date allowed by the Volcker Rule (except for "illiquid funds"). This means that banking entities are not under an obligation to dispose of any ownership interest in a CLO (or divest itself of any sponsorship in a CLO) until that date. Curiously, the Fed's Order does not define "CLOs" (other than to generally describe them as "securitization vehicles backed predominantly by commercial loans") - so it's not exactly clear what this extension applies to.
The Order is helpful, in that it (i) should forestall the prospect of "fire sale" pricing because banking entities have more time to find buyers or conform CLO interests, (ii) gives more opportunity for possible legislative relief, and (iii) preserves the valuation of CLOs that are set to mature between now and July 21, 2017. However, the Order doesn't alter the fundamental concern that declaring CLO ownership interests to be nonconforming may affect the valuation methodology that must be applied - regardless whether the mandatory divestiture date is July 2015 or July 2017.
While the Fed Order also states that a banking entity is not required to comply with the Section __.12 capital surcharge and 3% limits until that date, this statement has limited utility; the Section __.12 capital surcharge and 3% limits apply only to those retained ownership interests in funds that are "organized and offered" by a banking entity under Section __.11 - which may not apply to many CLO ownership interests.