Trade Associations Request Clarifications Regarding Holding Debt Securities Under New Volcker Rule Regulations

The Loan Syndications and Trading Association, SIFMA, the Structured Finance Industry Group, the American Bankers Association, and the Financial Services Roundtable (together, the “Trade Associations”) sent a letter to federal regulators requesting that they clarify how certain provisions of the recently issued “Volcker Rule” regulations would apply to debt securities of collateralized loan obligation (“CLO”) issuers. In particular, with respect to CLO issuers that are considered “covered funds,” the Trade Associations requested that the regulators clarify that holding debt securities issued by such CLOs would not constitute an “ownership interest” under the Volcker Rule regulations so long as the securities conferred a contingent right to remove a manager “for cause” (or to nominate or vote on a nominated replacement upon a manager’s removal for cause or resignation), without any other indicia of ownership interest. While the regulations define “ownership interest” to include “the right to participate in the selection or removal” of an investment manager of a covered fund, the Trade Associations argued that the right to remove a manager for cause should be viewed as an essential creditor’s right designed to protect debt interests, rather than an ownership interest. The Trade Associations cautioned that, in the absence of such a clarifying statement by the regulators, banking entities could begin to dispose of CLO debt securities, disrupting the CLO market and potentially resulting in ripple effects that affect banking entities and non-bank investors alike.

Lofchie Comment:  As part of the regulatory response to the savings and loan association crisis, the government forced S&Ls to sell their high-yield bonds into the market.  With so many forced sellers, market prices for the bonds dropped.  As a result, the forced sales caused damage to the S&Ls and increased losses to taxpayers.  Now bad regulatory policy repeats itself.  Even if regulators were to conclude that banks should not in the future buy certain types of securities, forcing massive divestitures of past investments seems such an obviously flawed policy, it is surprising the government would repeat it.  Massive forced divestitures do not “cut” losses; they increase them.

See: Comment Letter.


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