December 10, 2013 Alert - Agencies Issue Final Rules Implementing The Volcker Rule
The Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, the Commodity Futures Trading Commission, and the Securities Exchange Commission today approved final regulations implementing the “Volcker Rule”, which is formally known as the “Prohibitions and Restrictions on Proprietary Trading and Certain Interests in, and Relationships with, Hedge Funds and Private Equity Funds” Rule. The final regulations address proprietary trading and investments in hedge or private equity funds by banking institutions. A copy of the Volcker Rule can be found here; the Federal Reserve Board staff memo can be found here; and a fact sheet can be found here. A couple of the official statements can be found here and here. Please also click here for a Volcker spotlight we included in our November 13th newsletter.

SFIG will hold a membership call next week to delve into the key securitization points of the Volcker Rule. We will distribute a more comprehensive summary of the Volcker Rule and dial-in details in advance of that call.

Highlights of Volcker Rule

Some helpful changes:

The definition of covered fund now excludes 14 different types of entities. The exclusions include (a) foreign public funds, (b) wholly owned subsidiaries, (c) loan securitizations, (d) qualifying asset-backed commercial paper conduits, and (e) qualifying covered bonds.

As a result of these express exclusions from the definition of covered fund, the so-called “Super 23A” problem that existed in the proposed rule has been fixed in the final rule for excluded entities. The proposed rule section _.16 prohibited all covered transactions between a covered fund and a banking entity that acts as sponsor, investment advisor or manager for a covered fund, even if the covered fund met the conditions in the special loan securitization or foreign fund categories. This would have had the effect of prohibiting banks from engaging in any lending or similar transactions with loan securitization issuers (such as interest rate derivatives, servicing advance facilities and liquidity facilities) that were sponsored or advised by such bank or its affiliates even though the bank could own the issuer. The final rule corrects this glitch by exempting loan securitizations and various other types of transactions and issuers from the definition of covered fund itself.

The exemption of wholly owned subsidiaries from the definition of covered fund means that any securitization issuer that issues only debt not constituting an “ownership interest” to third parties will not be subject to any Volcker rule restrictions. Among other benefits, this effectively closes the huge gap that had existed in the proposed rule with respect to intermediate SPEs that did not hold loans and thus could not rely on the loan securitization exemption.

The loan securitization exclusion permits an exempt issuer to hold interest rate and foreign exchange derivative, securities obtained in a workout or other restructuring for debt previously contracted, as well as SUBIs and collateral certificates that meet certain conditions.

ABCP issuers are exempt from the covered fund definition if they meet certain conditions.

A non-US fund that is not otherwise exempt from the Investment Company Act by virtue of section 3(c)(1) or 3(c)(7) thereunder and that is sponsored by a foreign bank which is not controlled by a US banking entity is entirely exempt from everything including Super 23A. This is a great result for non-US securitization issuers that would have a hard time converting to a Rule 3a-7 Investment Company Act exemption due to the existence of a non-US trustee or a Regulation S offering outstanding.

Some lingering or newly created concerns:

The final rule has narrowed the definition of loan so as to expressly exclude securities and derivatives.

A covered fund includes a commodity pool for which the commodity pool operator claimed an exemption under 17 CFR 4.7. Thus any CPOs that claimed an exemption as a precautionary measure prior to the December 2012 guidance may have inadvertently created an additional Volcker problem.

If a non-US fund is not scoped out of the definition of covered fund by virtue of being sponsored by a non-US bank, it will be very difficult for the fund to meet the foreign public fund exemption if it has any private offerings outside the US, which is often the case in Regulation S transactions.

The conditions for qualifying ABCP issuers will not be able to be satisfied by all ABCP issuers. The conditions include (a) all securities issued must have tenors of 397 days or less, (b) the issuer invests only in the same assets permissible for permitted loan securitizations and asset-backed securities acquired in an initial issuance from an issuer or underwriter, and (c) a regulated liquidity provider provides full and unconditional liquidity coverage with respect to all of the outstanding securities issued by the issuer.

As noted, a loan securitization excludes securities (e.g., bonds) unless obtained in a workout/restructuring. Most CLOs currently permit a minority portion of the underlying portfolio to be bonds (as this facilitates the CLO remaining invested within issuer/industry diversification and other operating parameters).

SFIG Advocacy

SFIG’s Volcker Taskforce will be evaluating the Volcker Rule and identifying areas that might require clarification or interpretive guidance. If you would like to join the taskforce, please contact SFIG at Sairah.Burki@sfindustry.org or Richard.Johns@sfindustry.org.
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