Volcker Rule carveout to exclude some CLOs from ownership limitations

By Angela McDaniels

Tacoma, Wash., Dec. 10 - Collateralized loan obligations that do not hold assets other than loans, short-term cash equivalents and related derivatives have been completely carved out of the definition of "covered fund" under the Volcker Rule, according to the Loan Syndications and Trading Association.

LSTA said this means that a "loan securitization" is not subject to the ownership or transaction limitations of the Volcker Rule and, thus, warehousing and market making in their assets and liabilities would be permitted.

On Tuesday, the Federal Reserve, the Securities and Exchange Commission, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corp. and the U.S. Commodity Future Trading Commission released final rules implementing the Volcker Rule.

According to the LSTA, most of its recommendations on the Volcker Rule have been adopted.

In addition to the carveout mentioned above, LSTA listed the following impacts of the final rules on loans and, more specifically, CLOs:

• Loans are excluded from the ban on proprietary trading. This exclusion includes bridge loan notes and previously contracted securities; and

• In addition, the definition of "loan securitization" does not allow for vehicles to have any investments in securities, including bonds and CLO notes, for which most current CLOs have baskets. Furthermore, there is no grandfathering for existing CLOs, so to the extent that a CLO does not meet the definition of "loan securitization," it would be a "covered fund" and subject to the ownership and transaction prohibitions.

The Volcker Rule is a part of the Dodd-Frank Act and was designed to prohibit banks from engaging in proprietary trading and owning or engaging in certain transactions with hedge funds or private equity funds.

LSTA said the original proposed rules extended the ownership and transaction ban to collateralized loan obligations and other asset-backed securities, the effects of which would have been to prohibit most warehouse financing and market making by banks that structure and underwrite CLOs.

The Volcker Rule is effective April 1, 2014, but the Fed announced it will delay the end of the conformance period by one year until July 21, 2015. LSTA said this means that banks would have until July 21, 2015 to divest their holdings in CLOs that do not meet the requirements of a "loan securitization."

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