Federal Reserve plans extensions for banks with interests in CLOs; LSTA seeks 'grandfather' rule

By Jennifer Chiou

New York, April 7 - The Federal Reserve Board 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 covered by the Dodd-Frank Act.

Section 619 of the Dodd-Frank Act, commonly referred to as the Volcker rule, generally prohibits insured depository institutions and any company affiliated with an insured depository institution from engaging in proprietary trading and from acquiring or retaining ownership interests in, sponsoring or having certain relationships with a hedge fund or private equity fund, according to a Fed release.

In response to this announcement, the Loan Syndications and Trading Association said that the extension will not solve the problem and that issuing a comprehensive rule making that would completely grandfather CLO notes issued prior to the publication of the final rule is needed.

"While the LSTA appreciates the Federal Reserve's efforts to mitigate the damage that the final rule implementing the Volcker Rule would cause to banks' holdings of CLO AAA and AA rated notes, a two-year extension of the conformance period does not solve the problem," Elliot Ganz, general counsel and executive vice president for LSTA, said in the LSTA reply.

"CLOs have performed extraordinarily well, and there have never been any credit losses on CLO AAA and AA notes - this is why U.S. banks hold $70 billion of AAA and AA rated CLO notes, and non-U.S. banks hold another estimated $60 billion.

"Nonetheless, the application of the Volcker rule to bank holdings of CLO AAA and AA rated notes would likely force banks sell CLO notes into a declining market and thus realize material losses," Ganz noted.

The Fed previously extended the conformance period for all activities and investments by one year to July 21, 2015.

The Fed release stated that 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.

The LSTA stated that it believes that the agencies have the authority and responsibility to prevent artificial losses by issuing a comprehensive rule making that would completely grandfather CLO notes issued prior to the publication of the final rule.

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