LSTA executive says CLOs may face upheaval under Volcker Rule

By Jennifer Chiou

New York, Jan. 15 - The executive vice president and general counsel of the Loan Syndications and Trading Association testified that the definition of "ownership interest" in the final Volcker Rule will have significant unintended consequences on the collateralized loan obligation market, according to an LSTA release.

Elliot Ganz testified before the House Financial Services Committee that these consequences would result in material and arbitrary losses to American banks and negatively impact credit availability for American businesses, the release stated.

Earlier in the month, the association submitted a letter to federal regulatory agencies asking them to confirm that CLO debt securities that have the right to replace a manager for cause should not be considered "ownership interests" under the rule.

As previously reported, the Federal Reserve Board, the Federal Deposit Insurance Corp., the Office of the Comptroller of the Currency and the Securities and Exchange Commission were reviewing whether it would be appropriate and consistent with the Dodd-Frank Act to forgo subjecting collateralized debt obligations backed by trust preferred securities to the investment prohibitions under the Volcker Rule, which is under section 619 of Dodd-Frank.

Under the agencies' ruling, banking entities were permitted to retain interests in certain collateralized debt obligations backed primarily by trust preferred securities.

During the hearing, Ganz explained that the final Volcker Rule effectively "converts" CLO debt securities into the equivalent of equity securities, thereby making them ineligible to be held by banks, the LSTA release noted.

Without clarification on the first "indicia of ownership," Ganz said that banks would be forced to divest or restructure these notes over the next year and a half, possibly at a significant loss.

Ganz said that if banks are simultaneously forced to sell, the impact of this rule would be felt almost immediately in the downward pressure on CLO prices.

"The issues facing holders of CDO TruPS are nearly identical to those faced by holders of CLO notes," LSTA executive director Bram Smith said in a prior press release.

"Neither asset class should be considered as having ownership interest."

According to that release, the LSTA, the Securities Industry and Financial Markets Association, the Structured Finance Industry Group and the Financial Services Roundtable sent the follow-up letter to review CLOs because they have many of the same characteristics as the CDOs of trust preferreds.

"We are disappointed that the agencies have addressed the issue of CDOs of TruPs while not yet addressing the important concerns relating to CLO notes," Ganz said on Wednesday.

"We are hopeful that the agencies will quickly take up our request that they confirm in guidance that the ability of holder of highly rated AAA and AA rated debt securities to remove or replace a manager 'for cause' does not constitute an ownership interest."

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