Global credit funds & CLO's
February 2020
| Issue 220Published in London & New York.
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February 2020
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Issue 220News CLOs
CLOs in line to benefit with Volcker rewrite on the horizon
Reporter
Hugh Minch
The Volcker rule is set to get a shake-up and CLOs look likely to benefit, according to market sources. As Creditflux goes to press, a board of US regulators is expected to announce proposals to update the 2010 law.
The move could have broad implications for banks’ investments in CLOs if alterations to some of the definitions are approved. In perhaps the biggest U-turn, US CLOs might be able to invest in high yield bonds again.
Two sections of the Volcker rule — the prohibition of proprietary trading by US banks, and the ability of banks to hold an ‘ownership interest’ in a ‘covered fund’ — have been targeted for reform by the Trump administration.
The prop trading prohibition amendment was approved by the Federal Reserve in October. Now attention has shifted to the ban on banks’ ownership of covered funds, which is intended to prohibit equity positions in hedge funds, private equity funds and securitisations, including CLOs.
The definition of an ‘ownership interest’ is also said to be on the table when the board meets on 30 January. At present, a US bank cannot take the triple A portion of a CLO that holds bonds, as their voting rights to remove the collateral manager is defined as an ownership interest.
The Loan Syndication & Trading Association (LSTA) has been pushing for amendments to the Volcker rule from the early days of the legislation.
“We always thought that the regulators’ definition of ownership interest was wrong,” says the LSTA’s general counsel and chief of staff Elliot Ganz. “The ability to remove a manager is not an equity characteristic.”
US CLOs are not considered ‘covered funds’ under Volcker if they are ‘loan only securitisations’, a category carved out from the prohibition in 2013. While this has largely stopped US CLO managers from putting bonds in their portfolios, another threat to CLOs is looming: an ongoing lawsuit disputing whether term loan Bs are defined as securities. If loans are defined as securities they would be subject to ‘blue sky’ laws, and the ‘loan-only’ carveout under Volcker would cease to exist.
“Think of the following: a lawsuit comes along and concludes that term loan Bs are securities,” says Ganz. “The ‘loan securitisation’ exemption would no longer apply, CLOs would again become covered funds, and $90 billion CLO securities would again be ineligible under Volcker.”
The LSTA says a better definition of ownership interest is its priority when the regulators announce changes to Volcker. Constructive meetings with all five regulators have left it hopeful this will be approved.
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“We always thought that the regulators’ definition of ownership interest was wrong”
Elliot Ganz,
General counsel | LSTA
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