Volcker Rule Agencies Issue Interim Final Rule Exempting TruPS-backed CDOs

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Last week, the five agencies that jointly issued the final regulation implementing the Volcker Rule (the Final Rule) in December issued an interim final rule (the Interim Rule) that exempts collateralized debt obligations backed by trust-preferred securities, also known as TruPS CDOs, from the Final Rule’s broad restrictions.

As noted in a previous alert, inclusion of these securities within the coverage of the Final Rule led to a petition for judicial review filed by some banks and the American Bankers Association (ABA). While the Interim Rule will provide relief to smaller banking entities that qualify for the exemption, it is narrowly drawn and will not cover all similarly situated institutions.

The agencies that promulgated the Volcker Rule (collectively, the Agencies) are the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation (FDIC), the Office of the Comptroller of the Currency (OCC), the Commodity Futures Trading Commission (CFTC), and the Securities and Exchange Commission. Though only the three bank regulators (OCC, the Federal Reserve, and FDIC) were named respondents in the litigation, the two market regulators (SEC and CFTC) also participated in this effort to resolve the dispute.

The petitioners in the litigation assert that TruPS CDOs are debt securities, whereas the Volcker Rule, enacted by Section 619 of the Dodd-Frank legislation, is targeted only at equity investments. Another provision of Dodd-Frank, Section 171 (commonly referred to as the Collins Amendment), grandfathered, for purposes of regulatory capital, TruPS CDOs issued before May 19, 2010, by holding companies with $15 billion or less in total consolidated assets.

The Agencies are attempting to reconcile Volcker Rule interests with those of the Collins Amendment. The Interim Rule does not formally amend the Final Rule but co-exists as a separate but complementary regulation. It provides that the covered fund restrictions of the Final Rule are inapplicable to a banking entity’s owning an interest in, or sponsoring, any issuer of TruPS CDOs provided three conditions are met:

  • The issuer was established, and the interest was issued, before the Collins Amendment grandfathering date, May 19, 2010.
  • The banking entity reasonably believes that the offering proceeds received by the issuer were “invested primarily” in “Qualifying TruPS Collateral.”
  • The banking entity acquired the interest on or before December 10, 2013 (the date the Final Rule was issued), or acquired the interest in the course of a merger with or acquisition of a banking entity that itself acquired the interest on or before that date.

Regarding the second condition, according to the Agencies, the term “invested primarily” focuses on securitizations where a majority of the offering proceeds were invested in “Qualifying TruPS Collateral.” Such collateral is defined as “any trust preferred security or subordinated debt instrument issued prior to May 19, 2010 by a depository institution holding company that, as of the end of any reporting period within 12 months immediately preceding the issuance of such trust preferred security or subordinated debt instrument, had total consolidated assets of less than [$15 billion] or issued prior to May 19, 2010 by a mutual holding company.”

According to the Agencies, the exemption is targeted only at issuers formed primarily for the purpose of investing primarily in “Qualifying TruPS Collateral.” The exemption will not, however, cover obligations that display some similarities with TruPS CDOs, such as debt securities of collateralized loan obligations.

Following issuance of the Interim Rule, the ABA announced that it was dropping its request for emergency judicial relief but will maintain the litigation, at least for now, while the association consults with its membership on the “impact and implications” of the Interim Rule.

The Interim Rule is open for comment. Some issues worthy of comment are:

  • Whether the exemption should be enlarged to cover issuers that were not formed (primarily or otherwise) for the purpose of “investing primarily” in “Qualifying TruPS Collateral”
  • Whether the Interim Rule is fully consistent with both the Volcker Rule and the Collins Amendment