Tuesday, May 06, 2014

House Passes Bi-Partisan Legislation to Exclude Legacy CLO Debt Securities from Volcker Rule

The House  passed legislation clarifying that nothing in the Volcker Rule should be construed to require the divestiture, prior to July 21, 2017, of any debt securities of collateralized loan obligations (CLOs), if such debt securities were issued before January 31, 2014. The vote to pass was 4xx to. Introduced by Rep. Andy Barr (R-Ky.), the Restoring Proven Financing for American Employers Act, H.R. 4167, would amend the Volcker Rule to exclude certain debt securities of CLOs from the prohibition against acquiring or retaining an ownership interest in a hedge fund or private equity fund. The Senate companion bill is S. 1907.

Representative Barr, a key member of the House Financial Services Committee, said that the legacy debt securities of CLOs must be protected from the medicine that the Volcker Rule prescribes. In his view, this medicine would be far more damaging to the credit markets than the perceived illness of suffering losses from CLO paper. Congress must grandfather existing CLO investments, emphasized Rep. Barr.

The legislation would also clarify that a financial institution would not be considered to have an ownership interest in a CLO if there is no indicia of ownership other than the right of the firm to fire or remove for cause, or to participate in the selection or removal of, a general partner, managing member, member of the board of directors, investment manager, investment adviser, or commodity trading advisor of the fund, provided that the CLO is predominantly backed by loans.

H.R. 4167 provides that an investment manager or investment adviser must be deemed to be removed for cause if the investment manager or adviser is removed as a result of a breach of a material term of the management or advisory agreement or the agreement governing the CLO; the inability of the investment manager or adviser to continue to perform its contractual obligations or any other action or inaction by the investment manager or investment adviser that has or could reasonably be expected to have a materially adverse effect on the CLO, if the manager or adviser fails to cure or take reasonable steps to cure such effect within a reasonable time.

An amendment offered by Rep. Carolyn Maloney (D-N.Y.) during the mark up of H,R. 4167, and approved by voice vote, added, as a removal for cause, a removal for a comparable event that threatens or could reasonably be expected to threaten the interests of the holders of the debt securities.

In remarks on the House floor, Rep. Murphy noted that the legislation represents a truly bipartisan compromise that balances the goal of preserving a proven financing mechanism with concerns against watering down the Volcker Rule. The truth is, said Rep. Murphy, the Volcker Rule is not intended to capture debt. Debt is an everyday tool of plain vanilla financial institutions. The Volcker Rule is about equity ownership. Congress does not want banks owning hedge funds and private equity funds, but still wants lending. The legislation would provide narrow relief to existing CLO securities as long as they qualify as debt under the bill. For CLOs that are not debt securities under the bill, banks will get an additional two years to divest, which will prevent a disruptive fire sale of these securities. 

Rep. Patrick Murphy (D-FL)) added that the legislation also clarifies that the right to vote to remove a CLO manager in traditional, creditor-protective circumstances, such as a material breach of contract, does not, by itself, convert a debt security into an equity security under the Volcker Rule. (Cong. Record, Apr 29, 2014, pH3258).

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