Banks will avoid a costly, forced divesture of assets after an “interim final rule” was approved by regulators on January 14, exempting certain collateralized debt obligations backed by trust-preferred securities (TruPS CDOs) from ownership restrictions imposed by the Volcker Rule.
The move comes after an American Bankers Association (ABA) lawsuit claimed that the restrictions placed on TruPS CDOs would result in $600 million in losses for nearly 300 smaller banks, who would be forced to divest the assets before they matured. TruPS CDOs are highly advantageous for banks with under $15 billion in assets, as under Dodd-Frank, they may continue to be treated as Tier 1 capital.
The grandfathering exemption is limited to CDOs that were established before May 19, 2010 and obtained by the banks prior to the adoption of the Volcker Rule on December 10, 2013. Further, only TruPS CDOs that consist primarily of securities issued by banks with less than $15 billion in assets are covered by the exemption. By focusing on the assets of the issuer and not the owner, however, the exemption will benefit larger banks as well. For example, Zions Bancorporation, which announced on December 16 that it expected to lose $387 million in a divesture of its TruPS CDOs, will meet the requirements of the exemption, despite having $55 billion in assets.
While the banking industry is pleased with the change regarding CDOs, it remains highly concerned about the remaining threat posed to Collateralized Loan Obligations (CLOs), which is a much larger market. The Volcker Rule equates the control that CLOs grant to creditors over the managing of assets with “ownership.” This broad definition of ownership has attracted sharp industry criticism and a push for its narrowing, likely in search of a workaround to the rule’s restrictions on proprietary trading.