“Despite a White House veto threat, House lawmakers on Wednesday approved a package of 11 measures, including provisions seeking to encourage initial public offerings, and providing large and mid-sized financial institutions holding private equity-related debt some relief from the Volcker Rule.
“The legislation passed 271 to 154.
The package’s most controversial provision seeks to delay by two years until July 2019 a requirement that big and mid-sized banks divest or pay-down a large swath of their $85 billion worth of so-called Collateralized Loan Obligations, investments that includes loans that are made to businesses that are not considered investment grade. The bill comes after the Federal Reserve in April already provided the businesses a two-year extension of their 2015 CLO divestiture deadline until July, 2017.
“However, critics argue that CLOs can be made up both of loans and other riskier assets such as sovereign debt, structured derivatives and credit default swaps. Better Markets, a consumer advocacy, has argued that CLOs are often composed of debt that companies incur after being taken over by a private equity firm.
“And while smaller banks may have trouble with CLO divestitures, big banks own the majority. SNL Financial LC reports that as of Sept. 30 four big banks, JPMorgan Chase & Co. (JPM), Wells Fargo & Co. (WFC), Citigroup Inc. (C) and State Street (STT) control roughly 82% of the CLO securities held by the U.S. banking industry. SNL also reported that JPMorgan had the biggest CLO balance of $30 billion, or 40% of U.S. bank-held CLOs.
“Zachary Schechter-Steinberg, an external affairs specialist at Better Markets, noted that companies acquired by private equity firms issue debt that is often packaged together into a CLO that is sold to a financial institution. “Banks use the huge loans that finance private equity takeovers and structure them into CLOs,” he said.
“CLOs comprised entirely of loans are excluded from the Volcker rule divestiture requirement and are permitted to stay on the books of banks, while CLOs made up of a mixture of loans and other assets aren’t. It is unclear how much of the $85 billion in CLOs includes packaged loans and other assets.
“Schechter-Steinberg added that bank investments in CLOs may violate the law’s ban on proprietary trading and that the details of what makes up the investments are private raising concerns about whether they could become a vehicle for high-risk taking in a post-Volcker Rule environment. The Volcker Rule seeks to prohibit speculative trading by big banks however Steinberg suggests that CLOs could become an avenue for those kinds of risky investments.
“Our concern would be in a post-Volcker world with a ban on proprietary trading, these products may provide opportunities for banks to make risky, prohibited bets,” he said.”
Read the full The Deal article by Ronald Orol here.