It’s been a busy Christmas and New Year’s season for US regulators. After three years of work, the Federal Reserve Board announced in mid-December that five federal agencies have issued final rules to implement section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Volcker Rule”), which is intended to limit proprietary trading by banks. But their job was hardly done.
US regulators came back to work after the holiday to find that portions of the final version of the Volcker Rule have been challenged in a lawsuit over claims that requiring small banks to divest their holdings in certain collateralized debt obligations known as trust-preferred securities or TruPs C.D.O.s will cause 275 small banks about $600 million in losses and impact their ability to lend to consumers and businesses.
The American Bankers Association, an industry lobby that represents several community banks, objects to the portion of the rule that will force banks to sell TruPs C.D.O.s, and has filed a complaint before the U.S. Court of Appeals for the District of Columbia Circuit seeking a court order blocking the rule from taking effect before the end of the year (source: New York Times). The group claims that the regulators did not properly analyze the economic cost of this portion of the rule on small community banks and the impact on their capital levels.
Then, on 14 January 2014, the regulators released a final interim rule to permit banks to retain interests in TruPs C.D.O.s under the following conditions:
- The TruPs C.D.O. must have been established and the interest issued prior to 19 May 2010;
- The bank must have acquired its interest in the TruPs C.D.O. on or before 10 December 2013; and
- The bank must reasonably believe that the offering proceeds of the TruPs C.D.O. were invested primarily in Qualifying TruPs Collateral which is defined as any trust preferred security or subordinated debt instrument that was issued prior to 19 May 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
- a mutual holding company.
In order to reduce the burden of determining if a particular TruPs C.D.O. satisfies the requirements of the interim final rule, the banking regulators have issued a non-exhaustive list of qualifying TruPs C.D.O.s.
The interim final rule becomes effective on 1 April 2014. The regulators also solicited comments on whether the interim final rule is consistent with the Volcker Rule and the portion of Dodd Frank governing TruPs C.D.O.s treatment with respect to bank regulatory capital. Comments are due 30 days after the interim final rule is published in the Federal Register (which should be in the next few days).
This is considered a ‘win’ for the market in the prolonged Volcker Rule saga. It remains to be seen whether the regulators will also ‘yield’ to similar requests made by the market with regard to non exempt securities and other flaws of the Volcker Rule identified by industry lobbies.
One unintended consequence down, how many more to go?