On January 30, 2020, five federal financial regulatory agencies published the long awaited notice of proposed rulemaking (the “NPR”) to revise certain aspects of the Volcker Rule (Section 13 of the Bank Holding Company Act) with respect to the treatment of covered funds. The NPR follows over 2 ½ years of the agencies’ consideration of changes to the Volcker Rule, which was originally prompted by the June 2017 Treasury Report that solicited changes to ease the compliance burden on banks. The NPR includes several changes that were requested by the structured finance industry as well as some other changes that likely will be positively received by banking entities subject to the Volcker Rule.

The NPR had both a number of welcome proposals and surprising omissions. On the positive side, for those entities relying on the loan securitization exemption under the Volcker Rule, the NPR added a 5% allowance to own non-complying assets, which could include corporate bonds or other non-loan assets. In addition, the NPR added a safe harbor carve-out to the definition of “ownership interest” under the Volcker Rule. The safe harbor would apply to certain senior loan or other senior debt interests that satisfy three tests. The safe harbor would provide greater clarity around certain debt interests that structured finance industry participants ordinarily would not consider to be an ownership interest.

As a surprise to many, the NPR ‘s proposed change to the prong in the definition of “ownership interest” regarding the ability to remove a collateral manager or similar entity does not make any effective change from the status quo under the existing regulation. The NPR proposes to clarify that the right to remove a collateral manager or similar entity for cause does not convert a debt instrument into an “ownership interest”, but only if such right is contingent upon the occurrence of an event of default or acceleration event. Although some initially hoped this was merely a drafting issue, unfortunately Question 78 in the NPR clarifies the negative intent of the agencies – the ability to remove a collateral manager without the occurrence of an event of default or an acceleration event would continue to be considered to be an “ownership interest”. In Question 79, the NPR also unhelpfully repeats the essence of Question 180 of the prior notice of proposed rulemaking on these topics, raising concern over an issue that the industry had previously considered to be resolved in practice – that is whether or not having the right to share in income, gains or profits of a covered fund constitutes an ownership interest. Also missing from the NPR is (1) the removal of the requirement that Exchange Act ABS must be issued in order for the loan securitization exemption to be available and (2) any comfort that operating leases and any underlying leased assets are permitted to be held by issuers relying on the loan securitization exemption (other than within the new 5% bucket for non-complying assets).

Comments to the NPR are due to the agencies by April 1, 2020. We expect finance industry participants like the SFA, LSTA and others to provide comments but the NPR demonstrates movement by the agencies in the right direction.