Banking Regulators Issue FAQ Regarding TruPS CDOs Under Final Volcker Rule
Banking regulators issued an FAQ on December 19 regarding banking entities' interests in collateralized debt obligations (CDO) backed by trust preferred securities (TruPS) that meet the definition of ownership interests in covered funds as noted in section 619 of the Dodd Frank Wall Street Reform and Consumer Protection Act (Volcker Rule).
Covered Funds Definition
Banking entities have expressed concern over the Volcker Rule that "covered funds" must be divested by July 21, 2015. Many banking entities have argued that TruPS CDO investments meet the definition of "covered funds" and ownership interest under the Volcker rule. The FAQ addresses the question of covered funds and ownership interest for TruPS CDOs.
Investment Company Act Exclusions
The first question to consider is if the TruPS CDO is a covered fund which generally is defined by reference to sections 3(c)(1) or 3(c)(7) of the Investment Company Act (the Act) of 1940. Sections 3(c)(1) and 3(c)(7) of the Act are exclusions from the definition of an investment company. The FAQ noted that "the Final Rules provide that an entity that could rely on any exclusion or exemption from the definition of "investment company" under the Act other than the exclusions contained in section 3(c)(1) or 3(c)(7) of the Act would not be considered a Covered Fund so long as it satisfies the conditions of another exclusion or exemption of the Act."
If the TruPS CDO is relying on the exclusions in section 3(c)(1) or 3(c)(7) of the Act, then it would be excluded from a covered fund and the TruPS CDO would not need to be divested if it also satisfies the conditions of another exclusion of the Act.
Restructure of TruPS CDO During Conformance Period
The FAQ goes on to say that if a TruPS CDO in its current form meets a covered fund, the banking entity may restructure the TruPS CDO in order to not be a covered fund during the conformance period and then the divestiture would not be required by July 21, 2015.
Ownership Interest Considerations
After the consideration of whether the TruPS CDO meets the definition of a covered fund, an evaluation should be completed to determine if an ownership interest exists. The FAQ notes that a banking entity should consider whether they have the ability to remove the TruPS CDO's directors or investment advisors, if they have rights to receive a share of income and losses, rights to the underlying assets, rights to receive a spread, rate of return tied to performance of the TruPS CDO or whether the TruPS CDO may be reduced based on losses in the TruPS CDO. If no ownership interest exists, then the TruPS CDO investment would not have to be divested under the Volcker Rule.
Treatment of TruPS CDO Investment Losses
Under the Volcker Rule, banking entities will need to treat fair value losses on covered TruPS CDO investments as realized losses. This would include both credit and non-credit losses and most banking entities will need to consider this for their December 31, 2013 financial statements and call reports.
The FAQ is available on the FDIC website included on the FDIC Press Releases at http://www.fdic.gov/news/news/press/2013/pr13123.html.
For assistance in determining the application of the requirements to your bank or questions related to implementation dates, please contact a local Eide Bailly professional.
