Changes to Volcker Rule offer limited relief for structured finance transactions

Key takeaways:
  • Five U.S. federal financial regulators (the “Agencies”) recently adopted a final rule (the “Final Rule”) that makes a number of amendments to regulations (the “Existing Regulations”) implementing Section 13 of the Bank Holding Company Act of 1956, commonly known as the “Volcker Rule.” These changes give financial institutions involved in structured finance transactions some relief with respect to special purpose vehicles (“SPVs”) from the Volcker Rule’s prohibition on the sponsorship and investment in certain types of fund vehicles (“Covered Funds”), although they may not go as far as some in the industry had hoped.
  • The Final Rule modifies the Existing Regulations’ loan securitization exception (the “LSE”) to permit an SPV to hold up to 5% of its assets in bonds, which will permit such SPVs to maintain a “bond bucket” in a manner consistent with industry practice.
  • The Final Rule’s introduction of an exception for customer facilitation vehicles ("Facilitation Vehicles”) may also be helpful for certain types of structured finance transactions that establish an SPV to expose a single customer to a particular asset.
  • The Final Rule also modifies the “Super 23A” (as defined below) prohibition to permit banks to enter into swaps with SPVs that they sponsor, and it will allow banks to hold senior loans or debt securities in an SPV, even if they also have certain voting rights.

On June 25, 2020, the Agencies adopted the Final Rule, which modifies many of the Volcker Rule’s requirements with respect to the Volcker Rule’s prohibition on the sponsorship of and investment in Covered Funds, including many SPVs used in securitization, repackaging and other structured finance transactions.

The Volcker Rule applies to any U.S. bank, U.S. bank holding company or non-U.S. bank that has a U.S. branch, agency or bank subsidiary, along with all of their affiliates around the world (collectively, “Banking Entities”). The Existing Regulations generally prohibit a Banking Entity from “sponsoring,” or investing in certain equity and equity-like securities (“Ownership Interests”) issued by a Covered Fund. Under the “Super 23A” prohibition, the Volcker Rule also prohibits a Banking Entity from entering into certain transactions with Covered Funds that the Banking Entity either sponsors or to which it provides investment advice or management services.

The Volcker Rule has had a significant impact on many aspects of structured finance transactions. Traditionally, SPVs have often used Sections 3(c)(1) or (7) of the Investment Company Act of 1940 to avoid registration with the SEC, which brings them within the Covered Fund definition. Because of the significant restrictions imposed by the Volcker Rule, many banks have modified their approach to structured product transactions to avoid Covered Fund status, which has limited the flexibility that SPVs have.

The Existing Regulations generally do little to account for the differences between traditional asset management and structured finance other than their inclusion of the LSE, which was mandated by Congress. The Final Rule largely follows the path of the Existing Regulations in that respect, and reflects relatively few modifications to the Agencies’ proposal released in January (the “Proposed Rule”).

Our analysis highlights the Final Rule’s changes relevant to the structured finance industry. The Final Rule goes into effect on October 1, 2020.

Read our full analysis here.