Draft CLO Indenture Amendment Helps "Volckerize" CLOs | Practical Law

Draft CLO Indenture Amendment Helps "Volckerize" CLOs | Practical Law

A banking group has released a draft template CLO indenture supplement that may be used to remove securities baskets from existing CLOs so that they may continue to be held by national banks in compliance with the Volcker Rule.

Draft CLO Indenture Amendment Helps "Volckerize" CLOs

Practical Law Legal Update 2-571-2569 (Approx. 3 pages)

Draft CLO Indenture Amendment Helps "Volckerize" CLOs

by Practical Law Finance
Published on 19 Jun 2014 • USA (National/Federal)
A banking group has released a draft template CLO indenture supplement that may be used to remove securities baskets from existing CLOs so that they may continue to be held by national banks in compliance with the Volcker Rule.
As announced by the LSTA on June 13, 2014, a group of banks working with the Clearing House, a large-bank trade association, have released a draft template CLO indenture amendment that is designed to remove securities baskets from existing collateralized loan obligations (CLOs) to render them compliant with Section 619 of the Dodd-Frank Act (the Volcker Rule). Many existing CLOs (legacy CLOs) include a small basket of equity securities in the collateralized asset pool, which makes it impermissible for national banks to hold them under the Volcker Rule, beginning on July 21, 2017.
The Volcker Rule prohibits national banks from engaging in short-term proprietary trading and from having certain interests in or relationships with hedge funds or private equity funds. As has been well documented, this prohibition captures CLOs that fail to meet certain specifications under the rule. Existing CLOs were not exempted from this prohibition and, despite widespread pushback from the banking industry, it appears federal regulators do not intend to modify this prohibition or grandfather existing CLOs from the Volcker Rule's application. In an effort to avoid divesting these CLOs, banks have begun to restructure them to be Volcker compliant.
One of the primary characteristics of a CLO that triggers Volcker Rule application is when the securitized asset pool that collateralizes the transaction (in a CLO, mostly commercial loans) includes a basket of prohibited equity securities. While bank-ownership limitations on legacy CLOs that the bank has held since December 31, 2013 do not become effective until July 21, 2017, national banks have wasted no time in both structuring new Volcker-compliant CLOs and restructuring their legacy CLOs to exclude impermissible security baskets, sometimes referred to as "Volckerizing" the CLO (banks must otherwise generally become compliant with the Volcker Rule by July 21, 2015). According to the LSTA, at least eight CLOs have been refinanced this year, most of which are believed to have had their securities baskets removed to achieve compliance with the Volcker Rule.
The draft template includes, among other things, provisions that:
  • Modify the definition of eligible investments under the CLO indenture to exclude:
    • impermissible securities; and
    • securities that are held for a period of time shorter than 60 days, as prohibited under the Volcker Rule.
  • Describe a permitted securities condition, which allows the CLO to hold securities that may be otherwise excluded under the draft template if counsel of a national reputation offers an opinion that the securities are permissible under the Volcker Rule.
  • Prohibit hedging positions unless the permitted securities condition is met with respect to the hedging position or other analogous conditions are met to render the hedging position permissible under the Volcker Rule.
The template may of course be modified or added to by market participants, as needed.