Volcker Rule: Agencies Issue Interim Final Rule Exempting Certain TruPS-Backed CDOs from the Volcker Rule’s Prohibition on Banking Entities’ Holding Ownership Interests in or Sponsoring Covered Funds

Sullivan & Cromwell LLP - January 14, 2014

Earlier this evening, the Board of Governors of the Federal Reserve System, Office of the Comptroller of the Currency (the “OCC”), Federal Deposit Insurance Corporation (such three agencies together, the “Banking Agencies”), Securities and Exchange Commission, and Commodity Futures Trading Commission (the “CFTC” and, collectively, the “Agencies”) issued an interim final rule (the “Interim Final Rule”) regarding the treatment of certain collateralized debt obligations backed by trust preferred securities (“TruPS-backed CDOs”) under the final rule (the “Final Rule”) implementing Section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), commonly known as the “Volcker Rule.” The Volcker Rule imposes broad restrictions on proprietary trading and investing in and sponsoring private equity and hedge funds (“covered funds”) by banking organizations and their affiliates.

The Interim Final Rule—which does not technically amend the Final Rule but will operate as a “companion rule” to the Final Rule—specifies that the Volcker Rule’s covered fund restrictions do not apply to the ownership by a banking entity of an interest in, or sponsorship of, any issuer of TruPS-backed CDOs if three conditions are met. The Interim Final Rule is open for public comment on all aspects, and specifically whether the Interim Final Rule is consistent with the purposes of the Volcker Rule and Section 171 of the Dodd-Frank Act (the so-called “Collins Amendment”). Comments on the Interim Final Rule are due on or before 30 days after publication of the Interim Final Rule in the Federal Register.

Contemporaneously with the Agencies’ release of the Interim Final Rule, the Banking Agencies issued a non-exclusive list of issuers of TruPS-backed CDOs that meet the requirements of the Interim Final Rule. The Interim Final Rule provides that a banking entity “may rely” on this list.

The Interim Final Rule should provide welcome relief for the holders of TruPS-backed CDOs that qualify for the exemption. It should be noted, however, that the Interim Final Rule may not exempt all TruPS-backed CDOs and does not provide any guidance on how the term “ownership interest” in the Final Rule is to be construed as applied to other securities that are structurally similar to TruPS CDOs—for example, debt securities of collateralized loan obligations (CLOs). Even with respect to those TruPS-backed CDOs that are exempt under the Interim Final Rule, banking organizations may need to act quickly—and in advance of pending deadlines for reporting of 2013 financial results—to establish and document with their accountants that their holdings comply with the Interim Final Rule’s requirements at a confidence level that will support non-write-down of those holdings under applicable auditing standards.