September 21, 2017 - At ABS East this week, the LSTA (Meredith Coffey), SFIG (Sairah Burki), CREFC (Mike Flood) and NAIC (Eric Kolchinsky) got together to discuss regulation and the securitization markets, with a particular focus on what (and how) sensible FinReg reforms may materialize. We discuss the takeaways below.
First, the panel discussed where not to look – i.e., Congress. As has been demonstrated by 2017’s record of legislative achievements, Congress is struggling to pass regular-order legislation, let alone regulatory right-sizing. Furthermore, recent events such data breaches at financial firms only make it harder to get to constructive FinReg reform. And next year brings the mid-term elections. Republicans will want to show some legislative wins (see related QCLO article), with a concentrated effort on tax reform and potentially another run at healthcare reform. However, Democratic resistance may stiffen the closer we get to November 2018. Importantly, look for Congressional Republicans to support the Administration’s efforts for regulatory reform, such as the Treasury report.
And so, with a Congressional approach challenging, focus has turned to the Administration and the Regulatory Agencies themselves. In February, President Trump issued an Executive Order on Core Principles for Regulating the U.S. Financial System. In it, he stated that regulation should be efficient, effective and appropriately tailored. He also required Treasury to prepare reports i) analyzing whether financial regulations promote the Core Principles and ii) identifying those that inhibit regulation in a manner consistent with the Core Principles. After new heads are installed at the financial regulators, they are expected to turn to the Treasury Reports as they think about refining regulation.
The first Treasury report was released in June and recommended reopening Leveraged Lending Guidance and the Volcker Rule. And, in fact, the OCC already has sought comment on Volcker. As background, the Volcker Rule prohibits bank ownership of “covered funds” – e.g., hedge funds or PE funds. Sadly, the definition of covered funds became so broad that many securitizations were unnecessarily captured. SFIG, CREFC and the LSTA all responded to the OCC, suggesting that the definition of a covered fund be narrowed to what Congress intended: hedge funds and PE Funds. In addition, the LSTA also recommended that the definition of “ownership interests” of a covered fund be narrowed to actually reflect ownership. Right now, all tranches of a CLO are, in effect, deemed to be ownership interests. If we are successful, CLOs ultimately should be able to have small bond baskets to improve diversification.
The next Treasury report, expected in October, will cover capital markets. Specific topics should include risk retention, disclosure requirements, and regulation’s impact on capital and liquidity. SFIG has noted that a number of final or pending rules – such as High Quality Liquid Assets (HQLA), the Fundamental Review of the Trading Book (FRTB) and Basel Securitization Framework – penalize securitizations relative to other types of financing, thereby reducing market liquidity and increasing costs to borrowers. CREFC would like to see the regulators clear up interpretive issues with the final High Volatility Commercial Real Estate final rule. And, on the risk retention side, the LSTA would like to see a form of retention that is more closely tailored to the different securitization markets.
The panel also flagged several areas not directly related to the upcoming Treasury reports. First was LIBOR, an issue driving many incoming calls from our members. In response, SFIG, CREFC and the LSTA are having a Joint Trades LIBOR Symposium on October 3, 2017, which will cover i) macro perspectives across the securitization industry and ii) a roundtable discussion of industry participants’ views on the impact a LIBOR transition could have in the securitization markets. Finally, next week should see the introduction of tax reform. While no one knows exactly what will be in the proposal, there are some options – such as the reduction or end of interest deductibility – that concern industries that rely on debt.