SIFMA, the Securities Industry and Financial Markets Association, have sent a comment letter to the Comptroller of the Currency, the Board of Governors of the Federal Reserve, the Federal Deposit Insurance Corporation (FDIC), the Securities and Exchange Commission (SEC), and the Commodity Futures Trading Commission (CFTC) regarding proposed rules for implementing Section 13 of the Bank Holding Company Act of 1956 (the Volcker Rule). This rule was added as part of Dodd-Frank and SIFMA have concerns about the way it could affect insurance-linked securities and other asset backed securities.
SIFMA highlights that the Volcker Rule contains the following provisions:
The Volcker Rule generally prohibits any “banking entity” from: (i) acquiring or retaining any “ownership interest” in or “sponsoring” a “hedge fund” or “private equity fund”; (ii) entering into Federal Reserve Act Section 23A “covered transactions” (including loans, guarantees or purchases of securities or assets) with any “hedge fund” or “private equity fund” for which it serves as sponsor, investment manager or investment adviser (a prohibition which we hereafter refer to as “Super 23A”) and (iii) engaging in “proprietary trading.”
The problem is that insurance-linked securities issuers rely on an exemption from the Investment Company Act of 1940, but under this Section 13 ILS issuers could be viewed as hedge funds or private equity funds merely by relying on such exemptions. This would prohibit banking entities from sponsoring or having ownership in these issuers (clearly a potential issue).
SIFMA also note:
In addition, Super 23A would prohibit a banking entity that serves as sponsor, investment manager or investment adviser of such an issuer from extending loans to, purchasing assets from or entering into other “covered transactions” with such issuer which, as further discussed below, would significantly limit, and in many cases prevent, banking entities from securitizing their assets.
It had been previously recommended that the Volcker Rule be more explicit in its definition of hedge fund and private equity fund so as to avoid any confusion about certain categories of ABS (and so ILS). However SIFMA says that the agencies involved in the rule making have chosen not to exclude ABS issuers from their definition of covered funds, some exemptions do exist but they are too narrowly constructed to include ILS issuers. SIFMA worry about the impact to global securitization markets if the definitions are not amended in the ruling.
SIFMA’s proposal is:
In order to prevent these consequences, we recommend that the Agencies modify the Proposed Rules as follows:
(i) Because ABS Issuers are not hedge funds or private equity funds, the Agencies should, as intended by the Securitization Exclusion, exclude such issuers from the Proposed Rules’ definition of “covered funds.”
(ii) Further, because we do not believe issuers of insurance-linked securities (“ILS Issuers”) were intended to be “covered funds” under the Volcker Rule, the Agencies should exclude ILS Issuers from such definition.
SIFMA believe that excluding insurance-linked security issuers from the definition of covered funds is essential to ensure the practical viability of ILS transactions. SIFMA also proposed an alternative, should the rule makers not agree with the above, but note that it would not be the perfect solution.
It’s good to see SIFMA taking the necessary steps to raise the profile of this potential issue. Rulings such as this are often missed by market participants and this is exactly why organisations like SIFMA exist. You can read their letter to the agencies in full here.
Artemis will be attending the SIFMA ILS event in New York next week. If you’d like to meet with us please get in touch.