In this series, we highlight a few of the regulatory considerations present in a typical CRT structured as a synthetic securitization. Parts one and two of this series discuss the primary legal considerations that may be encountered in doing a CRT in the United States, but such considerations may not apply to all structures, and a CRT may give rise to additional legal, regulatory and accounting considerations not discussed in this series. We continue our series with a look at issues that may arise under the Volcker Rule1 and US risk retention rules in connection with structuring CRTs in the United States.

Volcker Rule Implications

If a CRT is structured to use a special purpose entity (SPE) that issues securities, the SPE will need an exemption or exclusion from registration under the Investment Company Act of 1940, as amended (ICA). One potential avenue is reliance on the exclusion provided by Section 3(c)(7) of the ICA, which is available for any issuer, the outstanding securities of which are owned exclusively by persons who, at the time of acquisition of such securities, are qualified purchasers (i.e., investors that meet certain thresholds for the holding of investment securities), and which is not making and does not at that time propose to make a public offering of such securities.

However, reliance on the exclusion provided by Section 3(c)(7) of the ICA can raise other structuring considerations under the Volcker Rule. The Volcker Rule defines a covered fund as including (i) an issuer that would be an investment company, as defined in the ICA, but for reliance on Section 3(c)(1) or 3(c)(7) of the ICA; and (ii) a commodity pool under Section 1a(10) of the Commodity Exchange Act (CEA) for which the commodity pool operator has claimed an exemption under 17 CFR 4.7 or is registered as a commodity pool operator in connection with the operation of a certain type of commodity pool.2

Why might those structuring a CRT need to consider whether the SPE is a covered fund? First, the Volcker Rule prohibits banking entities from engaging in certain transactions with covered funds, including acquiring or retaining any "ownership interest" in the covered fund as principal.3 If investors in a CRT will include banking entities subject to the Volcker Rule and a transaction makes use of an SPE that is a covered fund, it will be necessary to consider whether the terms of the instrument are such that the investors might be considered to have an ownership interest in the SPE. Banking entities are also generally prohibited from "sponsoring"4 covered funds absent an exemption, and Section 13(f) of the Volcker Rule (often referred to as Super 23A), generally prohibits a banking entity, directly or indirectly, from entering into a "covered transaction,"5 as defined under Section 23A of the Federal Reserve Act, with a covered fund for which the banking entity or any affiliate acts as sponsor, investment manager, or investment adviser. Therefore, a banking entity that enters into a CRT that makes use of an SPE that is a covered fund, needs to consider whether its relationship with such SPE could make it a "sponsor" of the covered fund or give rise to a "covered transaction" covered by Super 23A.

Footnotes

1 Section 13 of the Bank Holding Company Act of 1956.

2 12 CFR 248.10(b)(1).

3 12 CFR 248.10(b)(1).

4 A "sponsor" would include an entity that:

  1. Acts as a general partner, managing member, trustee of a covered fund (or serves a CPO of a pool that is a covered fund due to its commodity pool status);
  2. In any manner selects or controls a majority of the directors, trustees, or management of a covered fund (including having employees, officers, directors or agents who constitute that majority); or
  3. Shares the same name, or a variation of the same name, with a covered fund for corporate, marketing, or other purposes. 12 CFR 248.10(d)(9).

Shares the same name, or a variation of the same name, with a covered fund for corporate, marketing, or other purposes. 12 CFR 248.10(d)(9).

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