WASHINGTON – A joint regulatory agency proposal to roll back certain provisions of the Volcker Rule may be opening the door for future changes to reinstate the traditional tender option bond structure, which became illegal following rule’s effectiveness in July 2015, market sources said Wednesday.

The Securities and Exchange Commission voted 3-2 Tuesday to open a 60-day comment period on a proposal to ease the restrictions on proprietary trading in the Volcker Rule. The rule was named for former Federal Reserve Board Chairman Paul Volcker and was part of the Dodd-Frank Act reforms passed in 2010 after the financial crisis.

Most of the muni market was exempted by the Volcker Rule’s restrictions, but the rule’s definition of a “covered fund” captured TOBs and required alternative legal structures to be put in place.

Now, market sources say, it seems the SEC and bank regulators may be rethinking the approach even though the current proposal does not address the issue.

Michael Decker
Michael Decker, managing director and co-head of the municipal securities division at the Securities Industry and Financial Markets Association

“Regulators disrupted the market for tender option bonds with the adoption of the current Volcker Rule in 2014," said Michael Decker, managing director and co-head of SIFMA’s muni division. "It is encouraging that the Fed and other agencies raised the issue of TOBs and Volcker in their recent proposed amendments to the rule. SIFMA intends to provide input to the agencies on this issue during the comment period and we are hopeful that the final Volcker Rule amendments will address it.”

The Volcker Rule prevents banks and their affiliates from sponsoring a TOB program, owning a residual certificate issued by a TOB trust, or providing credit enhancement, liquidity, or remarketing services to these programs.

In a traditional TOB program, the “sponsor” will deposit a fixed-rate bond or note into a trust, which will then issue two new certificates — a floating rate certificate sold to a money market fund and a residual certificate which may be sold to a mutual fund or closed-end fund or held by a bank. The floating rate certificate will have a tender option, supported by a liquidity facility to cover the purchase price of the tender receipts not remarketed. That shortens the maturity of the bond or note so it that it becomes eligible for purchase by a tax-exempt money market fund.

In 2014 banks began to do Volcker-compliant deals with new structures, such as operating as a “joint venture” with other banks, which the rule permits as long as the group remains under 10 members.

The Securities Industry and Financial Markets Association kept up the pressure on regulators to exempt traditional TOBs from the definition of a covered fund, telling the Office of the Comptroller of the Currency late last year that “treating these TOBs and other similar financing vehicles as covered funds is inconsistent with the statute and ultimately results in higher financing costs for U.S. businesses.”

While the current proposal wouldn’t change anything for TOBs, it asks for feedback on what role banking entities play in TOBs and why they should be treated differently than other covered funds. It also asks how exemptions would address the challenges faced by banks sponsoring TOBs.

“Clearly, it’s an indication that TOBs are on the minds of the regulators,” said a market source who preferred not to be identified.

The SEC was the last regulatory agency to vote to move forward with the proposal, after the Federal Reserve, OCC, Commodity Futures Trading Commission, and Federal Deposit Insurance Corp.

SEC chairman Jay Clayton voted to open comment, and was joined by Republican commissioners Michael Piwowar and Hester Peirce. Democrats Kara Stein and Robert Jackson voted against it. Clayton pointed to the importance of the comment period.

“I strongly encourage all interested parties to comment on the many questions posed in the release,” Clayton said.

The regulatory agencies are expected to vote again following the comment period.

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