The change in administration that will take place on Jan. 20, 2021, will likely have significant consequences for leveraged lending market participants. The relatively "soft touch" regulatory approach taken by federal regulatory agencies toward leveraged lending under President Trump will be replaced by a more activist and potentially antagonistic approach under President Biden. While the brunt of this change will be borne, at least initially, by the federally regulated banks, nonbank leveraged lending institutions might experience a profound change in how they are regulated if the Democratic party gains control of the U.S. Senate.

Return of the Leveraged Lending Guidance

It is very likely that the 2013 Interagency Guidance on Leveraged Lending — which has been in legal limbo since the U.S. Government Accountability Office (GAO) determined in October 2017 that it was a rule and not guidance and therefore never lawfully adopted — will be resurrected in some form by the Biden administration. Because the Democrats will hold at least one house of Congress initially, it is unlikely that adoption of a leveraged lending rule would be invalidated by Congress under the Congressional Review Act. Accordingly, we expect that revived regulation of leveraged lending activities by regulated banks will take the form of a rule rather than guidance. Both Janet Yellen, Biden's announced choice for secretary of the Treasury, and Maxine Waters, chairwoman of the House Committee of Financial Services, have publicly supported reaffirming the 2013 Leveraged Lending Guidance. Chairwoman Waters has advocated for even stronger prudential regulation of leveraged lending.

Regulated Banks Sponsoring Debt Funds

On June 25, 2020, the federal financial regulatory agencies revised the Volcker Rule to allow regulated banks to sponsor debt funds. This change has been publicly criticized by Yellen and Chairwoman Waters as well. Yellen, commenting on this revision, stated on July 17, 2020, that: "My own view is it is a mistake to weaken core financial reform at a time when they're clearly putting their value in this financial crisis." Chairwoman Waters stated recently that this revision "gutted" the Volcker Rule. It is also noteworthy that Lael Brainard, a Biden favorite on the Board of Governors of the Federal Reserve, dissented from the adoption of this revision. It is likely that this revision to the Volcker Rule will be made more limited or reversed entirely by the Biden administration.

Regulation of Nonbank Leveraged Lending Institutions

Currently, nonbank financial institutions are subject to very limited, if any, regulatory restrictions on loans they may make. Subjecting nonbank financial institutions to prudential regulation by one or more federal financial agencies has long been an articulated goal of most who seek a more activist and aggressive regulatory posture toward the financial industry. Yellen recently stated that "We need to change the structure of the Financial Stability Oversight Council (FSOC) and build up its powers to be able to deal more effectively with all the problems that exist in the shadow banking sector. I think the structure is inherently flawed. I think the agencies need a definite financial stability mandate."

Under existing law, the fsoc cannot designate a nonbank financial institution for prudential regulation (absent a financial market utility or payment, clearing and settlement designation) unless it determines that such institution's nature, scope, size, scale, concentration, interconnectedness or mix of activities could pose a threat to the financial stability of the United States. By December 2014, the FSOC had so designated four nonbank financial institutions: American International Group Inc., General Electric Capital Corporation Inc., Prudential Financial Inc. and MetLife Inc. MetLife successfully sued in federal court to have its designation rescinded, and after that ruling, the FSOC rescinded the other three designations.

As a result of the high legal bar for FSOC designations, the GAO recommended in 2016 that Congress consider amending Dodd-Frank to expand the FSOC designation authority from an entity-specific authority to an activities-based authority. If such an amendment were to be approved, any entity engaging in leveraged lending, if leveraged lending were determined to potentially pose a threat to financial stability, could become subject to prudential regulation by the Board of Governors of the Federal Reserve. Through this mechanism, nonbank financial institutions could become subject to a new leveraged lending rule of the type discussed above (or other forms of regulation).

Since amending Dodd-Frank would require passage in the U.S. Senate, absent Democrat victories in both Senate runoff elections in Georgia, such a change in law would be very unlikely. However, if the Democrats gain control of the Senate, there is a realistic possibility such a law would be adopted and nonbank leveraged lending institutions would be designated for Federal Reserve Board regulation.

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