Middle-Market Public Policy Roundup

In this week’s roundup, we look at testimony from U.S. Treasury Secretary Steven Mnuchin, who appeared before the House Financial Services Committee last week to deliver an annual report on financial stability. The hearing addressed leveraged lending, an issue of particular importance to ACG members. The report Mnuchin delivered also contained information that highlighted the strong performance of the private equity industry, which we examine.

In addition, we also take a look at a member of Congress who was elected to the HFSC’s Subcommittee on Investor Protection, Entrepreneurship, and Capital Markets.

Covered Funds Definition Proposal Expected by Spring, Mnuchin Says

A proposal addressing the Volcker Rule provision barring banks from investing in private equity funds could be released by March 2020 or earlier, U.S. Treasury Secretary Steven Mnuchin told members of Congress last week.

Testifying before the House Financial Services Committee on Dec. 5, Mnuchin responded to questions about the Volcker Rule, including when he expects action on a proposal to modify the definition of “covered funds.” The Volcker Rule prohibits banks from investing in covered funds, which currently include private equity funds among other investment vehicles. Mnuchin, who also serves as chairman of the Financial Stability Oversight Council, said he hopes the definition will be revised over the next three to four months.

“A healthy banking system is critical to our economy and our banks have de-risked and built up significant amounts of capital,” Mnuchin said during the hearing. “The regulators have already made some proposed changes to the Volcker Rule that won’t create undue risk, but will create more liquidity in certain markets and we are working with them… on the covered fund issue.”

Financial regulators began accepting comments in July 2018 on a proposed rulemaking that would revise the Volcker Rule. In October 2018, ACG submitted a comment letter advocating for a modification of the current one-size-fits-all definition of a “covered fund” that has the effect of depriving banking entities from investing in private funds that are sponsored by middle-market firms. Although a final rule amending some Volcker Rule regulations was published in November 2019, the joint regulators indicated a proposal to modify the covered funds provision would be forthcoming.

The Volcker Rule was originally envisioned by former Federal Reserve Chairman Paul Volcker as a way to prevent banks from making speculative investments. It was included in the Dodd-Frank legislative package that Congress passed in 2010. Volcker died Monday at 92.

Lawmakers Challenge Mnuchin on Trump Financial Policy

Deregulation was also a topic of discussion at Mnuchin’s hearing. The chairwoman of the House Financial Services committee was among those who characterized changes to the Volcker Rule as part of a broader financial liberalization effort by the Trump administration.

“It appears that our banking regulators are following the deregulatory blueprint that the Treasury Department under Secretary Mnuchin’s leadership has mapped out point by point, and rolling back many of the critical reforms Democrats made to prevent another financial crisis,” said Rep. Maxine Waters, D-Calif. “If these rollbacks continue, there will be grave consequences for financial stability and our economy.”

Waters also pointed to budget and staff cuts at the Financial Stability Oversight Council, as well as reductions in the Office of Financial Research, a point made during previous hearings examining leveraged lending and systemic risk.

Rep. Bill Foster, D-Ill., echoed this concern, calling the reduction “shortsighted” and the impetus for the proposed Enhanced Financial Stability Research Oversight Act, which would restore the minimum funding levels for the council that were in place in 2017.

Later in the hearing, Reps. Carolyn Maloney, D-N.Y., Gregory Meeks, D-N.Y., and Alexandria Ocasio-Cortez, D-N.Y., raised the issue of the rising levels of leveraged lending, the connection to financial risk taking and the impact on financial stability. In response, Mnuchin said the FSOC is very focused on the leveraged lending market, although he does not believe leveraged lending poses a threat to banking or the insurance system.

Annual Financial Stability Report Highlights Strong Performance of the Private Equity Industry

Despite concerns over leveraged lending, private equity loan volume declined for the first time in years, according to an annual report published by the Financial Stability Oversight Council, even as assets continue to grow.

Loan volume generated by leveraged and non-leveraged buyouts from private equity funds across North America slowed to $126 billion in 2019 through September, a reduction of more than $100 billion from the same point a year before. It is the first time loan volume declined since 2015, data from S&P Leveraged Commentary and Data showed.

Even as loan volume declines, the value of assets under management by PE firms continues to rise. PE funds reached a record $3.2 trillion as reported by financial data company Preqin in 2018, the latest information available.

“The private equity industry continues to attract investor inflows, in part because the sector is viewed as an attractive alternative to hedge funds,” the report said.

The annual report, which is mandated by the Dodd-Frank Act, also cited a private equity index prepared by Preqin, which showed PE funds ended 2018 up 10.9% while returns for public companies listed on the S&P 500 declined during the same period.

PE funds also enjoyed high approval from investors; 90% of limited partners surveyed by Preqin said funds met or exceeded their expectations.

New Chair Appointed to House Capital Markets Subcommittee

Rep. Brad Sherman, D-Calif., was elected to serve as chairman of the House Financial Services Subcommittee on Investor Protection, Entrepreneurship and Capital Markets.

“My colleagues are already giving me good ideas for hearings and legislation,” Sherman said. “I am committed to defending investor protections, improving access to capital and maintaining the Wall Street reforms that have helped fuel our economy. As a CPA, I also look forward to looking at accounting issues.”

This subcommittee, which reviews laws and programs related to the U.S. capital markets and the securities industry and oversees the SEC and FINRA, is particularly impactful for middle-market private capital providers.