The exemption—granted by the OCC, Federal Reserve, Federal Deposit Insurance Corp., Securities and Exchange Commission, and Commodity Futures Trading Commission—gives grandfathering protection to CDOs as long as they meet thresholds ensuring they are tied primarily to securities issued by banks with less than $15 billion in assets. As a so-called interim final rule, it will be implemented while the agencies also open a 30-day public-comment period.

Based on earlier objections from smaller banks, the American Bankers Association had sued to block implementation of the Volcker Rule. Salt Lake City-based Zions Bancorporation—a holder of such CDOs—said it could lose about $387 million under Volcker, a centerpiece of the 2010 Dodd-Frank Act's overhaul of U.S. financial regulation.

“Our initial review of today's action by the regulators suggests that the Interim Final Rule provides a broad exemption for banks holding trust preferred securities from the original Volcker Rule,” ABA president Frank Keating said in a statement. “The ABA will be conducting a more comprehensive review of the amended language and will announce a decision regarding the pending litigation on this issue tomorrow.”

Zions owned $1.2 billion of bank-issued TruPS CDOs as of Sept. 30, the most among all U.S. banks, according to analysts at Sterne Agee & Leach Inc. About 3 percent of U.S. banks held similar CDOs and a sudden sale by Zions could disrupt the market, Sterne Agee said.

CLOs Still Off-Limits

The regulators' exemption narrowly addresses CDOs, not the banking industry's related complaint that Volcker could also force losses on certain collateralized loan obligations (CLOs). Several industry groups, including the Financial Services Roundtable and Securities Industry and Financial Markets Association, have written letters to regulators warning of market disruptions if banks have to sell off CLO ownership interests.

Hedge funds have gravitated to the $41.2 billion market in these securities, which after losing most of their value in the 2008 crisis have returned to almost 40 cents on the dollar in some cases, according to prices from JPMorgan Chase & Co.

Lawmakers from both parties had objected to making small banks sell off the securities. Senators Joe Manchin, a West Virginia Democrat, and Roger Wicker, a Mississippi Republican, introduced a bill yesterday providing grandfathering protection for banks with less than $50 billion in assets. House Financial Services Committee Chairman Jeb Hensarling, a Texas Republican, introduced a similar bill with Representative Shelley Moore Capito, a West Virginia Republican.

Industry representatives will testify before the House Financial Services Committee tomorrow on the Volcker Rule's impact, concentrating much of their criticism on the CLO treatment, according to their prepared testimony.

“CLOs provide over $300 billion in financing to thousands of businesses,” said David C. Robertson, a partner at Treasury Strategies Inc., in testimony on behalf of the U.S. Chamber of Commerce. He argued that Volcker was too broad in defining ownership in CLOs that would be affected by the rule's limits.

“The regulators, acting without prior notice, far exceeded the requirements of the statute,” Robertson said. Banks could be forced to restructure $70 billion in CLO debt, he said, which could create a “rush to liquidate.”

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