Volcker Underwriting RENTD: It’s Simple … No Need To Overanalyze by PWC
As banks face the July 21, 2015 deadline for proving their trading desk exemptions from the Volcker Rule, they have been focused on estimating the reasonably expected near term demand of customers (“RENTD”) under the market making exemption.1 However, trading desks intending to take the underwriting exemption (“underwriting desks”) must also estimate RENTD, which is defined differently for underwriting and in our view poses fewer implementation challenges.
Underwriting RENTD is the anticipated market demand for an underwritten deal’s securities (estimated as a monetary range). The Volcker Rule requires underwriting desks to take RENTD into account when setting three limits intended to prevent proprietary trading: the size of a desk’s underwriting positions, the length of time residual positions can be held,2 and the risks arising from certain underwriting support activities. These three limits will have to be justified to regulators and be regularly monitored by the bank.
If implemented strategically, estimating RENTD and setting these limits should be fairly straightforward and doable. Given the reputational risk from failed underwriting deals and existing regulations that govern securities offerings, most banks already have (and should use) policies and procedures that are already in place. These processes effectively estimate RENTD and set limits for underwriting deals that are similar to the three limits required by the Volcker Rule.
Furthermore, existing criterion for successful underwriting (i.e., that a desk place 100% of underwritten securities into the market and avoid retaining a residual position) naturally helps preclude an underwriting desk from engaging in proprietary trading.
This Regulatory brief explains (a) underwriting RENTD and RENTD-based limits, (b) considerations for setting those limits, and (c) our view of where banks are in their implementation efforts and where they should be.
What is underwriting RENTD?
Underwriting RENTD is an estimate of market demand for the securities of an underwritten deal based on historical (and current) deal and market information. Factors used to calculate underwriting RENTD are generally the same factors that have been considered by underwriters to decide whether to take on an underwriting commitment and how to price it, including:
- Market liquidity, depth, and maturity
- Transaction pipeline for similar deal or asset types
- Previous deals and similar offerings
- Historic and current trends in deal participation
- Book building activities (e.g., marketing)
- Clients’ investment appetites
Therefore, underwriting RENTD can be estimated largely based on these factors, rather than by conducting a painstaking trade-by-trade customer demand assessment (as is required under the market making exemption). Further simplifying the analysis, there is effectively no restriction on who an underwriting desk may consider to be a “customer” (because the term “customer” is broadly defined to include all “market participants,” unlike the more restrictive definition under market making RENTD).
It is noteworthy that prudent underwriters only agree to take on a deal to the extent that they can promptly place nearly 100% of the securities into the market. Therefore, in most cases, deals are oversubscribed over the notional amount in order to facilitate successful secondary trading after deal pricing. Following the same logic, RENTD can also be set at a range that exceeds 100% of a deal’s notional value.
See full PDF below.