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Leveraged Loan Risks May Require Legislation, SEC's Jackson Says

(Bloomberg) -- The U.S. Securities and Exchange Commission may need more power from Congress to police risks emerging in the $1.1 trillion market for leveraged loans, according to a top official at the Wall Street regulator.

Leveraged Loan Risks May Require Legislation, SEC's Jackson Says

"As a former banker, I think leveraged loans are an area where investors’ liquidity expectations might not match up with reality, and the SEC should do all we can to help investors understand that,” Commissioner Robert Jackson Jr. said in an interview this week. “The question is, is it time to go to Congress to get a new law to make sure the SEC can do that work? It may be time."

Once the purview of banks, loans to highly indebted companies have evolved into a large syndicated market that involves private-equity firms, asset managers, hedge funds and other players.

Mutual funds are increasingly buying the loans, raising questions about whether the sometimes hard-to-sell debt is appropriate for investors who typically like to be able to trade easily in and out of assets.

Liquidity Mismatch

To protect against risks, loan funds hold stockpiles of cash and liquid securities, and maintain credit lines from banks. Still, SEC chairman Jay Clayton is among officials who have expressed concerns about a possible liquidity mismatch for mutual funds that invest in leveraged loans.

Jackson, who holds a Democratic seat at the SEC, indicated he’s not certain how closely the agency is scrutinizing the market. It rivals the size of the high-yield bond market, but whereas bonds are securities, loans are considered private transactions.

"If you are wondering whether those areas in the markets that are getting really big are being looked at by the SEC, I am too,” he said.

Low Odds

The odds are likely low that legislation giving the SEC more authority over leveraged loans would get through a divided Congress. And for any bill to become law it would have to be signed by President Donald Trump, who has pushed a deregulatory agenda for the financial industry.

While the Federal Reserve regulates loans issued by banks, it doesn’t oversee financing provided by private equity and hedge funds, so-called shadow lenders. Philadelphia Fed President Patrick Harker said Wednesday that leveraged lending is high on his list of risks to watch right now.

“Most of that is not in” regulated banks, though, he added.

The International Monetary Fund flagged leveraged loans last week in its financial stability report. At a press briefing to accompany the report’s release, IMF financial counselor Tobias Adrian warned that risk-taking had increased and the “creditworthiness of borrowers has deteriorated.”

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