Managing Regulatory Blindspots: A Case Study of Leveraged Loans

Abstract

Leveraged loans have reached new peaks in the post-crisis period. This Article assesses U.S. leveraged loan regulation and highlights the ways in which the entity- or institution-based focus of regulation have been the source of critical blindspots that have limited the ability of regulators to monitor and address the risks of leveraged lending. First, the current regulatory strategy, which relies on institutions to set their own definitions of and standards for leveraged lending activities, magnifies regulatory conflicts that are inherent in a fragmented regulatory structure like the United States. Second, the institution-based regulatory boundaries in leveraged loan regulation create regulatory gaps and exclude a significant number of leveraged loans, particularly in the market's riskiest segments, from regulatory oversight. Third, the regulatory focus on protecting individual institutions from the risks of leveraged lending may inadequately protect or even undermine the safety and soundness of the financial system. To manage these blindspots, the Article suggests a shift from an institution-based toward a loan-based perspective in the regulation of leveraged loans, and describes how this regulatory shift could be achieved by relying on the regulatory infrastructure enabled by the passage of the Dodd- Frank Wall Street Reform and Consumer Protection Act.