| NEW YORK
NEW YORK May 24 Five months after regulations
took effect that require Collateralized Loan Obligation (CLO)
managers to hold some of their fund’s risk, several practical
issues about the rules’ application and lasting impact have yet
to be resolved, according to sources.
Risk-retention rules require managers to hold 5% of their
fund under the Dodd-Frank Act. The final regulation was
announced in 2014 and went into effect on December 24, 2016.
Despite a long runway from the announcement to effective
date, the US$450bn CLO market is still trying to find a
consensus on issues that have been raised in the last five
months, which have required significant negotiation of documents
CLOs are the largest buyer of US leveraged loans and provide
financing to back acquisitions. The retention rules may reduce
the loan buyer base by limiting the number of firms that can
issue compliant CLOs.
Despite numerous efforts to eliminate or alter the rule,
market participants are resigned to the fact the requirement
will not change in the near term.
To comply, managers may buy a vertical strip, which is 5% of
every tranche of a CLO, or a horizontal strip, which is 5% of
the face amount of all of the fund’s tranches that is held in
the equity slice. Firms may also buy a combination of the two.
Managers can buy the retention directly or use financing
from a third party. Some firms have set up a capitalized manager
vehicle (CMV) – a standalone management company that oversees
the CLO to buy the retention stake – or a majority-owned
affiliate (MOA) or capitalized majority-owned affiliate (C-MOA).
Since the rule took effect, the market has been working to
answer questions on how best to comply, including when mangers
need to disclose to investors how much risk they intend to hold
and who is responsible for those determinations.
Market consensus suggests that managers will first provide
preliminary information about horizontal tranche fair-value
determinations two business days prior to the CLO’s pricing
date, according to Deborah Festa, head of law firm Milbank,
Tweed, Hadley & McCloy’s West Coast securitization and
investment management practices.
The CLO’s trustee would then release the final calculation
within a month of pricing or potentially sooner if there is a
material change, she said. The market has also concluded that
these fair-value disclosures are generally the responsibility of
the CLO rather than the manager, Festa added.
Several questions remain, including what happens to the
retention if the manager changes, Festa said. Under the rules'
current language, the original manager would still be
responsible for holding the retention even if it is replaced due
to a sale.
“The market hasn’t had to face this yet,” she said.
“It is a, watch this space type-area to see how the market will
react and what people will be comfortable with.”
DISMANTLE DODD FRANK
The Loan Syndications and Trading Association (LSTA) is
reaching out to the new Republican administration in the hopes
it will be willing to loosen regulations as the market continues
to work to resolve the questions raised.
President Donald Trump has repeatedly said that he wants to
dismantle the Dodd-Frank Act and signed an executive order on
February 3 requiring Treasury Secretary Steven Mnuchin to advise
within 120 days on possible regulatory changes.
In a letter to Mnuchin on April 7, the LSTA said risk
retention should be eliminated in order to advance the interests
of investors. The trade group asked the US Senate to consider an
alternative, the QCLO, in a second letter that it sent last
month to Senate Banking Chairman Mike Crapo and Ranking Member
A ‘Qualified CLO’ would require a manager to hold 5% of the
CLO’s equity slice and meet a number of tests in areas including
diversification and structural protections.
A lawsuit that the LSTA brought against the Securities and
Exchange Commission and the Federal Reserve in 2014 is also
continuing. The trade group appealed its case earlier this year
after the Federal District Court for the District of Columbia
ruled against the LSTA in December.
(Reporting by Kristen Haunss; Editing by Tessa Walsh)