March 27, 2018 / 4:57 PM / a year ago

Regulators decline to challenge CLO retention exemption

March 27 (LPC) - Issuance of Collateralized Loan Obligation (CLO) funds could surge after the Federal Reserve (Fed) and Securities and Exchange Commission (SEC) decided not to appeal a February court ruling that exempted the deals from Dodd-Frank ‘skin in the game’ rules.

Regulators’ decision not to seek a review of the retention rules, which require managers to hold 5% of their funds’ risk, could boost CLO issuance by managers that lacked the capital to comply. It could also cut borrowing costs for companies that depend on the US$511bn US CLO market for financing.

The ruling could be transformational for the CLO market and will “only further increase the number of transactions that we will see this year and beyond,” said Deborah Festa, a partner at law firm Milbank, Tweed, Hadley & McCloy.

CLOs are the biggest buyers of leveraged loans and the passing of Monday’s midnight deadline in the Appeals Court is a key part of the industry’s push to roll back the regulation.

The Loan Syndications and Trading Association (LSTA), the trade group for the US$980bn US loan market, sued the Fed and SEC in 2014, saying the rules were “arbitrary, capricious” and “an abuse of discretion.”

“We believe that the DC Circuit Court’s decision was correct so we are pleased that the government chose not to appeal,” Elliot Ganz, general counsel at the LSTA, said in an e-mail.

A Fed spokesperson and an SEC spokesperson both declined to comment.

By April 2 the Appeals Court will give a mandate for the risk-retention rule for CLOs to be vacated, allowing managers of those funds to legally issue deals without holding retention.

The CLO market still has one hurdle to pass, however, as the US government has until May 10 to ask the Supreme Court to hear the case, Ganz said. If regulators do not appeal to the Supreme Court by then, the ruling will be final. Managers can continue to issue CLOs without retention in that time.


Despite the uncertainty of an appeal, issuance has been brisk this year at about US$28bn in 2018 through March 23, according to Thomson Reuters LPC Collateral data. Several managers have issued CLOs that are not risk-retention compliant, but included language to increase the fund to buy retention if the rule still stood at closing.

“The obvious conclusion is the ruling should help the CLO market grow, but we think the overall impact on size will be fairly modest considering most managers had solved for risk retention,” Brad Rogoff, head of credit strategy at Barclays, said in an e-mail.

Citigroup is predicting record CLO volume of US$140bn in 2018, compared to US$117bn in 2017, which was the second-largest year for volume, according to LPC Collateral data.

After February’s court ruling, Morgan Stanley increased its 2018 US CLO forecast by US$10bn to US$110bn and Deutsche Bank raised its forecast to US$120bn from US$110bn.

“The legacy of risk retention, absent an appeal, will be much greater investor education; opening the eyes of a lot of investors who may not have looked at CLOs previously,” said Tom Majewski, founder of Eagle Point Credit Management, which invests in the equity and junior debt of CLOs. (Reporting by Kristen Haunss Editing by Tessa Walsh)

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