LPC: CLO managers welcome Treasury risk-retention recommendations

Oct 6 (Reuters) - The US$470bn US Collateralized Loan Obligation (CLO) market cheered recommendations from the US Treasury Department that regulators should introduce a qualified risk-retention exemption for the funds.

The recommendation is part of a Treasury report on capital markets released Friday in response to a February executive order from President Donald Trump that sought Treasury Secretary Steven Mnuchin’s advice on possible regulatory changes. The Treasury previously released a report in June that recommended changes to leveraged lending guidance.

CLOs are the largest buyer of leveraged loans, which lower-rated companies rely on to support their businesses and use to back acquisitions. The funds have argued that rules forcing managers to hold 5% of their deals unfairly lumped CLOs in with other structured products that contributed to the financial crisis, and the increase in regulation could affect their ability to extend credit to borrowers.

Part of the Dodd-Frank Act, risk-retention rules, which took effect for CLOs in December 2016, are an “imprecise mechanism” to encourage alignment of interest between managers and investors, the Treasury said Friday.

“It’s nice to see CLOs recognized and for to say broadly syndicated CLO managers aren’t originating assets and that there should be broader exemption for such deals similar to the [Qualified CLO] legislation,” said Sean Solis, a partner in New York at law firm Dechert. “The reaction has been positive within the CLO community.”

CLO managers do not originate the underlying loans in their funds and are compensated with management fees contingent on performance, which is different than other structured products, the Treasury said.

“In the same vein as the broader recommendation that risk retention not be statutorily eliminated but should instead be right-sized, Treasury recommends creating a set of loan-specific requirements under which managers would receive relief from being required to retain risk,” according to Friday’s report.


The US loan trade organization, the Loan Syndications and Trading Association (LSTA), wrote to Mnuchin in April saying that risk retention for CLOs should be eliminated in order to advance the interests of investors, companies and consumers.

“The LSTA is gratified to see that the Treasury report recognizes that CLOs are different from other forms of securitizations and recommends a form of risk retention better suited for CLOs,” Meredith Coffey, executive vice president of research and analysis at the LSTA, said in an e-mailed statement Friday.

The trade group is set to argue October 10 in front of the US Court of Appeals for the District of Columbia Circuit on why they think CLOs should be excluded from risk retention.

The LSTA sued the Federal Reserve and Securities and Exchange Commission in 2014 to try and remove the funds from the retention requirement and the case has snaked through the legal system the last three years.

Following the release of the report, a lawyer for the LSTA sent a letter to the Court of Appeals flagging the Treasury report and highlighting the relevant CLO section.

“These conclusions provide further support for the LSTA’s arguments in this appeal that open market CLO managers and competition are harmed by the capital outlay requirements associated with the credit risk-retention rule,” Richard Klingler, the LSTA’s lawyer and a partner at Sidley Austin, wrote, according to a court filing. (Reporting by Kristen Haunss; Editing by Michelle Sierra and Lynn Adler)