January 30, 2019 / 5:57 PM / 20 days ago

Loan market asks Japanese regulator to exempt CLOs from proposed rules

NEW YORK, Jan 30 (LPC) - The US$1trn US leveraged loan market has asked Japanese regulators to consider exempting Collateralized Loan Obligation (CLO) investments from proposed risk-retention rules, concerned the requirement could temper new issuance.

The investments should not lead to higher capital charges because CLOs buy leveraged loans, which require credit analysis from multiple parties during the syndication process and as such are not “inappropriately formed,” a potential exception under the rule, the US loan trade group, the Loan Syndications and Trading Association (LSTA), wrote in a comment letter Monday.

The Japanese Financial Services Agency (JFSA) plans to introduce a quantitative standard where financial institutions must confirm the “originator” holds a 5% retention piece. If the CLO does not meet that standard, it will be assigned a triple risk weighting in the calculation of the financial institution’s capital adequacy ratio.

The regulator previously told LPC it will not apply the weighting if it can conclude the origination of the underlying assets “conduct appropriately.”

The JFSA said in an email Wednesday that it cannot comment on individual letters.

The proposal comes less than a year after a US Appeals Court exempted the funds from similar US regulation. CLOs are the biggest buyers of leveraged loans, and Japanese banks account for about 10% of the US$750bn global CLO market, according to a Bank of England estimate. A pullback by Japanese investors could make CLOs more expensive, decreasing new issuance, and in turn raising borrowing costs for US companies that rely on the loan market for financing.

“The continued participation of Japanese banks and other relevant Japanese financial institutions in acquiring CLO securities is essential to maintaining those CLOs’ market role in providing financing for soundly underwritten leveraged loans,” the LSTA said in its comment letter signed by Executive Director Lee Shaiman and General Counsel Elliot Ganz.

“Regulatory measures that would have the effect of decreasing CLO formation or increasing its costs would also have related, adverse effects on the availability and pricing of capital in the leveraged loan markets,” they wrote. US CLO managers may be forced to hold retention in new deals to allow Japanese institutions, a mainstay holder of the largest and most senior portion of the fund, the Triple A slice, to invest.

The LSTA focused most of its letter on a potential carve-out for loans that are appropriately formed, Ganz said in an interview.

The trade group stressed that loans are not “inappropriately formed” because they go through an underwriting process, often with multiple arrangers that need to agree to the structure and credit risk, and the CLOs purchasing the loans complete their own due diligence, he said.

In addition, loans are structured to be amenable to trade in the secondary market where they need to be liquid, and are often independently priced.

“That goes to the heart of underwriting and why loans are not inappropriately formed,” Ganz said. “The loan has many touch points where independent investors and banks look at it, review and get comfortable” with the risk.

The trade group said it will meet with the JFSA in Tokyo February 6. (Reporting by Kristen Haunss. Editing by Jon Methven)

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