October 6, 2017 / 3:58 PM / a year ago

European CLO managers benefit from US risk-retention exemption

Oct 6 (Reuters) - European Collateralized Loan Obligation (CLO) managers are benefitting from a provision in US risk-retention rules that allows them to save money and time by selling some of their funds to American investors without attracting the scrutiny of US regulators.

Firms including Blackstone Group’s European credit investment unit are using a foreign safe harbor exemption that allows managers in Europe to sell up to 10% of their fund to US investors without having to comply with US risk-retention rules.

The rules are part of the Dodd-Frank Act, a sweeping package of regulations enacted in response to the financial crisis, that require firms to hold onto some of their funds to better align manager and investor interests.

This exemption is the latest query facing the market as CLO managers and investors continue to work through the implications of the rule, which took effect in December.

The foreign safe harbor exemption, which is fewer than 1,500 words of the massive 684-page final US retention rule and adopting release, is a boon for European managers and could boost CLO issuance by allowing funds to expand their buyer base. A similar provision for US managers is not included in the EU rule.

Regulators said that the provision in the final US rule was designed to exclude transactions from retention requirements where “the effects on US interests are sufficiently remote so as not to significantly impact underwriting standards and risk management practices in the United States or the interests of US investors.”

Blackstone/GSO European CLO Management is marketing a EUR412m (US$482.9m) CLO with Deutsche Bank in Europe that is seeking to take advantage of the exemption, according to a source.

Prospective investors were told in a marketing e-mail that the Willow Park fund will rely on the foreign safe harbor exemption for US risk retention, the source said. The sentence, “Max 10% can be purchased by US investors,” was bolded and underlined, he added.

A Blackstone spokesperson declined to comment. A Deutsche Bank spokesperson was not immediately available to comment.


The provision is convenient for European mangers, particularly those opting to buy retention in equity, the most junior slice of the fund, James Warbey, head of the alternative investments group in London at law firm Milbank, Tweed, Hadley & McCloy, said.

US rules require managers that buy this ‘horizontal’ retention slice to give investors a fair value estimate of the entire CLO capital structure and the fair value of the retained interest. Managers that do not have to comply with the US rule do not have to issue the disclosure statement, saving the time and cost of outside auditors.

It can also allow a European manager to bypass the scrutiny of the US Securities and Exchange Commission (SEC), which has oversight for registered investment advisors.

An SEC spokesperson declined to comment.


While the exemption could be beneficial for the European CLO market, managers have to monitor carefully to make sure that their funds adhere to the 10% limit to remain outside risk retention-rules. Managers need to comply with US regulations if more than 10% of investors are from the US.

“In Europe, are being very meticulous and are scrutinizing that part of the US risk-retention rule very carefully,” said Sean Solis, a partner in New York at law firm Dechert.

Some managers are unsure about the definition of a ‘US person’ under the US rules, and are considering limiting the sale of notes to US persons to balance the commercial and economic impact, he said.

Arrangers working on deals will keep track of prospective investors and their location, Warbey said.

“If you have 5% of US investors [in the deal] and it’s creeping towards 10%, you start to think more carefully and may refuse investors if you do not want to make the deal compliant with US risk-retention rules,” he said. (Reporting by Kristen Haunss; Editing by Michelle Sierra, Tessa Walsh)

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