June 16, 2015 / 6:42 PM / 3 years ago

Regulators may allow CLO refinancing without risk retention penalty

NEW YORK (Reuters) - United States regulators are considering a compromise to help managers of Collateralized Loan Obligation (CLOs) funds to refinance as they struggle to comply with new rules designed to limit risk taking that were released last year, sources said.

The Securities and Exchange Commission (SEC) is considering allowing CLOs issued before December 24, 2014, to refinance tranches after risk-retention rules take effect in December 2016 without having to hold 5 percent of the deal, according to four sources with knowledge of the talks.

The SEC has been discussing the risk-retention rules with the Loan Syndications & Trading Association (LSTA) since the start of the year. The rules, introduced in the Federal Register in December, require CLO managers to maintain a financial interest in their investment vehicles, or “skin in the game,” of 5 percent, which few can afford.

Other regulators including the Federal Reserve and the Office of the Comptroller of the Currency (OCC) have also been consulted about the potential decision, which may be released soon in the form of a no-action letter, two of the sources said. The LSTA and SEC have been exchanging draft language for a potential no-action letter for about a month.

The SEC can issue a no-action letter in response to a request about whether an action would constitute a violation, according to the SEC’s website.

The potential rule concession would benefit deals completed before 2015. If the no-action letter is issued as discussed, it is not expected to apply to CLOs that were issued during the two years before the regulation takes effect on December 24, 2016, sources said.

Managers of CLOs issued after December 24, 2014, that choose to refinance more than two years later may have to comply with the rules and hold 5 percent of the refinanced tranche, sources said.

Spokespeople for the LSTA, OCC, Federal Reserve and SEC all declined to comment.


Only about 10 of the 30 largest CLO managers, which are mostly affiliated with an insurer or large asset manager, may be able to comply with risk-retention rules, which were released in October, according to a report from management consulting firm Oliver Wyman.

CLO issuance climbed to a record $123.6 billion in 2014 as managers raced to issue funds before the rules take effect. However, any potential relief provided may not go far enough.

The prospective change won’t “help nearly as many managers or CLOs as would have been anticipated,” Deborah Festa, a partner at Milbank, Tweed, Hadley & McCloy in Los Angeles, said in an interview. “What you will have are transactions that priced in 2015 or 2016 with relatively high interest rates, and equity investors that would not be able to refinance if the manager is unwilling or unable to take down the risk-retention position.”

The struggle to finance the 5 percent holding may drive mergers between firms, and acquisitions of smaller managers may become inevitable.

“We are starting to see the beginning of managers pursuing potential merger and acquisition strategies with parties that have more capital to meet risk-retention obligations at the end of 2016,” said Festa, who leads the firm’s West Coast securitization and investment management practices.

Kramer Van Kirk Credit Strategies (KVK), a Chicago-based manager, announced in April it had formed a partnership with New York-based private equity firm Public Pension Capital LLC (PPC). Under the agreement, PPC’s investment will allow KVK to meet risk-retention requirements, according to a news release.

Ziegler Capital Management, an investment management firm and unit of Stifel Financial Corp, announced a partnership this month with Valcour Capital management, a credit investment firm that oversees more than $1 billion of assets.

Fewer managers and a potential inability to cut interest rates to improve equity returns may lead to lower CLO issuance. There may be a 75 percent reduction in credit provided by CLOs over the long term due to the rules, according to the Oliver Wyman study.

More than $53 billion of CLOs have been raised in the U.S. this year, according to data compiled by Thomson Reuters LPC. Wall Street firms forecast between $70 billion and $110 billion will be arranged in 2015.

For now, the market must wait and see if a no-action letter is issued and start getting ready to meet risk-retention rules that go into effect in December 2016.

“The proposed change is only a moral victory,” Festa said. “It doesn’t give the broad relief the market was hoping for, which would have allowed any CLO that closed prior to the end of 2016 to be grandfathered. The relief itself is narrow.”

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