The CLO industry would love to have more explicit guidance from regulators on rules requiring managers to keep ‘skin in the game’ of these deals; specifically, they would like to know how deals currently grandfathered might trigger compliance when they are refinanced.

Unfortunately, that guidance is not likely to come any time soon.

True, the Securities and Exchange Commission published a “no-action” letter in July clarifying that a CLO manager could refinance without triggering compliance in a very specific situation. The most important condition was that the CLO had to be issued before the risk retention rule was published on Dec. 24, 2014, though there were others.

But that letter was some six months in the making, as its author, David Beaning, pointed out at IMN’s ABS East conference. He suggested it could take even longer to get another one. “The interagency process is a slow one that requires consensus,” said Beaning, until recently special counsel in the SEC’s Office of Structured Finance and now in private practice. “Timelines need to be adjusted.”

The SEC consulted on the no-action letter with the Federal Reserve, the Federal Deposit Insurance Corp., and the Office of the Comptroller of the Currency.

Beaning went on to elaborate on how the SEC, at least, came around to the CLO market’s way of viewing this particular kind of transaction. “The SEC became very comfortable because we viewed the refinancing as almost a conditional tender option for investors that allowed them to get out at par. If it was taken away, triple-A investors … would be harmed,” he said.

As it happens, there is another, very specific kind of transaction for which the CLO market would like to have regulators’ blessing.

Meredith Coffey, the Loan Syndications and Trading Association’s head of research described it this way: A manager prints a $500 million CLO before risk retention rules take effect, and in two years refinances the $200 million triple-A tranche. Based on a careful reading of the rules by law firm Cleary Gottlieb Steen & Hamilton LLP, this would only trigger a requirement to retain 5% of the risk in the triple-A tranche, or $10 million, either via equity or triple-A notes, and not 5% of the entire, $500 million deal.

“That’s the reading people we work with see,” said Coffey.

“When I was at the SEC, the staff felt that this interpretation represented a reasonable” approach, Beaning said, adding “I can’t speak for the other agencies.”

“Any chance of getting that in writing,” Coffey asked?

Beaning replied: “I’m no longer at the SEC, but I suspect your chances are zero.”

He struck a similar note following a subsequent discussion of various methods for complying with risk retention rules.

“I suspect the inter-agency process is not going to be nimble enough for participants in the capital markets,” he said. “They should look to their accountants and attorneys to provide the comfort they need. There are too many players with too much at stake, and too many regulators are [involved] not as direct regulators of CLO managers but as regulators of investors.”

Even though the SEC is the primary regulator of CLO managers, it “will very seldom act unilaterally, without consulting the other regulators.” 

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