The Loan Syndications and Trading Association is proposing a new risk retention plan for CLOs that meets the Dodd-Frank Act's requirements while allowing market players to originate new CLOs.
The new proposal also seeks to avoid disrupting the credit flow to the financial markets and the economy.
In a release published Thursday, the trade group said that it developed the plan because federal agencies, such as the Federal Deposit Insurance Corp., the Federal Reserve and the Office of the Comptroller of the Currency, seem unwilling to exempt these transactions from proposed guidelines that it believes will shut the market down.
“In contrast to the agencies’ proposed rule, which would require a CLO manager to purchase $25 million of notes for every new $500 million CLO, our proposal would envision CLO managers retaining 10% of the credit risk in a more manageable form," LSTA Executive Director Bram Smith said in a comment letter submitted to the federal agencies this week.
He said that the LSTA's approach would still align CLO managers’ interests with those of its investors while more than fulfilling the Dodd-Frank risk retention requirements.
An LSTA-organized industry working group developed the proposal, which would replace a CLO manager’s fee stream with a series of unfunded Class M Notes at every point in a deal’s capital structure.
These notes owned by the CLO manager would actually replicate the traditional fee stream and would expose the manager to over 5% of the asset pool's credit risk. Managers would also be buying 5% of the structure's equity, or most subordinated tranche. Together, the unfunded notes and the equity purchase serve to expose the manager to over 10% of the credit risk, which would double the Dodd-Frank Act-mandated 5% risk retention, the LSTA said.
The trade group said it continued to dispute the authority of federal agencies to require CLO managers to retain risk in their deals. Nevertheless, it said, the proposal demonstrates that it is willing to a way comply with Dodd-Frank in a way that works for CLO managers.
"This is a form of risk retention a CLO manager can undertake and still originate new structures,” said Meredith Coffey, executive vice president of research and analysis. “It’s a much better solution than the agencies’ proposed rules, which would effectively