Until the financial crisis brought CLO issuance to a virtual halt, CLOs were among the largest and fastest growing structured products in the marketplace, representing approximately 60% of institutional participation in syndicated loans in 2006. While the long-term impact of the Dodd-Frankrisk retention rules on CLOs remains uncertain, the short-term outlook for new CLO issuance is promising. As spreads on the triple-A rated tranches of CLOs have continued to tighten, the arbitrage on CLO collateral has become increasingly attractive in recent months. For the first time since the onset of the financial crisis, CLOs are showing signs of a sustained revival.
Although CLOs generally withstood the financial crises, the economic pressures brought to bear on CLO and CDO market participants tested the documentation utilized for these programs to an unprecedented degree. The controversies surrounding the proper interpretation of critical provisions of CLO documentation that arose during the market meltdown are too numerous to discuss in a single article. This article will therefore seek to address a representative sample of these issues, which generally fall into two categories: (1) provisions that need to be clarified or corrected for the benefit of all CLO market participants, and (2) provisions that warrant close scrutiny, but will ultimately need to be crafted to reflect the negotiated intent of the relevant CLO participants. As the CLO industry moves into its next phase, it is essential that the next generation of CLO documentation evolve to reflect the lessons learned from the worst market crisis since the Great Depression.