The latest in the string of regulatory proposals potentially impacting CLOs, Securities and Exchange Commission's (SEC) rule would attach significant obligations when using just about any technology to communicate with investors and potentially halt some communications.
Comments are due by Oct. 10 on the proposal that the SEC proposed on July 26, titled Conflicts of Interest Associated with the Use of Predictive Data Analytics by Broker-Dealers (BDs) and Investment Advisers (RIAs).
The rule's aim, according to the proposal, is to eliminate or neutralize "certain conflicts of interest associated with broker-dealers' or investment advisers' interactions with investors through these firms' use of technologies that optimize for, predict, guide, forecast or direct investment-related behaviors or outcomes."
The concerns it raises, however, prompted 13 trade associations, including the Loan Syndications & Trading Association (LSTA), to send a request September 12 to the SEC to withdraw the proposal. Market participants may also want to offer their two cents on a global effort to establish good CLO-market practices.
"The PDA Proposal is astonishingly broad in its scope, imposes incredibly prescriptive requirements, abandons long-held SEC principles and seems to be wholly unnecessary given the SEC's already existing rules that govern the duties of [BDs and RIAs]," the letter says.
The rule would cover virtually any technology that BDs and RIAs use to communicate with retail and institutional investors, according to the LSTA's Elliot Ganz in a note to constituents, requiring "intense and prescriptive review and require significant compliance and record keeping."
That communication, including those taking place in-person, would require the firms to evaluate any use or reasonably foreseeable use of the technology in investor interactions to identify potential conflicts of interest, including testing the technology prior to implementation and regularly thereafter, according to Mayer Brown, in a note to clients. The firms must then determine whether such conflicts place their interests ahead of clients, and they must eliminate or neutralize the effects of those conflicts.
The SEC has always said that soft dollars—paying a brokerage through commissions rather than directly—present a conflict of interest, noted Hardy Callcott, a partner at Sidley Austin. He added that investment advisers, including those to CLOs, have dealt with the issue by disclosing their soft dollar practices, so investors can evaluate the conflict. Order-management or market-data systems are typically used to disclose that information, but under the rule advisers would have to eliminate or neutralize the conflict.
"Unless the SEC clarifies the proposal, it could have the effect of eliminating advisers' ability to use soft dollars for many common technologies they currently rely on first research and brokerage services," Callcott said.
Dissenting to the proposal, SEC Commissioner Hester Peirce said that "the Commission's utter disregard for the operational feasibility is inexplicable."
Market participants may also want to offer their two cents on a global effort to establish good CLO-market practices. The International Organization of Securities Commissions (IOSCO)—the international association of securities and futures markets regulators—is seeking comments on a consultation report that it issued earlier in September. The organization is looking for feedback on 12 proposed "good practices" when operating in the leveraged loan and CLO markets, grouping them into five themes:
- deals based on a sound business premise
- loan documentation transparency
- better aligning loan origination and end-investor interests
- addressing market intermediaries' interests
- and ongoing disclosures
- The IOSCO is seeking comments by December 15.
IOSCO notes that good practices are neither standards nor recommendations, but are designed to support market participants' decision making. It says that at $4.6 trillion outstanding, the global leveraged loan market is close to record high levels, and the CLO market has grown in parallel, to be the largest investor group in broadly syndicated loans.
The 12 good practices mainly pertain to the leveraged loan market and benefit investors in those markets such as CLOs. They include adequate debt repayment capacity, generally considered to be the ability to repay 100% of senior debt or 50% of total debt over the medium term; underpinning enterprise values by multi-year forecasted cashflows; and underwriters aligning their interests with investors through risk retention or other means.
In terms of CLOs, potential conflicts of interest in their management should be appropriately identified and managed; and investors should be provided on a regular basis with all materially relevant information on valuation, credit quality and performance.
