On Tuesday, the European Banking Authority (EBA) published a consultation paper that would seem to threaten the recent revival of the European CLO market.
The paper seeks to clarify the requirements that either the sponsor or originator of securitization retain a portion of the risks in these deals. Article 122a of the Capital Requirements Directive, which was released by the Committee of European Banking Supervisors in December 2010, has a kind of get-around: it allows the deal’s sponsor to outsource this risk-retention to a third-party.
In a note published today, law firm Dechert said the market was expecting that the EBA technical standards would closely follow the guidelines to Article 122a. Instead, several key paragraphs found in the CEBS guidelines are not a part of the draft technical standards released by the EBA. So it’s unclear whether managers of future deals can rely on a third party in the future.
The consultation paper contains a wider definition of a “sponsor” than what the CRR has defined. The definition included in the EBA consultation paper covers investment firms and credit institutions as falling under the definition of "sponsor."
As a result, CLO asset managers that are investment firms can now be considered as a retaining entity, although the consultation paper does acknowledge that many CLO asset managers will face capital constraints if they act as a retainer, Dechert said.
The consultation paper acknowledges the potential impact that this wider definition, saying it “could potentially translate in the long term into a modification of the currently existing managed CLO model,” according to Dechert.
The law firm noted in its report that recent deals, including Cairn Capital’s Cairn CLO III and Apollo Global Management's ALME Loan Funding 2013-1, have used third parties to meet risk retention requirements.
The law firm is also concerned that the consultation paper does not mention grandfathering provisions for current CLOs that relied on the CEB guidelines. The implication is that CLOs structured based on these guidelines will be assessed on the EBA technical standards, rather than the guidelines.
The EBA has requested comments on the consultation paper by Aug. 22 and will organize an open public hearing on the proposals on July 22.