Regulators still haven’t done enough to exempt some of the biggest buyers of corporate loans from onerous reporting requirements that go into effect next year.

Beginning in January, foreign financial institutions will be required to provide more information to the IRS about their U.S. customers so the government can collect taxes, under the Foreign Account Tax Compliance Act of 2010, known as FATCA.

Existing CLOs that are domiciled offshore fall under the FATCA umbrella, but, because FATCA was not contemplated when they were issued, their legal structures leave them unable to comply with the requirements. Thus, they could be subject to a 30% tax withholding on loan interest or principal payments or sale proceeds.

In a comment letter filed with the IRS Monday, the Loan Syndications and Trading Association (LSTA) warned that FATCA risks disrupting the corporate loan market if existing CLOs are not exempted.

“CLOs aren’t structured to comply with FATCA and can’t fulfill those responsibilities,” Meredith Coffey, executive vice president of the trade group, said in a statement. If existing CLOs are subject to the law, “the result could well be large-scale liquidations of CLO assets, causing significant damage to the U.S. corporate loan market and the corporate borrowers that rely upon it,” she said.

In its comment letter, the LSTA notes the Treasury Department and the IRS have taken some steps to address the problem. Specifically, regulators have agreed to allow clearinghouses to fulfill the FATCA requirements on behalf of the CLOs, for any cleared securities. CLOs also will be able to benefit from the grandfathering of loans and CLOs’ debt tranches issued before January 1, 2013 which would exempt them from FATCA’s requirements.

However this does not go far enough to mitigate the problem. That’s because any loans held by the CLO that experienced a material amendment after the end of the year would lose their grandfather status, exposing the CLO to the reporting and 30% withholding requirement, the LSTA said.

It’s not uncommon for borrowers to seek an amendment from lenders extending the maturity of an existing loan in exchange for a principal reduction or higher interest rate if a refinancing might prove difficult.

In addition, many CLOs also contain un-cleared securities which means clearinghouses would not be able to fully meet the reporting requirements.

“We appreciate the work regulators have done but further steps are needed to fix the problem,” Tess Felfe, assistant general counsel of the LSTA, said in the statement.

The LSTA proposes that existing offshore CLOs whose debt and equity payments are made through a trustee, paying agent or clearing system be considered a “Deemed Compliant Foreign Financial Institution” and hence granted a special exemption with specific provisions designed to prevent tax abuse. The exemption would be limited in scope and would only apply to vehicles with a limited time horizon.

The LSTA also proposes that loans be allowed to retain their grandfather status, if loan modifications are made which do not also extend the maturity of a loan. The LSTA says this is a more realistic approach in light of the specific attributes of the loan asset class.

Subscribe Now

Access to a full range of industry content, analysis and expert commentary.

30-Day Free Trial

No credit card required. Access coverage of the securitization marketplace, including breaking news updated throughout the day.