Little Hope for CLO Relief from Risk Retention

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The CLO industry is fighting to the bitter end, but there is unlikely to be any relief from rules taking effect at year's end requiring them to keep skin in the game of their deals.

Speculative grade companies and their investors are pushing for relief on two fronts: in Congress and in the federal courts. Neither looks too promising at this point, according to Meredith Coffey, executive vice president of the Loan Syndications & Trading Association.

Legislation that would create an exemption to so-called risk retention rules for CLOs that meet certain standards was introduced by U.S Rep. Andy Barr, R-Kentucky, and approved by the House Financial Services Committee; it has a good chance of being passed in a vote on the House floor this summer, Coffey told participants Tuesday at IMN’s CLO conference. But the bill is appears to be DOA in the Senate.

She explained that there seems to be little chance it will be implemented in an election year, when legislators (particularly Democratic ones) will not want to be seen doing favors for the capital markets (i.e., Wall Street).

It does't help that Sen. Elizabeth Warren, a vocal opponent of CLOs, sits on the Senate banking committee.

Barr’s bill would create a “qualified” CLO exemption by which a CLO that meets standards for transparency, mutual interest of investors and managers, plus other criteria, would be allowed to take a minimum 5% of the equity tranche of a CLO, instead of the notional value of all the issued notes.

Coffey also expressed doubts that a legal challenge the LSTA and other groups have brought against the Federal Reserve on risk retention would be resolved until the summer of 2017 – well after the this year’s implementation of the new U.S. standards. The case was recently assigned to the U.S. district court level by a three-judge panel on the U.S. Court of Appeals in Washington, D.C. (which included Supreme Court nominee Merrick Garland).

Coffey expressed dismay that the rule’s inevitable implementation comes despite what she says is a firm case that CLOs don’t meet the “securitizer” requirement as set forth by Dodd-Frank, or that they would be able to reasonably meet the 5% capital retention floor for CLOs.

What perturbed her too, tongue in check, was the date of the risk-retention rule’s enforcement date.”

“The rules go live on Dec. 24, 2016 because, what the hell, while we’re at it lets screw up Christmas,” she said, to a smattering of laughter to the audience at the Grand Hyatt New York.  

The bottom line, Coffey stated: “We are right and the rule is wrong.”  

Her remarks came the day after Richard Johns, executive director of the Structured Finance Industry Group, delivered equally somber news to attendees about the potential impairment that the cumulative avalanche of global regulations and precedent-setting court decisions will have on the $1.6 trillion worldwide securitization market.  

Johns garnered some laughs on Monday, as well, but only that his end-of-day speech that was delaying the rush for post-conference cocktails awaiting the attendees.

Johns’ speech centered on the industry’s much more serioius news that numerous global rules establishing new capital ratios is likely to negatively impact banks.

“It’s not good the amount of regulation out there,” said Johns, who divided the regulations betweem the “good/bad” rules that might ostensibly provide some benefit to institutional investors (at whatever cost to issuers) and the “bad” ones that provide none to either counterparty.

Johns covered the new U.S. capital rules governing the ABS and CLO markets, including liquidity coverage and net stable funding ratio rules that are treating all mortgage-backed securities and asset-backed securities as illiquid assets that must be accounted for capital requirements.

Along with the international Basel Committee on Banking Supervision’s reviews on rules on capital retention rules on banks and broker-dealers, securitization markets could find themselves with an investor base that would have 20% to 50% less liquidity available for asset acquisitions.

This is also while Basel is proposing banks identify their “step in risk” exposure to non-bank, or shadow-banking entities, should the latter fail and leave the regulated bank with a potentially systemic exposure.

On the structure of transactions themselves, Reg A/B II is greatly expanding the disclosure requirements for ABS vehicles, and the Federal Reserve is propping credit limits to single-counter party exposure, which will likely impact CLOs that could potentially have exposure to single-entity borrowers in a collateral pool.

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