The Loan Syndications and Trading Association (LSTA) today submitted to joint regulators a 20-page comment letter explaining why managers of Open Market CLOs are not subject to the risk retention provisions of the Dodd-Frank Act.
The LSTA urged the joint regulators to retract their suggestion in the Notice of Proposed Rule Making (NPRM) on risk retention that managers of Open Market CLOs fall under these rules.
The trade group noted that Open Market CLOs are very different from the types of securitization structures covered by Dodd-Frank. The assets underlying CLOs are liquid and transparent syndicated commercial loans to a broad base of U.S. firms that are made only after careful credit analysis and due diligence. Aside from these, the LSTA pointed out that these types of structures performed very well through the financial crisis.
In this light, the trade association also urged the joint regulators, to the extent they do not agree with the LSTA’s legal arguments, to exempt Open Market CLOs from the Dodd-Frank Act's risk retention provisions to avoid the serious negative consequences that would result from implementing the risk retention rules.
“It is not surprising that the plain language of the risk retention provisions of Dodd-Frank do not apply to managers of open market CLOs,” said Bram Smith, LSTA executive director. “Rather than being originators of loans who sell assets into securitization vehicles for the purpose of transferring risk from their balance sheets, managers of Open Market CLOs select loans in the open market for purchase by Open Market CLOs. Managers neither originate nor sell assets to Open Market CLOs. In this way, they function more like managers of mutual funds. If the risk retention rules were applied to managers of Open Market CLOs, we would risk a shutdown of a business that provides much needed credit to U.S. companies that create jobs and invest in growth.”
The LSTA is also strongly behind the alignment of interests between issuers and investors underlying the risk retention provisions of Dodd-Frank, although the trade group said that such alignment already exists between managers and investors in terms of these CLOs.
Open Market CLO managers get most of their compensation only if the CLO performs as expected. If the note holders in Open Market CLOs do not receive their ongoing interest payments, the CLO managers cannot collect most of their management fees. The LSTA pointed out as well that Open Market CLOs performed very well in the recent financial crisis.
The LSTA also said that none of the risk retention options described in the NPRM has any practical application to these managers. It added that as asset managers, they are not in themselves sources of capital.
Thus, the trade group said that forcing risk retention obligations on managers of Open Market CLOs will have the effect of cutting off an significant source of credit for American firms.
In its comment letter, the LSTA gives detailed recommendations for the creation of a narrow exemption for Open Market CLOs from Dodd-Frank's risk retention provisions.
The LSTA is hoping that these suggestions will assist the regulators to ensure the continuation of this important credit source, even in the event that they do not accept the LSTA’s legal position.
For the complete comment letter, please see link below.