Like every sector in the European securitization market, CLOs are struggling with the onslaught of regulation.
A current major concern for the market is risk retention under the European Union's Capital Requirements Directive Article 122a.
As it is written currently Article 122a will, according to the participants at this week's Global ABS 2011 in Brussels, essentially kill the industry. It is also the wrong way to regulate CLOs because of the nature of the product.
CLOs, several panelists said, are not designed to follow the originate-to-distribute model. Aside from this, they are actively managed vehicles that have performed well.
According Jonathan Wishnia, a member of Lowenstein Sandler, said that the short version of it is that regulators must have decided to apply this "imperfect directive" to an asset that has performed well and is diversified. The directive also does not recognize, he said, the kind of players in the CLO space. Wishnia was part of a panel on the impact of leveraged loan performance on the CLO market.
In a report early this year, law firm Ashurst (see report) commented on the uncertainty of how the rules will apply to non-balance sheet deals, including CLO funds that are arranged by an investment bank while being managed or advised by a collateral manager. The law firm concluded that it is likely that arrangers and/or collateral managers, which are not credit institutions, in practice will still have to disclose a 5% retention to EEA bank investors.
At the panel on CLO secondary market liquidity, panelists mentioned that the required risk retention can spur further consolidation of CLO managers. This might also confine the industry to those managers with a bigger balance sheet and push out credit opportunity funds and separate accounts. In short, risk retention and the looming CLO reinvestment periods combined can further drive out the smaller players from the industry.
In the meantime, the CLO picture is somewhat brighter in the U.S., at least for now. Regulators extended the due date for comments on the Dodd-Frank Act's Credit Risk NPR or “proposed rule" to Aug. 1 from June 10.
Article 122a became effective across Europe starting on Jan. 1. Many panelists attributed the still-active U.S. CLO sector to the fact that the rules are not in place yet, unlike the European regulations pertaining to risk retention, although the practical application of 122a to CLOs is still being worked out.