Managers and arrangers of U.S. collateral loan obligations have struggled to satisfy the European Union’s risk retention requirement. However, the final draft rules published by the European Banking Authority (EBA) at the end of last year include a new concession that may assist U.S. managers in accessing an investor base in the region.
The Capital Requirements Regulation provides that certain European Economic Area-regulated investors, including credit institutions and investment firms, shall be exposed to thee credit risk of certain securitizations only if the originator, sponsor or original lender of that securitization has explicitly disclosed that it will retain, on an ongoing basis, a material net economic interest of at least 5%. The only parties to a deal that can satisfy this requirement are the original lender, originator or sponsor.
U.S. collateral managers and arrangers have been hard pressed to identify an entity that is both willing and able to retain this economic interest. This is because neither the “original lenders” under the loans nor the sellers of the loans (being “originators” for the purposes of the relevant definition) have any interest in committing to retain 5% of the loans that they originate or sell. European collateral managers face the same issue. However, there is an additional difficulty for U.S. collateral managers: even if they are willing to retain this interest themselves, they do not qualify as sponsors. The definition of “sponsor” is limited to credit institutions and certain entities subject to the requirements of the EU Markets in Financial Instruments Directive.
U.S. collateral managers and arrangers have given thought a possible work-around: identifying an entity that can act as an “originator” to acquire the loans and then sell them on to the CLO. This solution would rely on a limb of the definition of an “originator” that includes “an entity that purchases a third party’s exposures for its own account and then securitises them.”
The difficulty with this “originator” structure is that reinvestment by the CLO is dependent upon the on-going cooperation of the originator during the life of the CLO the originator would need to sell to the CLO not only the loans contained in the initial portfolio, but also all other “post-closing” loans, both during and after the reinvestment period. This rules provide that, where there are multiple originators, the retention must be fulfilled by each originator in relation to the proportion of the total securitized exposures for which it is the originator. So if a loan were to be acquired other than from the entity identified as the originator, the seller of that loan would constitute a second originator and would need to hold a share of the retention.
However, the final draft the EBA’s regulatory technical standards (RTS), published on Dec. 17, introduces a significant new concession: It provides that the retention requirement may be fulfilled in full by a single originator, provided that this originator has “established and is managing the program or securitisation scheme.” That means that the collateral manager can satisfy the risk retention requirement so long as it has itself acquired some of the loans and then, after a period of holding them for its own account, sold them to the CLO.
It may be sufficient for the collateral manager to originate a single loan sold to the CLO there is no level of origination required beyond the requirement that the collateral manager be an originator. In this case, however, consideration would need to be given to the consequences of default, redemption or sale of that loan. In addition, the collateral manager of any CLO using such a structure will need to ensure compliance with the Investment Advisers Act of 1940 (including the rules relating to client cross-trades and principal trades) and any U.S. tax guidelines to which the CLO is subject.
The final draft RTS will not take effect until it is issued by the European Commission in the form of an EU regulation. It is expected, but not certain, that the RTS adopted by the European Commission will be in the same form as the final draft RTS.
Nick Shiren is a partner and Robert Cannon is an associate in the capital markets department of the London office of Cadwalader, Wickersham & Taft.