NEW YORK, Aug 11 (Reuters) - US regulators are remaining publicly silent as questions about risk-retention rules continue to mount, which is leading to confusion in the Collateralized Loan Obligation (CLO) market as participants try to add provisions in documents that could be prohibited under the rules.
Risk-retention rules that require CLO managers to hold some of their funds’ risk came into effect more than seven months ago as part of the Dodd-Frank Act, and require firms to have ‘skin in the game’ to ensure manager and investor interests are aligned.
Market participants are lobbying the Securities and Exchange Commission (SEC) for clarity on questions and discrepancies in application of the regulation.
CLOs are the biggest buyers of US leveraged loans and issuance is booming. US CLO volume of US$52.4bn is up 100% in the first six months of the year compared to the first half of 2016.
The SEC oversees investment managers and has given some informal guidance to CLO market participants, but has not issued formal or public responses such as an interpretive letter or no-action letter since the rule took effect in December 2016.
A response, or the lack of one, may indicate regulators’ views of the significance of the issue, according to Travis Norton, policy advisor and counsel at Brownstein Hyatt Farber Schreck.
“If [the question] affects an entire market or an entire segment of the economy, it will probably get regulators’ attention quickly,” Norton said. “If it is a niche issue, even if it has merit, it moves down the priority list, even if the issue is glaring and easily resolvable.”
Lingering questions have led to long, drawn-out document negotiations, and requests for the inclusion of provisions in CLOs that may or may not be allowed under the rule.
One outstanding question is what happens to retention after a firm sells its CLOs. Under the rules, the original CLO manager would still be responsible for holding the risk even if the firm no longer oversees the deal.
CLO investors and managers have asked for language to be included in the documents of new funds to allow new managers to purchase existing risk-retention securities at a fair market value after a sale.
It is unclear if the SEC would allow this and CLO market participants are citing this question as an example of where the legality of the rules do not quite match with the practicality of the situation.
An SEC spokesperson declined to comment.
Market participants are suggesting that the SEC release a frequently asked questions document to address multiple questions simultaneously, similar to the one the Federal Reserve, the Office of the Comptroller of the Currency (OCC) and the Federal Deposit Insurance Corp (FDIC) issued after the 2013 implementation of updated US leveraged lending guidance.
CLO market participants are speculating that the SEC has not offered public, formal guidance because any response would have to be coordinated with other regulators that also issued the rules, including the Fed and FDIC.
The rules are also relatively new and the SEC may want to see how the market adjusts and what type of consensus forms, the sources said. (Reporting by Kristen Haunss; Editing by Tessa Walsh and Michelle Sierra)