May 11, 2018 / 4:23 PM / 2 months ago

CLO risk retention now just a memory as final appeal deadline passes

NEW YORK (LPC) - After three and a half years of litigation, US Collateralized Loan Obligation (CLO) managers are now completely free of Dodd-Frank ‘skin in the game’ rules.

The phrase "Equal Justice Under Law" adorns the west entrance to the U.S. Supreme Court building in Washington December 3, 2014. Picture taken December 3, 2014. To match Special Report SCOTUS-ELITES/ REUTERS/Jonathan Ernst

The deadline for regulators to ask the Supreme Court to consider their case in a 2014 lawsuit by the US loan trade association passed Thursday, removing the final risk-retention hurdle hanging over the market.

“We are very pleased that this three and half year journey is over and that the risk-retention rule will no longer apply to CLO managers,” said Elliot Ganz, general counsel at the Loan Syndications and Trading Association (LSTA), the trade group that filed the suit.

“While the judicial process was bumpy, we are delighted that it ultimately worked and our members can get back to focusing on what they do so well, providing capital to American companies.”

The LSTA sued the Federal Reserve (Fed) and Securities and Exchange Commission (SEC) arguing that risk-retention rules that require CLO managers to hold 5% of their deal were “arbitrary, capricious” and “an abuse of discretion,” and could limit funding to the neediest borrowers. CLOs are the largest buyers of leveraged loans, which companies including retailer Party City and American Airlines rely on for financing.

In February the US Court of Appeals for the District of Columbia Circuit ruled in favor of the trade association, finding that CLOs no longer need to comply with the rule that is designed to align manager and investor interests.

After an initial 45-day window passed without regulators asking for a review back to the Appeals Court, on April 5 the District Court for the District of Columbia vacated an earlier ruling in favor of regulators, and managers were allowed to start issuing CLOs without holding retention.

Spokespeople for the Fed and SEC declined to comment.

But the threat of a Supreme Court review remained. Regulators had 90 days from the Appeals Court’s February 9 ruling to ask for the review, which they chose not to do.

The market “has been operating on the assumption that this was going to be the state of play, but this has freed people up to make decisions based on what makes sense for marketing and a deal structure perspective, and not be locked into the risk-retention mandate they were before,” said Paul St. Lawrence, a partner at law firm Cleary Gottlieb Steen & Hamilton.

Even with risk retention, US CLO volume is up almost 43% this year through May 8 compared to the same period in 2017, with more than US$43bn of deals raised, according to Thomson Reuters LPC Collateral data. Citigroup is forecasting a record US$140bn of US CLO issuance this year.

Reporting by Kristen Haunss; Editing by Michelle Sierra

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