Cayman Islands: Cautious Confidence In The CLO Market Gives A Boost To The US Credit Markets By Julian Black And Nicola Bashforth

Last Updated: 8 November 2012
Article by Appleby  

At a time when global capital markets enter a fifth year of stagnation, one segment of the credit markets is seeing signs of recovery, and whilst the collateralised loan obligation market is not yet up to par with the pre-credit crisis peaks, the year to date has seen the highest level of activity since 2007. During the first six months of this year, US$17.9 billion of CLOs were issued in the US, compared to US$12.3 billion for all of 2011, and the general feeling is that post Labour Day, the summer-lulled market will pick back up again and we could end the year at US$25-30 billion of issuance.

The deal pipeline is strong and managers are seeing the appetite of traditional investors in AAA rated tranches, such as the Japanese banks and pension funds, increase, albeit cautiously, with one eye on the eurozone. The investor demand for the product means a knock on demand for the underlying assets themselves, being commercial loan collateral and that availability of credit is aiding the post credit-crunch recovery in the US.

Back-to-basics: So what is a CLO?

A CLO or 'Collateralised Loan Obligation' is a term used to describe a type of structured finance transaction. Typically a CLO issuer will be a Cayman Islands incorporated exempted company and that issuer will issue several tranches of notes, which is debt, with an expected rate of investment return. The total amount of debt issuance on any one deal is large, totalling anything from US$200 million to US$1 billion. The notes are tiered, such that one tranche receives payments (interest and any principal due) on a payment date and, if additional funds are available, the next tranche of notes will receive payments. The top slice is often called the triple A debt because it receives the highest rating from the rating agencies (AAA). Investors in this piece typically have a conservative investment strategy and are risk averse. Down at the bottom of the 'waterfall' sits what are called 'equity investors', this subordinated debt (lowest tranche of notes) receives no fixed rate of return but basically receive the remaining profits of the deal after the higher tranches have been paid. These investors have greater tolerance to risk and, if the deal is performing well, they will see a greater rate of return. The benefit of a CLO to investors is that they are able to gain exposure to an investment product typically reserved for direct bank lenders and loan originators.

What is the collateral?

The proceeds of the issuance of the tranches of notes will be used to buy a bundle of commercial loans. These are generally large broadly-syndicated loans advanced by a lender to 'Corporate America' in an amount of US$10-20 million, which the lender then sells to the CLO issuer, using the proceeds to carry on its lending business. The Cayman based CLO issuer is the entity that holds the loan, takes the risk of such loan defaulting and uses the proceeds of the underlying loan payments to pay out the obligations on the notes to the CLO investors. The bundle of loans in a typical US CLO have a diverse spread in terms of the underlying obligors across numerous sectors of the economy (such as telecommunications, metals & mining, oil and gas, engineering, healthcare, entertainment, leisure, chemical and retail corporations) and geographically spread across North America. In choosing the pool of collateral, the intention is to spread the risk so the assets are not based in any one sector or location.

Weren't CLOs involved in the financial crisis?

At the heart of the financial crisis lay a different type of financial product, the CDO, which is a 'Collateralised Debt Obligation'. The assets held by a CDO issuer were a mix of numerous types of debt assets and other highly complex financial instruments. In particular, CDOs included high volumes of securities ultimately backed by sub-prime residential mortgages often concentrated in particular US States (such as FL, AZ and CA). When the US residential market began defaulting, that caused defaults by the CDO issuers and financial catastrophe for those who had bought or guaranteed huge amounts of these CDO securities, for example Lehman Brothers and AIG.

CLOs of the pre-credit crisis, known as CLO 1.0, managed to remain relatively unscathed with nominal defaults because of the nature of the underlying collateral. Today's CLO 2.0 has, with the benefit of hindsight, improved further in terms of documentation and the underlying asset quality. To obtain the best ratings on the notes, the rating agencies are looking for the pool of collateral to include predominantly senior secured loans and only allow a small amount of the proceeds of issue to be used to purchase second-lien or even unsecured debt. Consequently, CLOs are now seen as incredibly robust funding vehicles that have proven the tests of time.

Who is involved?

A CLO transaction involves numerous parties and the quality of the team and legal counsel is critical given the complexity of the transactions and size of these deals. Many of the 'bulge bracket' investment banks act as arrangers and underwriters of CLOs. They help structure the deal, pull in investors and assist in the marketing of the deal. There is a collateral manager who will manage the underlying assets and produce reports on the asset performance. There will be a notes trustee (typically the trust arm of the major banks such as Wells Fargo, US Bank National Association, Bank of New York Mellon, Citibank, NA) who act for the benefit of the noteholders, reviewing the collateral and collateral manager performance, noteholder communications as well as holding the underlying collateral as security for the secured parties in the transaction. Both the arranger and the collateral manager will have their own US onshore counsels which are usually the large international law firms based in New York as the transaction documents are predominately governed by New York law.

Cayman's role

Cayman provides the legal jurisdiction for US CLO issuers, based on our time zone proximity to New York and the provision of quality professional services in the jurisdiction which are attractive features to underwriters, collateral managers and their counsel. There will be Cayman counsel for the issuer, the issuer's independent Cayman directors and corporate administrator. The CLO is not a tax driven transaction, but the use of Cayman enables the transaction to go ahead without adverse tax consequences and attract many non-US investors. Some of the world's largest asset and investment management groups actively partake in the CLO market, whether as collateral managers or their private equity and fund businesses investing in the notes. While such groups might be seeing other areas of their business generating fewer profits (ie traditional investments in stocks and shares), they are seeing impressive revenues from CLO management fees and returns in some cases of 10-15 per cent on the subordinated debt tranche. With the heightened involvement of private equity and funds in the secondary loan market, some might say they are morphing into quasi-lending institutions. The post credit crisis market has seen significant levels of CLO manager consolidation as some of the largest private equity/ fund houses bulk up their credit desks.

Why is this significant for the US economy?

The availability of credit to US companies is an essential part of the US, and, therefore, global economic recovery. Without long-term debt finance as a cheap source of funding, companies can fail to meet the day to day demands on their business. That is where CLO's step in. While a CLO issuer does not originate, or provide finance directly to companies, they do provide a secondary market for those loans. Originators that lend to corporate America sell their loans and use the funds to continue to lend. The CLO market is the buyer for a good portion of commercial loans originated in the US. In 2008/2009 when the markets froze, companies needing to borrow suddenly found that the cost to obtain a loan increased because traditional sources of funds, eg banks, stopped lending. Demand on the CLO side means the cost of that credit stays reasonable.

While the hedonistic level of 2006 and 2007 issuances might be relegated to history, the element of optimism returning to this area of the financial markets can only be a good thing for the overall economic outlook.

Previously published in Cayman Financial Review, November 2012

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Related Topics
Related Articles
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of

To Use you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions