On 9 February 2018, shortly before CLO industry participants converged on Las Vegas for the industry's largest annual gathering, SFIG Vegas 2018, the Court of Appeals for the DC Circuit ruled in favour of the Loan Syndications & Trading Association ("LSTA") in its lawsuit against the SEC and the Federal Reserve Board. Years in the making, the LSTA's case hinged on whether a CLO manager could be said to be a 'securitizer' under the Dodd Frank risk retention rules. The court found that it was incorrect to say that the manager was a 'securitizer' because managers of open market CLOs were not transferring assets into the deal, but acquiring assets from 3rd party sellers on behalf of the CLO.
Whilst industry participants wait for definitive news on whether the government agencies intend to appeal the decision, conference attendees seemed to agree there was little appetite in the current administration, or among those key regulators appointed by the same, to appeal the decision. Whilst market participants do not expect a significant influx of new managers into the space, if the decision was to become effective, some predict a few managers with active 2.0 era CLOs, who have not yet issued a risk retention compliant deal, will likely re-enter the space (albeit with the likely handicap of wider spreads). It was also predicted that small and mid-size managers may increase activities once they are no longer capital constrained; those who have outperformed their peers in recent months may also experience an upgrade in tiering in such circumstances.
Investors cautioned they would continue to look for quality deals, and made the point that the securitisation market was doing well, despite risk retention. Some investors expressed concern that the LSTA ruling may mean managers are less incentivised to give investors a voice at the table in structuring discussions; managers who continue to implement a risk retention strategy will be favoured by investors.
It was said that, for many managers, risk retention compliance was a pain coming in, and will be a pain going out. With no legal tolerance for non-risk retention compliant deals during this period of uncertainty, managers will continue to issue compliant deals until there is more clarity around the court decision. As for the time and money spent implementing a retention strategy? Unwinding these strategies will require careful consideration - consensuses seemed to be that most managers will probably retain until the next refi/reset opportunity on existing deals. As such, market participants are expecting significant refi/reset activity in the months following any clarity on the ruling, with some predicting $140 million in such activity by year end, up from $90 million last year.
On the whole, regardless of where the appeal process goes, predictions for strong market fundamentals more generally appear set to drive continued growth in the CLO market in the coming months.
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