LSTA objects, gives alternatives to re-proposed risk retention proposals that would harm CLO market

By Toni Weeks

San Luis Obispo, Calif., Oct. 30 - The Loan Syndications and Trading Association submitted comments to federal regulators on Wednesday objecting to the re-proposed regulations to implement risk retention rules under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 on Collateralized Loan Obligations, according to an LSTA news release.

The LSTA also offered alternative solutions in the comment letter to prevent the "harmful consequences" that the re-proposal poses to the CLO market and the economy.

Under the re-proposal, CLO managers would have to hold securities issued by the CLO in an amount equal to 5% of the fair value of the CLO, and banks that arrange corporate loans hold 5% of the notional amount of each loan that could be purchased by a CLO. In each case, the party retaining the risk would be prohibited from hedging or selling its exposure for the life of the CLO or loan.

"The risk retention options offered by the oversight agencies would result in a drastic reduction in the issuance of CLOs, which provide almost $300 billion in loans to America's job-creating corporations," LSTA executive director Bram Smith said in the release. "The agencies' proposed rules, if implemented, would dramatically decrease CLO formation and significantly impede important credit markets that companies rely upon for growth."

According to the LSTA, risk retention rules were designed to apply to "originate-to-distribute" asset-backed securities, not CLOs, which are actively managed vehicles that purchase commercial loans in the open market but do not originate and sell them.

CLOs experienced virtually no defaults during the recent financial crisis and surpassed the financial performance of investment-grade bonds, the LSTA noted. Research indicates that imposing risk retention would reduce CLO formation by more than 75%.

In the comment letter, the LSTA provided a proposal for avoiding the negative consequences caused by imposing the risk retention rules.

As they did in the mortgage market, agencies should recognize a category of high-quality leveraged loans that would not attract risk retention, the LSTA suggested. The quality level would be based on the low loss experience on these loans, the robust underwriting process undertaken by CLO managers for the loans they select and the fact that virtually all CLO managers are registered advisers subject to strict federal securities laws.

In addition, the LSTA suggested that the agencies permit third-party investors to be the sponsor if they hold a significant portion of the CLO's equity and have an active role in the CLO's asset selection criteria.

"LSTA is providing a reasonable solution to address this issue," said Elliot Ganz, general counsel and executive vice president of LSTA, "and we are committed to engaging with the agencies to assist them in the challenging task f implementing Dodd-Frank in a manner that does not adversely impact CLOs, the corporate credit market and America's job-creating companies."

The LSTA is the trade association for the corporate loan market. It is located in New York.

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