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LSTA: Dodd-Frank requirements for CLOs threaten market failure
By Jennifer Chiou
New York, April 4 - The Loan Syndications and Trading Association proposed in a comment letter to joint federal agencies new risk retention guidelines for collateralized loan obligations, which would meet requirements contained in the Dodd-Frank Act and also allow the CLO market to continue to function.
The LSTA said it a news release that the joint agencies, including the FDIC, the Federal Reserve and the Office of the Comptroller of the Currency, "currently appear to favor guidelines, which would effectively shut down the market."
"In contrast to the agencies' proposed rule, which would require a CLO manager to purchase $25 million of notes for every new $500 million CLO, our proposal would envision CLO managers retaining 10% of the credit risk in a more manageable form," Bram Smith, executive director of the LSTA, said in the release.
"Our approach would continue to align the manager's interests with those of its investors while more than fulfilling the Dodd-Frank risk retention requirements."
The association's proposal, which was developed by an industry working group organized by the LSTA, would replace a CLO manager's current fee stream with a series of unfunded class M notes at each point in a CLO's capital structure, the release stated.
The notes, which would be owned by the CLO manager, would replicate the traditional fee stream and would expose the manager to more than 5% of the credit risk of the asset pool, the LSTA said.
In addition, managers would purchase 5% of the equity tranche of the structure. Together, the unfunded notes and the equity purchase would expose the manager to more than 10% of the credit risk, doubling the 5% risk retention mandated by the Dodd-Frank Act, the LSTA noted.
The trade association for the corporate loan market was founded in 1995.
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