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February 02, 2018  

CLO Issuers Hopeful on Looming Court Ruling

The collateralized loan obligation market is abuzz with speculation that a pending court decision would render such transactions exempt from the Dodd-Frank Act’s risk-retention rule.

At issue is a lawsuit the Loan Syndications and Trading Association filed in U.S. Appeals Court in Washington in 2014, arguing that the Federal Reserve and SEC were mistaken in applying the skin-in-the-game requirement to CLOs. The talk among industry participants last week was that the court was ready to issue a decision in the trade group’s favor.

Whether the scuttlebutt was based on solid evidence remains in question, however.

A Jan. 26 post on the LSTA’s website from lead counsel Elliot Ganz acknowledged the rumors while noting that it hadn’t heard from the court. Ganz suggested the chatter may reflect the fact that the court issues opinions an average of three months after hearing oral arguments, which happened on Oct. 10 in this case.

Possibly helping to feed the speculation is that the judges on the appeals panel, Douglas Ginsburg, Brett Kavanaugh and Stephen Williams, were appointed by Republican presidents who had market-friendly leanings. “The LSTA is playing it cautious. But if you talk to people in D.C. — the lobbyists, and especially the ones for the large asset managers — the rumors are hot and heavy that the court is going to favor the LSTA,” one lawyer said.

That said, the rumors appeared to die down a bit after last week passed without word from the court — which typically releases opinions on Tuesdays and Fridays.

Sources said the Trump Administration has indicated that it wouldn’t appeal a ruling in the LSTA’s favor. And even if the court goes against the group, the White House might pursue other policy adjustments. An Oct. 6 report from Treasury Secretary Steven Mnuchin, for example, suggested an exemption for CLOs that meet certain criteria. Most deals would qualify.

The LSTA has argued all along that CLO issuers should be exempt from Dodd-Frank’s risk-retention rule. Under the requirement, those firms currently must keep 5% interests in their deals until they pay down two-thirds of the transactions’ principal. The mandate has pushed many issuers to the sidelines, while forcing others to adopt new structures and raise outside capital.

Over the long term, a favorable court ruling almost certainly would boost the supply of new CLOs while helping to make the offerings more profitable for managers. That said, a brief pause in issuance could come first as those firms review the wording of the decision and adjust the terms of upcoming deals accordingly. They also could flood the secondary market with equity retained from previous transactions.

There additionally are differing opinions about the extent to which certain types of issuers would benefit. On one hand, it could become more affordable for smaller firms to set up CLO programs. On the other hand, larger firms could continue their current risk-retention practices — something many investors view as protecting their interests.