LSTA Comments on EU STS Amendments that Could Increase Risk Retention to 20%

July 20, 2016 - In early June, we learned that the European Parliament’s Committee on Economic and Monetary Affair’s (ECON) proposed amendments to the EU’s “STS” securitization rules were, shall we say, problematic. In a nutshell, the amendments had the potential to increase risk retention to 20% and to effectively prevent US CLO managers from issuing European CLOs and from accessing the European CLO investor base. Needless to say, we had to comment. And so, on Tuesday, the LSTA submitted a comment letter to European Parliament explaining why we believe that these amendments would be a bad idea. The comment letter is available here and the key issues – and our feedback – are recapped below.

As background, the STS rules were meant to reduce capital charges on “simple, transparent and standardised” securitizations in order to help revitalize the European securitization market. (To be clear, CLOs do not qualify as STS.) However, some members of European parliament saw the STS rules as an opportunity to introduce more restrictions into all securitizations (STS and otherwise). Specifically, the proposed amendments to STS include i) increasing the risk retention from 5% to 20%, ii) requiring the originator, sponsor or original lender to be EU regulated entities, iii) limiting investors in European securitizations to EU regulated institutional investors, iv) mandating extensive disclosure and v) prohibiting securitizations from being established in non-EU countries that are, effectively, tax havens.

In our response, we focused on four issues: i) risk retention increasing to 20%, ii) the requirement that the risk retainer must be a European institution, iii) the requirement that the investor must be a European institution and iv) language that could prevent Cayman Islands-based CLOs from being permissible securitization SPVs.

Needless to say, we believe the increase from 5% – already rather challenging – to 20% would be problematic for all securitizations. The challenges are particularly acute for open market CLOs; after all, open market CLO managers do not naturally have big balance sheets to purchase and hold 5% - let alone 20%! Second, we believe that limiting the manager and the investor to EU entities will reduce geographic diversification (and hence increase portfolio riskiness). We also believe that forcing all securitizations to be purely European could be perceived as a protectionist measure and could be poorly received by other jurisdictions. Finally, we discussed extensively why CLOs use the Cayman Islands as a jurisdiction (primarily to ensure tax neutrality). In addition, we extensively documented how the Cayman Islands meet all the conditions that the STS amendments puts forth for suitable (non-tax haven) jurisdictions for CLOs.

The LSTA will continue to follow this issue and will engage as appropriate. For more information, please contact Meredith Coffey ([javascript protected email address]) or Elliot Ganz ([javascript protected email address]).

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