September 21, 2016 - September 21, 2016 – Despite widespread Zika concerns – which were extensively ridiculed by Miami-based friends of your correspondent – CLO practitioners descended upon IMN’s ABS East Conference this week. A big theme? US Risk Retention. With less than 100 days left before it goes live, most speakers acknowledged that Risk Retention is the New Normal. What would that mean? Panelists suggested we are entering a world where 40-50 managers are consistent issuers and US CLO formation sits around $50-60 billion per year.
Clearly, this suggests some Risk Retention casualties. Panelists noted that managers with just 1-4 CLOs (and no retention solution yet) may slowly fade away as their AUM runs off. Some folks think Risk Retention funds will come to fruition, while others hold out hope for acquisitions by deep-pocketed investors looking to enter the space. (But there are a limited number of these white knights, speakers added.) Meanwhile, acquisitions by other, larger managers might not happen because the buyer and seller disagree on valuation. So that was fun. (Still, while that “New Normal” is depressing, one should note that a $60-billion-a-year CLO market is a viable market.)
Leading up to those uplifting themes, LSTA EVP Meredith Coffey moderated a Sunday kick-off session that previewed a number of regulatory issues. Panelists included Scott MacDonald from Maples and Calder, Cindy Williams from Dechert, and Mike Zak from U.S. Bank. Of course, US Risk Retention was the topic du jour. One size does not fit all with respect to risk retention solutions; the panelists calculated that about 60% of the risk retention compliant CLOs year-to-date are using the Capitalized-Majority Owned Affiliate (C-MOA) structure, 25% are using a straight MOA and 15% are using a Capitalized Manager Vehicle (CMV) structure. Of course, while these CLOs may be structurally risk retention compliant, they aren’t really risk retention compliant because they have not done the appropriate disclosure, undergone the fair valuation of the retention – and dotted other i’s and crossed other t’s. All these nitpicky issues must be resolved by Christmas Eve; if you haven’t sorted out all these nits, see Dechert’s On Point on becoming really risk retention compliant.
Panelists also reminded the audience that, even after the Effective Date (Christmas Eve 2016!), they must be aware of certain risk retention tripwires. In particular, if almost any pre-Effective Date CLO is refinanced or repriced after Christmas Eve, it will be viewed as the offer and sale of new CLO securities and the manager would have to purchase and retain risk in the CLO. (A recent proposal accepted by the SEC – the Applicable Margin Reset/Auction Rate Securities approach – might mitigate this issue; see Dechert’s On Point for a discussion.) In addition, amendments that require a 100% vote also may be viewed as an offer and sale of new CLO securities and thus also trigger the need for risk retention by the manager. So, to flat-out misquote Elmer Fudd, “Be very, very careful”.
To be fair, there are issues beyond risk retention that should not be ignored. An old issue – FATCA – actually still requires a bit more work. With over 100 countries committing to implement the OECD Common Reporting Standard (“CRS”), FATCA has gone global. Cayman CLO issuers cannot rely on US tax forms for CRS compliance and must obtain a separate CRS Self-Certification Form from its certificated investors (including US investors). You should expect these self-certification forms to form part of the subscription and transfer KYC packs. For more information, see Maples’ FATCA Update.
While FATCA is an oldie but a badie, there’s a new issue on the block: Market Abuse. The European Market Abuse Regulation (“MAR”) came into force on July 3rd and replaces the existing EU market abuse regime. Critically, MAR extended the scope to include issuers listed on EU multilateral trading facilities, including the GEM of the Irish Stock Exchange, where the vast majority of BSL CLOs are listed. While the scope of “insider information” in a CLO transaction should be minimal, issuers are required to adopt policies and procedures to comply with MAR. To learn how not to go offside, see Maple’s Market Abuse Update.