June 1, 2017 - While U.S. CLO managers are working to adapt to the 5% risk retention requirement, European CLO managers breathed a sigh of relief when it became clear that their own risk retention levels would remain at 5% and not climb higher (at least for now). Below, we discuss the details.
For several years, Europe has been working on a project to define “Simple, Transparent and Standardised” (“STS”) securitizations that would attract lower capital charges. This should, in turn, jumpstart securitization and bring more credit to European companies. However, a group within the European Parliament used the STS process to make securitization rules more stringent, consequently making securitization harder rather than easier. The faction sought to increase the risk retention amount (20% was mooted), require the originator/sponsor/original lender to be a European institution, require the investors to be European institutions and require extensive disclosure. This would have made the situation for European CLOs even more challenging.
Fortunately, after weeks of contention, Tuesday’s outcome in the “trilogue” between the European Parliament, Commission and Council appears relatively benign. Risk retention will remain at 5% for both vertical and horizontal retention. (Caveat: The 5% is not necessarily permanent; the European Systemic Risk Board will monitor risks and can increase retention levels if warranted.) It looks as though the requirement for European originators, sponsors or original lenders to be European regulated entities has been dropped. It appears that the requirement for investors to be European-regulated entities mighthave been dropped, but that is not yet clear.
There are still a few technical details to be worked out in early June, and the Permanent Representatives Committee of the Council of Ministers is expected to endorse the agreement before the European Parliament’s plenary vote.
More color on the final outcome can be found on the Bloomberg Terminal, in LCD and in a Citi Securitized Products Flash. But perhaps the particularly interesting color emerges from between the lines of the European Commission’s press release and the European Parliament’s release. The Commission welcomed the result, saying it would lead to substantial increase in investment opportunities for investors and lending to Europe’s households and businesses. Meanwhile, Parliament warned that securitization will be revived only by strengthening its prudential framework, eliminating moral hazard and restricting investors to appropriate entities (as the agreement does). The LSTA, which commented on the proposals last summer, will continue to follow the contretemps.