July 18, 2023 - In Monday’s Summer Series Session, the LSTA’s Meredith Coffey and Elliot Ganz discussed four ways that policy shifts can hit the loan and CLO markets. First is through the courts; second is through exogenous shocks that drive policy shifts; third is through regular-way rulemaking by the Regulatory Agencies; and fourth is through legislation. We offered up case studies to demonstrate each approach.
The Kirschner litigation is the mother of all case studies in how court cases can have policy effects on the loan market. For those willfully in denial, the Kirschner case will determine if Term Loan Bs are securities – and if they are, the implications for the loan market would be profound. (This will be discussed in detail in a post later this week.)
Similarly, LIBOR transition is the mother of all case studies in how exogenous shocks can have policy effects in the loan market. Because it became clear in 2017 that the IBORs were failing and their days were numbered, the public and private sector pulled together, channeled thousands of experts and millions of dollars into managing a transition to a more stable interest rate benchmark. The result in the US largely was Term SOFR which, as of earlier this month, became the de facto US lending rate for both new and old business loan contracts. And yes, it was like Y2K (in that thousands of experts labored for years to ensure that the actual transition was uneventful!).
The more “normal” route to policy shifts in the loan and CLO markets is through regulatory agency rulemaking. Rules have been coming fast and furious through the SEC in the last 18 months, including ESG, Private Funds Disclosure Rule, Custody, Outsourcing, Conflicts of Interests in Securitizations and – the example of the webcast – the Open End Fund Liquidity Risk Management Rule. Here the SEC and the industry agree in principle: Open End Funds should meet redemption requests in a timely manner. The issue is how. The SEC’s view is that redemptions should be met almost exclusively by selling and settling assets very quickly without moving the market price. (But when you sell a lot, prices move.) In contrast, the industry and the LSTA demonstrated that loan funds also have a series of tools – such as Highly Liquid Investment Minimums (HLIMs), lines of credit and expedited settlement arrangements – that allow funds to meet redemption requests even as settlement may be pending. We also agreed to enhance the liquidity toolkit noted above – and await the SEC’s response.
The final route to policy shifts is through Congressional legislation. The most famous to hit the loan market is the Dodd-Frank Act, which brought us risk retention and the Volcker Rule. In the case of risk retention, it was back to the court (for litigation by the LSTA) to clarify that open market CLOs were not actually captured in the Dodd-Frank Act. For the Volcker Rule, it took many years of analysis and advocacy to permit a small basket of securities in CLOs, as well as the recognition that an investment in AAA notes was not an equity interest(!). These case studies demonstrate that policy shifts can come from any direction and that it behooves market participants (and trade associations!) to be vigilant and proactive. The presentation replay and slides are available here.