CLOs and Regulation: A Risk Retention Case Study

Abstract

Open market collateralized loan obligations (CLOs) have been the unintended victim of many forms of post-financial-crisis regulation, including the proposed risk retention rules. Although the sentiment of the risk retention rules might be noble, their application to open-market CLOs has been disastrous. The Dodd-Frank definition of securitizer simply does not correspond to open market CLOs, and therefore the federal agencies charged with writing the rules have tagged the CLO manager—i.e., the buyer rather than the seller—for the purpose of the risk retention rules. The reality is that CLO managers are thinly capitalized asset managers, and therefore risk retention, as currently written, would shutter the open market CLO business. A reproposal of the risk retention rule for CLOs by the federal agencies and an industry response have resulted in only possible mitigants. Industry participants hope that the agencies will continue to work on a solution that does not decimate a market that worked admirably through the worst financial crisis since the Great Depression.