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CLO Rule Aimed to Pass Retention to Banks Won’t Work, RBS Says

Newly proposed rules allowing managers of collateralized loan obligations to shift risk retention requirements onto banks probably won’t work, according to Royal Bank of Scotland Group Plc.

Regulators, including the Federal Reserve and Federal Deposit Insurance Corp., today proposed allowing CLO managers to avoid holding 5 percent of the fund if the banks arranging the loans they purchase retain the risk instead, RBS said today in a research note. This new option under the proposed regulation, which is part of the sweeping financial overhaul mandated by the Dodd-Frank Act, isn’t viable for fund managers because banks underwriting loans typically don’t retain any portion of the debt.

CLO issuance of $52 billion this year is nearing the $56 billion sold in all of 2012, according to an Aug. 20 report from Wells Fargo & Co. The rule may lead to a reduction in the number of firms managing CLOs as smaller managers with less access to capital needed to hold 5 percent of their pools will be forced to leave the market.

“While this was an accommodating attempt by regulators, it may fall short on the scope of the issue,” Kenneth Kroszner, a CLO analyst at RBS in Stamford, Connecticut, wrote in the research note.

CLOs purchase junk-grade corporate loans and package them into securities of varying risk and return.

The creation of new funds, which collapsed after Lehman Brothers Holdings Inc. failed in 2008, is on track to be the most since a record $104.7 billion of CLOs were formed in 2007.

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