CLO Sales Threatened in Europe as Investors Await Rule Clarity

  • GSO, Chenavari said to face delays to deals they're marketing
  • More details on rules may be released at the end of September

European policy makers are undermining their own efforts to promote asset-backed securities with regulations that are deterring investors from a vibrant part of the market.

Investors are shying away from some bonds backed by risky loans because they’re concerned rules being proposed by the European Union mean some collateralized loan obligation structures will be prohibited, according to two people familiar with the matter, who asked not to be identified because they weren’t authorized to speak about it. Blackstone Group LP’s GSO Capital Partners and hedge-fund firm Chenavari are facing delays to deals they’re marketing as investors await more clarity, the people said.

Europe’s asset-backed debt market has contracted almost 50 percent since 2010 as regulators cracked down on the securities around the world after they were blamed for deepening the global financial crisis. Policy makers are now promoting the instruments because they encourage more lending to companies, while at the same time trying to limit excess risk-taking by making arrangers keep parts of the deal.

“While certain risk retention structures can be controversial, scrutiny and further tinkering could slow the pace of new deals,” said Tracy Chen, a Philadelphia-based money manager at Brandywine Global Investment Management, which oversees $67 billion of assets, including European asset-backed securities. “CLOs are one of the few sectors in the securitized debt market that saw the beginnings of a revival in new issuance this year.”

Retention Requirements

To curb excesses in the market, European investors are prevented from investing in new securitizations unless the originator or sponsor of the deal holds 5 percent of the notes. The rules, in place since 2011 and known as risk retention requirements, were designed to make sure sellers of transactions were on the hook for losses along with investors.

There are two ways of meeting the requirement. The first involves the CLO manager retaining a portion of the notes, known as sponsor retention. The second route allows a separately capitalized entity that originates or acquires and securitizes the loans to retain the required portion. That means the CLO manager can avoid directly owning any of the deal.

Draft Rules

In the draft rules leaked last month, the European Commission showed it’s trying to close a loophole that allows originator deals to misuse the retention requirements, according to Mark Nicolaides, a partner at Latham & Watkins LLP in London.

“The EU wants the entity making decisions about which assets go into a securitisation to be the same entity that holds the 5 percent retention interest,” Nicolaides said. That’s so “an originator’s interest is aligned with noteholders,” he said.

Originator structures have gained popularity in the past year because they tie up less of manager’s capital. CVC Capital Partners and AXA Investment Managers are among firms to have sold deals like this, according to Barclays Plc.

The GSO and Chenavari transactions are both originator-style deals. Andrew Dowler, a spokesman for Blackstone in London, declined to comment on any potential delay to the sale.

“Investors are definitely interested in Chenavari’s forthcoming CLO story given the strong track record of the firm,” said Kirstie McLaren, a company spokeswoman. “Most CLO investors are however currently looking forward to the clarification from regulators on the retention rules, which is expected very soon.”

Clarity on the rules may be included in a comprehensive package on securitization at the end of September.

Until there’s more guidance, liquidity of potentially non-complaint deals will be affected, said Anuj Babber, head of consumer securitization at Prudential Plc’s M&G unit in London.

Europe’s CLO market is set for its highest full-year sales tally since 32 billion euros ($36 billion) in 2007, according to Morgan Stanley. Issuance of new debt totals about 9.6 billion euros this year, the data show.

“There’s a healthy pipeline of CLOs in the market today,” said Denis Struc, a senior analyst at Henderson Global Investors in London, which oversees 82 billion pounds ($127 billion) of assets. “For CLO managers that chose the sponsor route for retention, while this approach means each deal takes up space on their balance sheet, new transactions should not be delayed.”

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