EU Regulator May End Third Party CLO Investments, Ashurst Says

Europe’s top banking regulator may prevent arrangers of collateralized loan obligations from bringing in outside investors to meet their risk retention requirements, according to Ashurst LLP.

The European Banking Authority has proposed changing the definition of “sponsor” to include investment firms that often arrange CLO deals, according to a report from Ashurst, a legal adviser for banks. The alteration “would not permit a third party equity investor to act as retention holder.”

Arrangers of securitizations must retain 5 percent of a deal to align the interests of originators with investors. CLO managers were able to bring in outside investors to be the risk retention holder because of difficulties finding an institution able to satisfy the definitions of originator, sponsor or original lender, Ashurst said.

CLOs purchase speculative-grade loans and package them into securities of varying risk and return, typically from AAA ratings down to BB. The lowest portion, known as the equity tranche, offers the highest potential return and the greatest risk because investors are the first to see their interest payouts reduced when loans backing the CLO default.

The proposed alteration would also have an impact on outstanding CLO deals, Ashurst attorneys wrote. It “is likely to affect liquidity, and therefore the price at which CLO paper trades, as potential purchasers will be on notice that the transaction does not comply with the final technical standards.”

The EBA said in its draft paper that the changes “could potentially translate in the long-term into a modification of the currently existing managed CLO model.” Consultation on the new rules runs to August and they may be introduced at the start of 2014.

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