Global credit funds & CLO's
October 2020
| Issue 228
Published in London & New York.
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October 2020 | Issue 228
CLO market splits en route to Volcker rule compliance
Hugh Minch
Volcker rule amendments freeing CLOs from many of the restrictions of the past decade came into law on 1 October, allowing managers greater flexibility in how they invest their portfolios. But the market is split on how exactly CLO documents should be structured as the first slate of unrestricted CLOs print.
Managers and investors are faced with two options to issue legally compliant deals: they can continue to rely on the loan securitisation exemption (LSE) under Volcker, which now permits them to hold up to 5% of their portfolio in non-loan assets, such as high yield bonds; or they can do away with the LSE and rely on the safe harbour rule, since a triple A investment in a CLO is no longer considered an ownership interest and is therefore Volcker compliant.
Industry lawyers say there is no market consensus between the two routes in recent new issue CLOs. If the market is able to coalesce around a favoured route, CLO portfolios could look very different in the months and years ahead, because deals that do not rely on the LSE could have bond buckets greater than 5%.
“We’re seeing some deals that have a 5% or even 10% bond bucket, but in other deals there has been some push-back because the debt investors have not due-diligenced the manager’s investment team with respect to high yield bonds,” says Allen & Overy partner Nick Robinson. Managers may have to go the LSE route if a US bank subject to Volcker restrictions has an equity position in a CLO. This is rare, but market participants say there are examples of such scenarios. In addition to bond buckets, managers and equity investors across the board are pushing for greater flexibility to add extra capital into their deals to participate in workouts, especially in light of increased defaults resulting from the coronavirus pandemic. “There’s more flexibility on the deal acquiring workout securities in a restructuring if the CLO does not rely on the LSE,” says Paul Hastings partner Eugene Ferrer. “If the deal relies on the LSE, then it’s less flexible because the collateral manager must determine that acquiring workout securities will be permitted by the LSE.”
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“If the deal relies on the LSE, then it is less flexible ”
Eugene Ferrer
, Partner | Paul Hastings
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