News in brief

Insurance regulator’s ideas raise concerns

The latest proposals by the NAIC, created in response to fears of rating shopping, would create a new process for its securities valuation office to challenge the mapping for filing exempt securities where it disagrees with ratings, especially for structured equity and funds.

The proposal for this process is running in parallel with another new financial modelling process specifically for CLOs.

Under this new system, CLOs will be subject to a financial modelling process, effective from 1 January 2024, with a task-force created to develop the specific modelling methodology.

As Dechert concludes: “We anticipate that these changes could introduce uncertainty into insurers’ investment processes, potentially leading to negative impacts on the securities market.

“We believe a better approach is to provide clear upfront standards and criteria for investment structuring, rather than the NAIC’s proposed ‘relief valve’ approach, which substitutes their judgment for that of the NRSROs after the fact.”

Managers watch as unfunded tranches are issued

Unfunded tranches are almost always junior mezz, that, instead of being issued at pricing, are written into CLO documents as something that can be issued at a later date. The proceeds are then distributed to the equity investors.

“Creating an unsold junior mezz tranche is a useful option for equity investors at times when single B investors are hard to come by,” says Dealscribe head of research Paul Tilt. “They can then increase the leverage of the deal later if single B demand increases.”

According to Dealscribe unfunded tranches have been included in 40% of 2023 EUR CLOs, but until recently the structure was more an abstract concept than a reality. That changed in April when Bain triggered the feature for the first time in its Bain Capital Euro CLO 2022-2. A second example surfaced in August as Contego CLO X issued its own unfunded tranche.

Although relatively uncontroversial in principal, market participants are having to take another look at the mechanisms involved now there are real life examples to draw upon.