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Opinion CLOs
The NAIC’s Super Bowl Sunday memo seems to suggest regulations may not change greatly
by Thomas Majewski
Thomas Majewski
Founder & managing partner
Eagle Point Credit Management
One might feel frustration to see a third team take the field and add to the chaos
The action on Super Bowl weekend was certainly not what anyone expected. Instead of the same story we’ve witnessed over the past two years, the ground shifted in a way that could affect outcomes for years to come… and I’m not talking about the football.
More than a year and a half ago, the National Association of Insurance Commissioners (NAIC) set out to examine concerns it had over some newer or growing areas of securitisation for insurance investors. These included Collateralised Fund Obligations (CFOs), rated feeders and other structured products like CLOs. The curiosity around whether the current risk-based capital (RBC) rules were still adequate after more than 30 years without an update was reasonable, especially in the face of the growing appetite from insurance investors for CLOs.
What started as a reasonable inquiry has taken many twists and turns. For CLOs specifically, the process has been challenging for the NAIC, due to the actively managed nature and long-standing extraordinary credit performance of the asset class. How does one model the dynamic nature of the portfolio during the reinvestment period, which has allowed CLOs to be resilient — and often outperform — in times of volatility?
Adding further complexity to the process, the NAIC has had two groups working on this problem separately, with potential disagreements concerning the end results.
Insurance investors dispute risk assumptions
On one side, the CLO modelling project undertaken by the Valuation of Securities (E) Task Force (VOSTF) has been met with opposition from insurance investors as the VOSTF argues that products like CLOs and CFOs are riskier than historical performance indicates. Numerous market letters have been sent to the VOSTF in hopes of encouraging greater revisions in its assumptions, which seem overly punitive and unrealistic.
On the other side, the American Academy of Actuaries (AAA) was engaged to evaluate market data and opine as to whether a comprehensive modelling RBC regime would work for CLOs. The current regime uses the rating as a single factor RBC determination. The AAA’s findings are still to be produced, but many believe that the AAA should inform the ultimate modelling project since it seems it will use historical data to inform realistic (yet still conservative) assumptions.
The uncertainty in the outcome of the modelling project has created a significant amount of insecurity for insurance investors as expectations can seemingly vary materially at the lower mezz and equity levels.
Then came the recent executive committee (EC) memorandum from the NAIC, released on Super Bowl Sunday. Despite its brevity, the memorandum seeks to refocus and streamline processes that the NAIC will undertake to address gaps across the RBC framework by prioritising consistency across asset classes, data-driven outcomes and solutions that consider the tenet “equal capital for equal risk”.
EC aims to resolve market uncertainty
One might first feel frustration to see a third team take the proverbial field and add to the chaos. In this instance, however, the EC is likely to provide clarity and care in addressing the loud concerns of many market participants.
The EC says it plans to work closely with external consultants and internal committees to undertake a comprehensive analysis to address inconsistencies, by providing solutions to bridge the gaps that are uncovered. In addition, the EC will seek to improve transparency and communication to limit the misunderstandings of the past year. In other words, the EC has noticed the difficulty the market is having with the current trajectory and is focused on remedying those problems.
It is still difficult to know what the ultimate outcome will be. The NAIC could delay previously proposed changes, eliminate them entirely or adjust them slightly. Importantly, given the tone and approach from the EC, it seems unlikely it will result in a substantial change from the current regulatory environment.
As we await both the AAA’s report and the results of the EC’s broader gap review, one thing is clear: the final framework will be the product of thorough analysis and multiple perspectives, which should ultimately benefit both insurers and the broader CLO market.
