Reprieved: US CLO managers are not subject to risk retention, court rules

09 February 2018

The LSTA has prevailed in its lawsuit against the SEC and the Federal Reserve, with an appeals court ruling that US CLO managers are not subject to credit risk retention laws under the Dodd-Frank Act.

 

The LSTA filed the lawsuit in October 2014, arguing that CLO managers are not securitisers and therefore are not subject to the Dodd-Frank regulations. In a judgment handed down on 9 February, the US Court of Appeals for the DC circuit agreed -- reversing an earlier district court decision.

 

The outcome was welcomed by the LSTA, a not-for-profit trade organisation that represents numerous CLO managers.

 

“The LSTA is delighted with this result, which vindicates our analysis of the clear statutory language and reflects the reality that CLOs have performed very well for more than 20 years, including through the financial crisis,” says Elliot Ganz, general counsel at the LSTA.

 

“This is an outright win for the LSTA”, adds a partner at a law firm. The government agencies will have 45 days to decide whether or not to appeal the decision, but the law will remain in effect until then. “If they don’t appeal, this could very likely be the end of risk retention for CLOs in the United States," the partner adds.

 

While abolishing US CLO risk retention has many benefits, there are hazards lying in wait.

 

“Most of the dual-compliant US CLOs that have been issued use the originator/manager route to complying with European risk retention rules,” says New York-based Scott Faga at Paul Hastings. “However, an originator must hold assets on its own account and transfer these into a CLO – essentially acting as a securitiser. It’s therefore possible that these deals will have to continue to comply with US risk retention.”

 

London-based Michael Smith, a CLO specialist at Paul Hastings, notes that US managers seeking dual compliance status have tended to favour the originator option over the sponsor route. “A sponsor has to be an EU-regulated entity and this can pose problems for US managers.”

 

Smith adds that many European CLOs have relied on the Foreign Safe Harbour exemption to sell up to 10% of their deals into the US.