For the past two years, the Loan Syndications & Trading Association has lobbied, largely unsuccessfully, to limit the impact of rules requiring CLO managers to keep "skin in the game" of their deals.
The trade group has appealed to Congress as well as federal regulators, arguing that risk-retention requirements, which were designed to discourage irresponsible underwriting, should not be applied to collateralized loan obligations. It has even taken the Securities and Exchange Commission, as well as the Federal Reserve, to court.
Now it is appealing directly to U.S. Treasury Secretary Steven Mnuchin.
An executive order signed by President Trump in February directs federal agencies to create task forces to evaluate federal rules and recommend whether to keep, repeal, or change them. In an April 7 letter, LSTA officials suggested several measures that would create exceptions to risk retention for CLOs. The preferred method would be for the Securities and Exchange Commission to use its rulemaking authority to exempt "persons, securities or transactions" from the Dodd-Frank Section 941 regulation requiring risk retention on asset-backed securities.
The LSTA said relief could come through either an outright exemption from the rules, or a modified requirement that managers be required to hold a much smaller stake in the credit risk (or equity portion) of a managed portfolio.
"The LSTA submitted this letter because we remain concerned about the long-term impact of risk retention on the CLO sector and loan market itself," Meredith Coffey, an executive vice president for research and regulation with the LSTA, said in a statement. "The leveraged loan market — and the thousands of companies that utilize it — benefit from the stability and reliability of CLOs."
Although the letter was directed to Mnuchin, the LSTA now has some potential allies at the SEC, in both acting chairman Michael Piwowar or his likely successor, Wall Street attorney Jay Clayton.
Piwowar, the only Republican appointee on the commission, has been a vocal critic of what he called "one size fits all" credit risk retention. In several speeches, including a keynote address at a securitization conference in 2016, the commissioner criticized the rule's failure to recognize the "distinct and different attributes" of asset classes in securitization, without consideration of the varying risks between asset-backed residential and commercial mortgages, auto loans and credit card receivables.
Trump nominated Clayton as the next SEC chair; the appointment was approved by the U.S. Senate Banking Committee earlier this month and is slated for a confirmation vote before the full Senate next month. Clayton's work has been in mergers and acquisitions as well as capital markets for clients such as Goldman Sachs, Barclays and UBS. He told the committee the Dodd-Frank Act should be "looked at" in terms of what goals it has achieved.
The LSTA's letter reiterates arguments the organization has made since the risk-retention rule's application to CLOs was finalized in December 2014. The primary argument is the fact CLO managers are not originators of loans but "thinly capitalized" asset managers who purchase collateral for deals from issuers and third-party investors, a business model "predicated on asset management rather than direct investment," the letter stated.
The LSTA insists that "applying the risk-retention rules to CLO managers provides no benefits because those rules were designed to align the interests of investors with loan originators and to avoid market risks caused by 'originate-to-distribute' securitizations," such as the collateralized debt obligations offered up by pre-crisis subprime mortgage lenders that offloaded their disastrously risky portfolios into the secondary market.
"Because CLO managers do not originate loans," the LSTA stated in the letter, "the originate-to-distribute concern does not apply."
The LSTA cites risk retention as one of the causes of a 40% decline in new CLO issuance since late 2014. While enforcement did not take place until after December 2016, CLO issuers spent the interim preparing for the rules by instituting risk-retention features on deals, with many consolidating their operations with those of other well-capitalized asset management firms.
"The responsible agencies' own analysis conceded that the rule would significantly impair CLO formation and the resulting capital available from CLOs to support the loan syndication market," the letter stated. "And they disagreed with LSTA's analysis only with respect to the particular degree of impairment."