An alternative risk retention structure is circulating among lobbyists of securitisation reform in the US. The structure would significantly improve the outlook for the collateralised loan obligation (CLO) market, which faces an ominous future under the regulators’ joint proposal.
Since its release in March, a key criticism of the proposed rules has been its treatment of CLOs. The representative sample method of risk retention – where the sponsor retains a 5% representative interest in the securitised asset pool – was hoped to be a good alternative to the holding of a straight 5% interest.
But the requirement for the asset pool to contain at least 1000 assets makes the method prohibitively expensive for CLO transactions that are typically backed by high value assets.
The alternative being discussed by lobbyists and counsel is an extension of the seller’s interest-form of risk retention being offered to revolving master trust structures.
This method permits sponsors in deals backed by revolving lines of credit to retain a seller’s interest – as they normally do – that ranks pari passu with securitisation investors and equals 5% of the unpaid principal balance of the securitised asset pool.
Permitting CLO sponsors to hold their 5% interest outside of the securitised asset pool would significantly improve the instrument’s prospects.
“That is under discussion. It is not in the proposed rules at the moment, but I think there is some serious interest in permitting that,” said Morrison & Foerster partner Ken Kohler speaking at a firm webinar on securitisation reform last month.
There would be no need for an asset pool threshold (to ensure the sponsor’s interest is representative) as their interest would be in exactly the same assets, Kohler added.
The representative sample method is problematic for other sponsors, too.
The sample size is too high even for some non-CLO structures, and the sponsor’s interest would have to be serviced in the same manner as investors’ – an otherwise unnecessary burden for assets held on balance sheet.
This, according to Dechert partner Ralph Mazzeo, is an example of how the representative sample requirements won’t work in practice. But he expects the final rules to improve on this.
“The regulators were allowed by Congress to permit alternatives to the straight 5% risk retention requirement so I think it’s important that that alternative is something that is legitimate and can actually be utilized in a live deal, not something that just looks good on paper,” Mazzeo said.
Back to the table
Six regulators working on the rules has made it difficult for law firms and trade groups to get some clarity and feedback on what the final rules will look like.
No direct dialogue and each agency having different goals has sparked some concern, particularly over the process going forward. Requiring the six agencies to reconvene annually to discuss the rules is one solution.
“That’s what’s being talked about now,” said Mazzeo, “to make sure there is some mechanism to get the regulators to come back to the table and look at it again on a regular basis.”
At the top of clients’ lists of priority, however, is the premium capture reserve account provisions, said Mazzeo.
For lawyers, divergence between European and US securitisation reforms is more important. Risk retention provides some good examples: Europe does not permit the US’s L-shaped retention method, and the extraterritorial reach of US proposals may require some entities to comply with both sets of regulations.
“I think it’s evident that the regulators and policymakers on both sides of the Atlantic have given some lip service to the idea of convergence and a level playing field to avoid regulatory arbitrage where people pick and choose their jurisdictions,” said Kohler at the same webinar.
The deadline for comments on the proposed rule have been extended from June 10 to August 1 following the Financial Services Committee’s approval of delaying the derivatives rulemaking process under Dodd-Frank.