June was a
record-breaking month for collateral loan obligation (CLO)
issuance in Europe. That dealflow could be further buoyed
if CLOs are classified as 'high quality’ under the
recently closed European Central Bank (ECB) and Bank of England
(BoE) securitisation consultation.
ECB’s joint consultation with the BoE
Commentary on the discussion paper, titled The case for a better functioning securitisation
market in the EU, has focussed on how asset-backed
securitisation (ABS) can improve small and medium-sized
enterprises’ (SME) access to finance.
But attention has now turned to the prospects of
other types of ABS in their quest for 'high
quality’ designation and the preferential
regulatory treatment likely to come with it.
It is these instruments – and CLOs in
particular – which will test the regulatory
understanding of 'high quality’, and reveal the
central banks’ true intentions for the
"If the question is whether some securitisations
are better quality than others, then CLOs should fall into the
higher quality bracket due to their structural robustness and
the structure of the senior secured loans which underpin them,"
said Nick Voisey, director at the Loan Market Association (LMA) which filed a
comment letter with the regulators.
Voisey noted CLOs’ low default rates
compared to other types of securitisations. European leveraged
loan default rates are also significantly lower than SME
- The comment period for the BoE
and ECB discussion paper on reviving securitisation closed
earlier this month;
- There is debate as to whether
CLOs should qualify for any 'high quality’
designation and the regulatory treatment that comes with
- CLOs have very low default rates
– even during the crisis;
- But the prevalence of open-market
CLOs with a fluid underlying asset pool makes it difficult to
assess their quality against given criteria;
- The fact the consultation is
issued by central banks – which have clear policy
objectives – means they could prioritise ABS that
has a direct link with the real economy, such as SME-backed
Jacky Kelly, partner at Weil Gotshal & Manges in London
agreed that as CLOs of senior leveraged loans performed well
during the downturn, from a statistical perspective there is no
reason not to include them in any designation.
Another argument for CLO designation is that investors have
the benefit of publicly accessible information on the
underlying. "There is a relatively liquid market for senior
secured loans which leads to transparency," Kelly added.
But the focus has been on low default rates and high
recoveries when there is a default.
The fact that any 'high quality’ designation
could, inadvertently, be taken by investors as approval of the
credit makes it even more important for qualifying instruments
to have a strong track record.
"It might be dangerous if a bracket was seen to be a quality
stamp which was not based on robust historical performance and
an awareness of a resilient structure," said Voisey.
There are, however, structure and market-based issues that
could work against CLOs’ bid for 'high
quality’ designation. They are similar to the
reasons why CLOs did not make the list of instruments eligible
for the prime
collateralised securitisation (PCS) label in 2012.
As with the PCS label, the BoE and ECB’s
difficulty will be that the vast majority of post crisis
– or CLO 2.0 – deals are actively managed.
The manager is not the originator, but a third party collateral
manger that actively manages the underlying collateral.
"Making a fulsome assessment of static and fully ramped up
CLOs is all well and good, but the analysis becomes a little
more complicated when you look at the current crop of deals
which are hugely actively managed," said Jonathan Walsh, global
securitisation head at Baker & McKenzie.
The eligibility criteria upon which the
manager’s buying and selling of loans must be
based is signed off by a credit rating agency. But this
increases the number of variables, making these structures are
still more difficult to assess against any
"I think the nervousness stems from the fact that you are
backing the structure, quality of the collateral manager,
quality of the eligibility criteria, and a pool that may change
from time to time," said Walsh.
Elephant in the
The unspoken question in the debate, is the extent that
political objectives attached to SMEs will drive the outcome of
It’s notable that the discussion paper was
issued by entities responsible for promoting their economies;
not their respective financial regulators
"The central banks’ intervention must be
justifiable in terms of their monetary policy mandates
– this leads them to focus primarily on asset classes
that have an obvious connection with the real economy," said
Linklaters’ Nicola Kemp.
While SME loans clearly fall into this category, there is
less political ambition to have large-cap corporate lending
kick-start the real economy.
In recent weeks, however, there have been signs that the ECB
may push its SME funding agenda through other avenues.
Its paper from earlier this month, titled SME Access to Finance in the Euro Area: Barriers and
Potential Policy Remedies, contained little reference to
neither ABS nor the securitisation discussion paper.
The Bank also has high hopes for its targeted longer-term refinancing operations
(TLTROs). The latest series will see the ECB lend eurozone
banks €700 billion ($945 billion) – with interest
payable in arrear in 2018 – to on-lend to
The BoE/ECB comment period closed on July 4. The central
banks are still analysing the responses and will make a joint
announcement on the outcome.
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