Milbank Alternative Investments Practice partner Deborah Festa was recently quoted in Private Debt Investor’s July/August 2018 CLO Report. In February 2018, the Loan Syndications and Trading Association (LSTA) won a rare victory over US regulators in a DC Circuit case in which the court held that managers of open-market CLOs need not comply with “skin in the game” risk retention requirements of the Dodd-Frank Act.
Since December 2016, US CLO managers that sponsor CLOs—securitization vehicles that are the largest buyers of broadly syndicated leveraged loans—have been required to hold securities issued by each of those vehicles representing at least 5 percent of the principal amount of the entire capital stack. These risk retention requirements were intended to be part of a broader move for increased regulatory oversight of the “originate to distribute” securitization model blamed for much of the financial crisis. The LSTA’s arguments for exempting open-market CLOs as an asset class centered on the unique structure of the vehicles when compared to that of other asset-backed structures that employ asset sourcing techniques involving the direct transfer of assets from balance sheets and that fail to offer the same kinds of built-in economic incentives for sponsors to promote the vehicles’ success over time.
According to Ms. Festa, “the fee structure used by CLO managers already aligns their interests with investors.” She adds, “CLO managers get paid at three levels; their base management fee, a subordinated management fee which is paid after interest on the secured notes, but before the equity gets any payment. Then they have the potential to receive an incentive fee after the equity reaches a certain target return. That whole compensation model is designed to create incentives for the manager to perform well and have its interests aligned with investors.”
