Contrary to many industry comments the new rules will require managers of open-market CLOS to retain risk.

On October 21, 2014, six US federal regulators (the Agencies) began voting to adopt final rules implementing the risk retention requirements of Section 941 of the Dodd-Frank Act.1 The rules require a “securitizer” to retain at least five percent of the credit risk of securitized assets, and prohibit the securitizer from transferring or hedging that retained risk. For these purposes, a “securitizer” is an issuer of an asset-backed security or a person who organizes and initiates a securitization transaction by selling or transferring assets — either directly or indirectly — including through an affiliate or issuer. Pursuant to the final regulations, the manager of a collateralized loan obligation transaction (CLO) is considered to be the securitizer for purposes of these rules. This Client Alert summarizes the key elements of the new rules that will apply to CLOs.

The Agencies specifically rejected numerous industry comments to the effect that open-market CLOs should be treated differently than other categories of securitizations because the sponsor of the transaction is an investment adviser and not in the chain of title on the assets. By contrast, in most other securitizations, the sponsor of the transaction transfers financial assets that it owns, directly or indirectly, to a special purpose entity that issues asset-backed securities (ABS). Although the collateral manager for open-market CLOs generally causes the issuing entity to purchase those assets in secondary market acquisitions, the rule expressly states that CLO managers will be subject to risk retention requirements. There are exceptions for CLOs that invest only in CLO-eligible loan tranches and for CLOs that meet the conditions of a safe harbor for foreign related transactions, each as discussed below. Unless relying on these exceptions, it appears likely that U.S.-based CLO managers, and CLO managers of transactions with a sufficient U.S. nexus, will need to retain risk (or have their majority-owned affiliates retain risk) in accordance with the standard requirements of the rule.