Over the last year and a half, asset managers of collateralized loan obligations (“CLO Managers”) have been focused on developing various strategies to enable them to comply with the retention requirements of the final U.S. risk retention rules (“U.S. Risk Retention Rules”)1 which become effective on December 24, 2016 (the “Effective Date”). Because most CLO Managers of broadly syndicated CLOs historically operated as independent fee for service agents (akin to mutual fund managers as opposed to the “originate to distribute” sponsors envisioned by the US Risk Retention Rules), these risk retention compliance strategies have invariably required some capital formation component, including the capitalized manager vehicle (“CMV”), majority-owned affiliate (“MOA”) or capitalized majority owned-affiliate (“C-MOA”), a hybrid of the two, each of which have been discussed in previous Dechert OnPoint articles.2 Such capital formation activities have in turn provided the impetus for an increasing number of collateralized loan obligations (“CLOs”) issued prior to the Effective Date that are designed to be “structurally” compliant with the U.S. Risk Retention Rules (i.e., with the CLO manager or a majority-owned affiliate owning a 5% vertical or horizontal interest (the “Retention Interest” or “eligible vertical interest” or “eligible horizontal residual interest,” as applicable) in the CLO upon closing). For sponsors with regulatory capital constraints, the eligible vertical interest may result in better capital treatment and therefore be preferable, whereas sponsors seeking a potentially higher return may prefer an eligible horizontal residual interest...
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