SEC Issues No-Action Relief on Proposed CLO Applicable Margin Reset Mechanism | Practical Law

SEC Issues No-Action Relief on Proposed CLO Applicable Margin Reset Mechanism | Practical Law

The SEC issued a no-action letter clarifying that a proposed applicable margin reset mechanism included in certain CLO notes would not constitute an offer and sale of asset backed securities by an issuing entity. ABS risk retention rules therefore do not apply to the transaction.

SEC Issues No-Action Relief on Proposed CLO Applicable Margin Reset Mechanism

Practical Law Legal Update w-003-5394 (Approx. 3 pages)

SEC Issues No-Action Relief on Proposed CLO Applicable Margin Reset Mechanism

by Practical Law Finance
Published on 21 Sep 2016 • USA (National/Federal)
The SEC issued a no-action letter clarifying that a proposed applicable margin reset mechanism included in certain CLO notes would not constitute an offer and sale of asset backed securities by an issuing entity. ABS risk retention rules therefore do not apply to the transaction.
On September 1, 2016, the SEC issued a no-action letter to Sancus Capital Management LP clarifying that a proposed "applicable margin reset" (AMR) mechanism built into certain notes issued in a collateralized loan obligation (CLO) transaction would not constitute an offer and sale of asset-backed securities (ABS) by an issuing entity within the meaning of Regulation RR (17 C.F.R. Part 246). ABS risk retention rules therefore do not apply to the transaction.
The proposed AMR mechanism addressed in the no-action letter is known as a reverse Dutch auction, which serves to reset interest rates at predetermined scheduled intervals during the life of the CLO. This procedure specifies a maximum number of AMR dates and is not applied to any class of securities issued under the CLO more than two or three times over the life of the CLO.
This AMR was modeled after mechanics used across the auction rate securities (ARS) market. When used in ARS, the AMR is not considered to be an offer and sale by an issuing entity. The mechanism therefore does not trigger application of the risk retention requirements under Section 15G of the Securities Exchange Act to those transactions (see Practice Note, ABS Risk Retention under Dodd-Frank).
This clarification from the SEC is necessary because most CLOs include a refinancing and/or repricing mechanism to reduce the interest paid on one or more senior tranches of CLO securities to then-current market rates. CLOs that close prior to December 24, 2016 are exempt from new risk retention requirements. However, uncertainty remains over whether a refinancing or repricing after that date would constitute an "offer and sale of asset-backed securities by an issuing entity" triggering application of the risk retention requirements to a grandfathered CLO.
Under the no-action relief, none of the CLO issuer, the CLO manager, the holders of any CLO securities, or any other party would have any discretion to call for or cause an AMR date to occur. As long as the conditions precedent to an AMR date delineated in the offering documents are satisfied, no such party would have any discretion to cancel the occurrence of an AMR date.
The request letter stated that the occurrence of an AMR date could also be subject to certain conditions precedent, including:
  • Suggested standard conditions such as the absence of an event of default under the CLO indenture.
  • Economic conditions evidenced by publicly observable economic or market indicators.
  • The CLO trustee having received an opinion of counsel that the AMR will not cause certain adverse tax consequences.
  • A proposed "settlement agent" having received confirmation from at least three broker-dealers of their intent to submit bids in the AMR.
The relief granted to grandfathered CLOs under this relief is limited specifically to AMRs that are subject to these conditions.