On February 24, 2016, Meredith Coffey, of the LSTA, testified on behalf of the LSTA and the collateralized loan obligation (CLO) and syndicated-loan community regarding the proposed qualified CLO (QCLO) exemption from Dodd-Frank risk retention requirements for asset-backed securities (ABS) and the continued impact of the Dodd-Frank Act on CLOs.

The testimony was given to the Capital Markets Subcommittee of the House Financial Services Committee at a hearing on the impact of Dodd-Frank and Basel III on fixed income markets and securitization.

Under the final Dodd-Frank ABS risk retention rules, the sponsor of a securitization must retain 5% of the transaction's credit risk (see Practice Note, ABS Risk Retention under Dodd-Frank). The rule is designed to align the interests of securitizers with those of investors. Under the final rule, CLO managers are deemed to be sponsors, to which the retention requirement applies. This has caused some panic in the CLO community. The LSTA and others have asserted that the rule will devastate the CLO market.

In fact, the US CLO market has cooled dramatically in recent months, and the retention rules, scheduled to take effect for CLOs in December of this year, have been held partially responsible. Federal regulators have been leery of providing relief for CLOs due to fears of a bubble in the leveraged loan market (see Legal Update, Next Bubble? US CLO Assets Under Management Hit $340 Billion).

The proposed QCLO rules would allow managers of certain CLOs that adhere to the QCLO criteria, which are designed to ensure the quality of the underlying collateral assets, to purchase and retain five percent of the transaction's equity rather than the fair value of the CLO (see Legal Update, House Bill Would Broaden US CLO Risk Retention Exception). To become a QCLO, a CLO must meet six requirements regarding its:

The LSTA has previously testified three times on the continued adverse impact of the Dodd-Frank Act on CLOs, the importance of CLOs as a safe source of financing, and the necessity of a "common sense" solution such as the QCLO, which it says could help to avoid a material disruption of the CLO and corporate loan markets.

In addition to these testimonies, the LSTA continues to pursue relief for CLO managers from Dodd-Frank risk retention requirements via a lawsuit it filed against the Federal Reserve and the SEC (collectively, the agencies) on November 10, 2014 in the US Court of Appeals for the District of Columbia (see Legal Update, LSTA Sues Federal Regulators over Risk Retention Rules for CLOs).

Oral arguments were scheduled for February 5, 2016, and the LSTA reported that the judges focused on whether:

Although both the LSTA and agencies agree that the higher court was the proper venue, one of the judges implied that the case should be heard in a lower court. If the judges choose not to transfer the case, they will likely reach a decision by July 2016. However, if the case is transferred to the district court, the case may need to be expedited given the December CLO risk retention compliance date.