On April 7, 2017, the Loan Syndications and Trading Association (LSTA) submitted a letter to the Secretary of the Treasury seeking the elimination or modification of ABS risk retention rules for managers of collateralized loan obligation (CLO) transactions.

The letter was written in response to the executive order on core principles for financial regulation issued by President Trump on February 3, 2017, directing the Secretary of the Treasury to consult with member agencies of the Financial Stability Oversight Council (FSOC) to identify and report upon policies and regulations that are counterproductive to the executive order's core principles on financial regulation. The LSTA submitted the letter to identify the risk retention rules for consideration by Treasury to during its consultations with its member agencies on the executive order.

The LSTA letter asserts that the rules provide no benefit to market participants and thus inhibit one of the executive order's core principles of making "regulation efficient, effective, and appropriately tailored." The LSTA letter states that the rules are "harmful to the capital markets, investors, US companies dependent upon loans supported by CLOs, and consumers," and expresses that the LSTA seeks to eliminate the risk retention rules as they apply to open-market CLO managers. The letter also provides three alternatives for reformation of the rules.

The LSTA reasons that none of the concerns that prompted the risk retention rules, such as the avoidance of market risks caused by "originate to distribute" securitizations, apply to CLO managers because CLO managers are not loan originators. Unlike loan originators, CLO managers have a financial interest in the underlying CLO assets since their compensation depends on the performance of the assets.

Furthermore, the LSTA asserts that CLOs provide inherent protections for investors through transparency of securitized assets and the built-in restraints on the management practices of open-market CLO managers. The LSTA cites the favorable performance of CLOs during the financial crisis, with the default rate being one-tenth to one-fifth that of equally rated corporate bonds, as evidence of their resiliency and built-in protections for investors.

Accordingly, the LSTA contends that the risk retention requirement as applied to CLO managers provides no benefit to the market and instead imposes significant harms on the market and market participants, including:

The LSTA concludes by providing the following three alternative methods to reform the rule and thus avoid the harms that it suggests will otherwise result from the rule as applied to open-market CLOs:

The LSTA expressed concern over the rules as they apply to open-market, or independent, CLOs, which securitize assets that are purchased on primary and secondary markets. The LSTA submitted numerous comment letters before the rules were adopted, arguing that the risk retention requirements should not be applied to open-market CLO managers.

In addition, on April 14, 2017, the LSTA submitted a letter to Senators Michael Crapo and Sherrod Brown in response to the Senate Banking Committee's request for legislative proposals to foster economic growth. In the letter, the LSTA asserted that the current risk retention rules adversely impact CLO managers and outlined a legislative proposal to ease the requirements through the organization of qualified CLOs, or "QCLOs" (see Practice Note, ABS Risk Retention: LSTA Lawsuit and Other CLO Risk Retention Reform Efforts).

The LSTA's latest efforts to reform the risk retention rules as they apply to CLOs come on the heels of a defeat in federal court. On November 24, 2014, the LSTA filed a lawsuit against the Federal Reserve and the SEC, seeking relief for CLOs from the risk retention rules, claiming that the final rules "disproportionately punish an industry that was not involved in the financial crisis" by requiring CLO managers to retain 5% of the credit risk of securitized asset pools (see Legal Update, LSTA Sues Federal Regulators over Risk Retention Rules for CLOs).

On December 22, 2016, the US District Court for the District of Columbia ruled against the LSTA, holding that the risk retention rules apply to CLOs (see Legal Update, District Court Rules Against LSTA in CLO Risk Retention Suit). The court found that a CLO manager is a "securitizer" and that the measurement of credit risk under the rules was appropriate and reasonable. The court therefore declined to provide an exemption for CLOs. The LSTA has appealed the ruling.

For more information on the ABS risk retention rules, see Practice Note, ABS Risk Retention under Dodd-Frank.