CLO rule change benefits PE?

A proposed rule preventing CLO managers from bringing in outside investors to help finance deals could give private equity backed CLOs a competitive advantage, but could seriously hamper available leverage in Europe.

Changes have been mooted to the rule prohibiting collateralized loan obligation (CLO) managers from bringing in outside investors to finance 5 percent of the original raising of CLO. 

The European Banking Authority’s (EBA) updated rule was presented in a consultation paper on draft technical standards on the risk retention (or “skin in the game”) requirements of the Capital Requirements Directive. The skin in the game rules cause European credit institutions to suffer a punitive capital charge if it invests in a securitization transaction in which the originator, sponsor or original lender does not hold a minimum 5 percent of the economic exposure of the transaction.

The proposed amendment to the rule  broadens the definition of a CLO sponsor to now include MiFID regulated investment firms. This would make it hard for the firms now caught by the directive to issue new CLOs without either the balance sheet or funding available to be able to finance the skin in the game. This means that when the current crop expire, a massive chunk of liquidity could disappear from the European debt markets.  

But private equity owned CLO managers may have an advantage over other managers because of their access to funds and they might find themselves facing less competition in the market, sources add.

Macfarlane’s debt partner Rachel Kelly adds that prior to these proposals there was a flurry of activity from new entrants to the market but Kelly believes the new regulations will slow this down. There were five new CLOs issued this year compared to the three issued in the previous three years previously.

Traditional private equity firms that are diversifying with debt vehicles include Europe’s largest CLO manager, Blackstone’s GSO Capital Partners, and Carlyle too is a major player in the CLO world with a current European CLO valued at €365 million. 

The newly proposed regulations will not come into force until 2014, although the risk retention rules as set out in Article 122a of the Capital Requirements Directive are already in force.

The consultation on the draft technical standards runs until August 22, with a public hearing at the EBA to be held on July 22.