Congress hits out at CLO risk rules

Prominent House Members have called for changes to proposed rules requiring collateralized loan obligations (CLO) managers to retain 5 percent of the CLO's fair value in a letter to the Securities and Exchange Commission (SEC).

The bi-partisan letter from Congressman Scott Garrett, chair of the Capital Markets Subcommittee of the Financial Services Committee, and Jim Himes, a leading member of the Committee, says the rules as proposed would unduly inhibit the issuance of new CLOs. The rules were contained in 2010 landmark financial reform bill Dodd-Frank Wall Street Reform and Consumer Act but have yet to be implemented by the SEC.

The lawmakers asked the SEC to consider alternatives to the current approach and even offered their own risk retention rules, proposing a regime for “qualified CLOs”.

The letters says qualified CLOs must meet certain criteria. For instance, the CLO would have to consist almost entirely of US dollar denominated senior secured loans and could contain no re-securitizations or derivatives other than basic interest rate or foreign exchange hedges.

The portfolio would also have to be diversified such that no more than 3.5 percent of a CLO's assets could relate to any single borrower, and no more than 15 percent of its assets could relate to any single industry. “The CLO's equity would have to equal at least 8 percent of the value of its assets, which would provide a substantial cushion for CLO debt investors,” added the letter.

The Qualified CLO label would also only be available if the CLO manager is an SEC-registered investment adviser and, as such, has a fiduciary duty to the CLO investors.