DC Circuit Strikes Down Dodd-Frank Measure for CLO Managers

(CN) – Collateralized loan obligation managers are not “securitizers” as defined by the Dodd-Frank Act, and therefore cannot be required to maintain at least a 5 percent interest in the assets underlying the CLOs they create, the D.C. Circuit ruled.

The 2010 Dodd-Frank Wall Street Reform Act required the Securities and Exchange Commission to enact rules to require “any securitizer” to retain at least 5 percent of the credit risk of any securitized asset that it “transfers, sells, or conveys” to a third party.

The measure was meant to ensure that the securitizer had an economic interest in ensuring the underlying assets were properly valued – unlike many of the subprime mortgages which were improperly assessed for risk, and precipitated the 2008 financial crisis.

When enacting this rule, the SEC and Federal Reserve decided to apply the credit risk retention requirement to managers of collateralized loan obligations (CLOs), a kind of security that pools commercial loans.

The Loan Syndications and Trading Association, an industry group that represents CLO managers, challenged the rule as applied, arguing that the Dodd-Frank mandate does not encompass the activities of CLO managers.

CLO managers do not hold the securitized loans at any point, but rather directs a Special Purpose Vehicle (SPV) – a corporation specially created for this purpose – to issue notes in exchange for investors’ capital. Then the SPV purchases the assets to securitize them.

A federal judge found for the agencies, but the D.C. Circuit reversed the decision last week.

“The agencies’ disregard of context leads them to embrace a reading of ‘transfer’ that would include any third party who exerts some causal influence over a transaction. It would thus sweep in brokers, lawyers, and non-CLO investment managers who, though they play a part in organizing securities and ‘causing’ the transfer of securitized assets, are clearly not the initiators of securitizations that Congress intended to regulate,” U.S. Circuit Judge Steven Williams said, writing for the three-judge panel.

He continued: “It is an astonishing stretch of language to read a mandate to ‘retain’ to apply to one who would never hold the item at all apart from the mandate, with no congressional text mandating the prior acquisition.” (Emphasis in original.)

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