The SEC is reportedly considering a compromise that would allow legacy collateralized loan obligations (CLOs) (those CLOs issued before December 24, 2014) to refinance tranches after the final Dodd-Frank ABS credit risk retention rules take effect for CLOs in December 2016 without having to hold the required 5% of credit risk of the CLO transaction as required under the final rules. It is intended that the compromise would help managers of CLO funds to refinance as they struggle to comply with the final credit risk retention rules, which were approved by federal regulators in October 2014 (see Practice Note, ABS Risk Retention under Dodd-Frank).

The rules require CLO managers to maintain a 5% financial interest in their investment vehicles, or "skin in the game," which industry groups say few can afford. The SEC and the LSTA have been discussing the possibility of an SEC no-action letter in response to an LSTA request for no-action relief on the refinancing issue. The discussions followed the filing of a lawsuit by the LSTA challenging the application of the final ABS risk retention rules to CLOs in October 2014 (see Legal Update, LSTA Sues Federal Regulators over Risk Retention Rules for CLOs). The LSTA has asserted for years that the risk retention rules are misapplied to CLOs, which already align manager risk with investor risk and which have always performed well, even during the financial crisis.

The no-action relief is not expected to apply to CLOs that are issued during the two years before the regulation takes effect on December 24, 2016. Managers of CLOs issued after December 24, 2014 that choose to refinance may therefore have to comply with the rules and hold 5% of the refinanced tranche.

According to a report from management consulting firm Oliver Wyman, only about 10 of the 30 largest CLO managers may be able to comply with the risk retention rules. Most of the largest firms that may be able to comply with the rules are affiliated with an insurer or large asset manager. CLO issuance in 2014 was a record $123.6 billion as managers raced to issue CLOs before the retention rules take effect.

Many argue that the potential SEC relief may not go far enough. According to the Oliver Wyman study, fewer managers and a potential inability to reduce interest rates to improve equity returns may lead to lower CLO issuance. The struggle to finance the 5% holding could drive mergers between firms and acquisitions of smaller managers.

More than $53 billion of CLOs have been raised in the US this year, according to data compiled by Thomson Reuters LPC. Between $70 billion and $110 billion is forecast for 2015. However, predictions that there could be as much as a 75% reduction in credit provided by CLOs over the long term due to the rules seem somewhat exaggerated.