Policy Fight Threatens European CLO Market


A policy fight is threatening the recovery of collateralized loan obligations [CLOs] in Europe.
The debate is very familiar to U.S. bankers and regulators: Who should keep ‘skin in the game,’ and how much, when loans are packaged and sold?
A draft paper released by the European Banking Authority (EBA) in May calls into question what had been a common interpretation of the requirement for sponsors to retain a 5% economic interest in CLO deals. Participants understood that a third party could have this exposure, as long as the interests of this third party were aligned with those of the sponsor.
This interpretation made it easier for smaller CLO managers to bring new deals to market. Now that it has been called into question, the pipeline that some estimate could have reached $7.8 billion in volume by year-end is virtually shut, at least temporarily.
“The EBA consultation has already had a negative effect in stopping or slowing transactions in the pipeline,”says James Waddington, a partner in the London office of law firm Dechert. “This is unfortunate since these CLO transactions were beginning to provide additional liquidity to the European loan market where banks have been somewhat constrained, including lending to small- and medium-sized businesses.”
The CLO market’s performance matters to banks because they invest in and market CLOs, and CLOs also invest in loans syndicated by banks.
The U.S. CLO market has been on a roll. It hit $55 billion last year after slowing during the financial crisis, and some have said it could reach $70 billion this year.
The revival of the European market began just a few months ago. Six European managed CLOs have been completed this year, three of them before the draft paper’s publication. Predictions for more are currently being rethought.