Monday, February 12, 2018

Appeals court says CLO managers are not ‘securitizers’ under Dodd-Frank

By R. Jason Howard, J.D.

The D.C. Circuit Court has reversed the district court’s ruling that collateralized loan obligations (CLOs) are "securitizers" under SEC credit risk retention rules (The Loan Syndications and Trading Association v. SEC, February 9, 2018, Williams, S.).

Retention rules. Congress, pursuant to Section 941 of the Dodd-Frank Act, directed the defendant agencies and two other banking agencies to “prescribe regulations to require ‘any securitizer’ of an asset-backed security to retain a portion of the credit risk for any asset that the securitizer ‘transfers, sells, or conveys’ to a third party, specifically ‘not less than 5 percent of the credit risk for any asset,’” reasoning that “when securitizers retain a material amount of risk, they have ‘skin in the game,’” which aligns their interests with investors in asset-backed securities.

The SEC, along five other federal banking agencies, however, adopted final credit risk retention rules that did not exempt open market CLOs. Those CLOs securitize assets bought on the secondary market (as compared to balance sheet CLOs, which securitize assets held by one institution).

The Loan Syndications and Trading Association (LSTA) claimed the “final rules stretched the definition of ‘securitizer,’ inaptly used fair value in calculating risk retention, and failed to provide exemptive relief.”

District court. The district court held that the SEC’s and federal banking agencies’ implementation of final joint credit risk retention rules met the requirements of the Administrative Procedure Act and were entitled to Chevron deference.

Appeal. On appeal, the LSTA’s primary contention was that, “given the nature of the transactions performed by CLO managers, the language of the statute invoked by the agencies did not encompass their activities.”

The appeals court agreed with LSTA that CLO managers are not “securitizers” under Section 941 and that they need not retain any credit risk. Upon reaching that determination, the appeals court did not need to address the risk calculation issue.

The lower court’s decision was reversed and the case remanded with instructions to grant summary judgment to the LSTA on whether application of the rule to CLO managers is valid under Section 941. The district court was also ordered to vacate summary judgment on the issue of how to calculate the 5 percent risk retention and to vacate the rule insofar as it applies to open-market CLO managers.

The case is No. 17-5004.