CLOs shift to complex risk retention vehicles
Third-party originator platforms seen as compliant
ICG uses Napier Park, follows Five Arrow in May
European CLO managers are turning to a more complex solution for solving risk retention rules, taking advantage of a more settled regulatory climate and funding incentives.
The more straightforward approach has typically seen sponsor retention where a CLO’s manager retains 5% either all in equity or through a vertical slice of the tranches.
“Since the Brexit vote last summer and the provisional agreement reached by the European authorities in May this year, we are seeing more CLO managers using the originator route,” said a market source.
Originator structures see a third party hold the risk retention, working with the collateral manager to source at least half of the assets sold to the CLO.
European CLO investors have preferred to buy sponsor rather than originator structures, which were seen as being at risk of circumventing the law because they are created for the sole purpose of securitising assets.
This is starting to change.
“These platforms, if set up correctly, do actually work and meet the spirit and letter of the rules, even when the new rules come into force in the beginning of 2019,” said Franz Ranero, a partner at Allen & Overy.
STS SINKS IN
While most CLO managers still create their own risk retention solutions, there has been an increase in originator platforms that are not captive to a particular manager.
In mid-July, Intermediate Capital Managers used a third-party originator, Napier Park, to hold the risk retention for St Paul’s CLO V, a €365m reset it priced via Credit Suisse. Napier Park was also the third-party risk retention holder for Five Arrows’ Contego IV, which priced in May.
“I think the reason why we’re seeing a bit more of an uptick in third-party originator structures, as compared to manager-originators, is because of the political compromise on the upcoming EU securitisation regulations,” said Ranero.
“The various changes proposed by the European Parliament’s Economic and Monetary Affairs Committee - which would have thrown a dark cloud over originator platforms - were struck down.”
The Simple, Transparent and Standardized Securitisation framework (STS), part of the EU Capital Markets Union, has soothed fears about a high-risk retention requirement for CLOs. Last year EU MEP Paul Tang proposed a 20% risk retention, which has since reverted to a more market-friendly 5%.
However, despite more clarity on the regulatory climate, market participants acknowledge third-party originator vehicles are still viewed by investors with some hesitancy in Europe.
“It’s a fairly new approach to risk retention, which also meets the EU’s guidelines,” said Michael Curtis, a managing director at ICG.
The Class As on ICG’s St Paul’s CLO V priced at three-month Euribor plus 90bp, in line with Barings 2017-1 EUR CLO, which used a sponsor structure that also printed that week.
“You could argue that we should have priced wider because we have a third-party risk retention structure. Some of our regular investors did not participate in the deal as they were unfamiliar with the structure,” said Curtis.
Brexit has also been cited as a reason for more originator structures, as some investors fear UK-based managers would no longer comply with the EU’s financial markets and regulatory standards under MiFID - specifically, that they would no longer meet sponsor criteria.
“If you are a sponsor, you have to be a MiFID entity, and if you are in London and you fall out of MiFID [compliance], it becomes a problem,” said an investor. “With an originator, you don’t need MiFID.”
But Ranero said that he does not think Brexit is influencing the move to third-party originators.
“The reason ICG or Rothschild or whomever would use a Napier Park type of platform is because they prefer not to commit the capital and funding to hold the risk retention themselves - so they’re willing to partner with another party to find another solution to holding the risk retention in a compliant manner.”
This can also benefit CLO investors.
“Third-party originator risk retention vehicles are able to negotiate CLO manager fee discounts, which can potentially improve economics for CLO liability investors,” said Serone Capital’s chief executive, Neil Servis.
“However, this may have the effect of reducing the CLO manager’s alignment in the case where capital is provided by sources other than the manager, and as a result could lead to future market tiering.”
He also said, however, that third-party capital providers to originator structures are committed to the life of the deal.
Nonetheless, there are concerns that third-party originators distance CLO managers from their funds with risk placed with less directly accountable parties.
“Some of these vehicles are basically funded by third parties that have nothing to do with the actual sponsor, and are managed by another company. So there is that moral aspect of it that might be a risk,” said one investor.
He said, however, that he feels comfortable with most of what he has seen - unlike in the US CLO market, which has seen some aggressive structures even including a “re-pack” of the risk retention - taking a vertical strip and then issuing another set of notes from the retention holder.
“That is proper selling of the risk. We haven’t seen anything like that in Europe, at least for now.”
Meanwhile, CLO risk retention activity continued at pace last week. Investment manager Neuberger Berman closed a CLO risk retention vehicle for approximately $450m of committed capital. Neuberger Berman Loan Advisers will comply with both US and European CLO risk retention rules.