US funds face fewer regulations
February was a good month for the CLO industry. After a long period of uncertainty, the US Court of Appeals ruled that CLO funds would be exempt from complying with Dodd-Frank Act risk-retention rules. The deadline for regulators to appeal has already passed.
How much fuel this will add to an already heated market is unclear. Fears that regulators could force CLO managers to retain risk capital on all securities issued have done little to dampen appetite thus far. Last year saw a record $117 billion in new issuance in the US, according to Thomson Reuters – and there is good reason to believe 2018 will be no different.
Europe still faces high hurdles
Where US managers have been unshackled from regulation covering risk retention, equivalent rules in Europe remain in place. On the face of it, European CLO funds face a greater administrative and financial burden as teams work to comply with regulations.
The flip side is that it has created a higher barrier to entry for the European market, a distinct advantage for industry incumbents. However, European investors may find it more difficult to gain exposure to the US CLO market as smaller, Stateside managers forgo European commitments in order not to have to comply with EU rules.
Competition is getting more aggressive
As CLO activity ramps up, more players will be vying for fewer deals. According to industry professionals, another headwind facing the CLO market is loan supply. The most selective managers are looking to avoid aggressive terms, as strong demand from investors shifts pricing in favour of borrowers.
The market will favour managers who can generate returns through active management and can differentiate themselves with strong risk controls, credit selection and an ability to provide access to new collateral through market relationships.
CLOs are gaining traction with a wider group of LPs
The CLO market is finding broader appeal among institutional investors and asset owners. The asset class is also attractive to a wide range of investor types – including banks, insurance groups, asset managers, private equity houses and asset managers – looking for floating rate assets in a rising rate environment.
Investors increasingly find they are better placed to meet their mandate objectives by having access to a tranched structure with a range of risk profiles. Asian LPs, which had previously withdrawn from the market in the wake of the global financial crisis, have now rekindled their interest in CLOs by taking senior portions of capital structures.
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