On February 9, 2018, a three-judge panel of the United States Court of Appeals for the District of Columbia Circuit (the “D.C. Circuit Court”) invalidated the credit risk retention rule, 79 Fed. Reg. 77,601 (Dec. 24, 2014) (the “Risk Retention Rule”), as it applies to the collateral managers of open-market collateralized loan obligation transactions, or CLOs. Under the Risk Retention Rule, CLO collateral managers are currently required to purchase notes representing at least 5% of the credit risk associated with each CLO that they structure.
The Risk Retention Rule was adopted in 2014 pursuant to Section 941 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), which requires any “securitizer” of asset-backed securities to retain at least 5% of the credit risk associated with the assets collateralizing such securities. In 2016, in response to a lawsuit filed by the Loan Syndications and Trading Association, a District of Columbia district court held that the Risk Retention Rule was a valid exercise of federal agency authority and that collateral managers of open-market CLOs – the most typical CLO arrangement, in which assets are purchased at arm’s length transactions on the open market rather than being acquired from an entity involved in the structuring of the CLO – could appropriately be considered “securitizers” under Section 941. Loan Syndications & Trading Ass’n v. SEC, 223 F. Supp. 3d 37 (D.D.C. Dec. 22, 2016).
Last Friday, the D.C. Circuit Court disagreed, ruling that collateral managers of open-market CLOs are not “securitizers” under the Dodd-Frank Act and are accordingly not subject to the requirements of the Risk Retention Rule. See -- F.3d --, 2018 WL 798290 (D.C. Cir. Feb. 9, 2018). The D.C. Circuit Court emphasized that, whereas the Dodd-Frank Act defines a “securitizer” as, among other things, an entity that transfers assets to an issuer of asset-backed securities, managers of open-market CLOs typically never own the assets that collateralize a CLO, and thus cannot transfer them to the issuer. Instead, the manager acts as an agent of the issuer in selecting the assets to be purchased by the issuer from third parties. The D.C. Circuit Court thus invalidated the Risk Retention Rule insofar as it applies to managers of open-market CLOs, and remanded the case to the D.C. District Court with instructions to “vacate the Risk Retention Rule insofar as it applies to open-market CLO managers.” Id. at *7.
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