Regulators Overstepping Their Authority in Policing CLOs, White & Case Lawyer Says

Under the Dodd-Frank Act, government regulators, including the FDIC and SEC, have released risk-retention proposals for asset-back securities, including collateralized loan obligation funds ("CLOs"). The proposals, which are out for comment until June 10, will require entities that securitize assets to retain risk, meaning owning a percentage of the securities issued in the transaction. The purpose of this is to ensure that financial firms do not create bad assets that are put into securitizations that get sold into the market.

“Regulators will overstep the written law’s authority if they apply their risk retention requirements to CLOs as proposed,” says David Thatch, a partner in White & Case’s securitization practice group. “The law, as written under Dodd-Frank, does not expressly provide the power that regulators assert. While the definition of asset-backed security is expansive and would include managed CLOs, the risk retention requirement language under the law and the proposed rules are explicitly tailored and, as written, do not cover managed CLOs.”

Thatch (pictured) recognizes that, in the current political environment and under the common law, regulators have many arguments and options available to them when interpreting the scope of the risk retention obligation.

However, he says, the plain language of the text of the Dodd-Frank Act and the proposed rules, which must be within the confines of the Dodd-Frank Act, do not provide a legal basis for requiring collateral managers of CLOs to retain the credit risk.

“Given that the act's plain meaning is in clear conflict with the regulators’ proposed interpretation, regulators may face a credible legal challenge to their regulatory authority, requiring them to demonstrate their legal authority for the inclusion of managed CLOs in the risk retention regime,” Thatch says.