Senator Elizabeth Warren (D. MA) recently introduced the provocatively styled “Stop Wall Street Looting Act of 2021” (“SWSLA”). a 113-page bill that primarily targets perceived weaknesses in the private equity market. Dropped way in the back of that bill is a short provision that threatens to impose significant and unnecessary costs and obligations on managers of Collateralized Loan Obligations (CLOs), a critical source of capital to the $1.3 trillion syndicated loan market that finances the needs of American companies. This harmful provision is a solution in search of a problem that does not exist.
The SWSLA would reimpose on CLO managers the “risk retention” provisions contained in Section 941 of the 2010 Dodd-Frank Act, requiring them to purchase and hold 5% of the fair value of each CLO they manage. This would effectively reverse the 2018 decision of the U.S. Court of Appeals for the D.C. Circuit in a case brought the Loan Syndications & Trading Association, the “LSTA”, against the Securities and Exchange Commission and the Federal Reserve Board. Re-litigating this issue is senseless and unjustified by the facts. The original statutory rationale for imposing risk retention was to require managers of “originate-to-distribute” securitizations to have “skin in the game” to ensure that the interests of the managers are aligned with those of their investors. This may work for securitizations of residential mortgages that are originated by banks and sold to captive securitization vehicles they create. But it assuredly does not make sense for CLOs where managers do not originate loans but, instead, purchase them in the open market and manage the pool much like a mutual fund for the benefit of investors in CLOs. Indeed, not only did Court of Appeals agree with the LSTA’s statutory arguments that the Dodd-Frank Act did not apply to CLO managers, but it also agreed that CLOs already achieve the policy goals sought by Congress through the incentives and transparency built into their structure.
The Court’s view has been affirmed by federal regulators, independent auditors and validated by decades of experience. CLOs have performed extremely well for over 30 years, including through the 2008 financial crisis and the Covid-19 pandemic. Unlike many originate-to-distribute securitizations, whose investors suffered significant losses, investors in CLOs experienced barely any losses at all. Moreover, the syndicated loan market is vital to the nation’s economic well-being. For example, in 2019 it provided significant capital to growing American companies which contributed over $2.7 trillion in economic output, employed over 10 million Americans, and generated economic activity in every Congressional district across the U.S., resulting in over $288 billion in federal and state tax revenue. And, contrary to the naysayers; federal regulators and the Government Accounting Office (GAO) have all concluded that neither syndicated loans nor CLOs are systemically risky.
At bottom, CLOs have performed very well, do not impose systemic risk, and their interests are not misaligned with those of their investors, which risk retention was designed to prevent. Reimposing the risk retention mandate, as SWSLA proposes, would be costly and cumbersome and would likely lead to an increase in the cost of capital for many American companies. Moreover, many managers, particularly the smaller ones, would not be able to meet risk retention requirements and would struggle, likely losing their businesses and the jobs they provide.
When considering legislation that would significantly impact the corporate debt market, we encourage members of Congress and other policy makers to thoughtfully consider established market facts and documented data. Failure to recognize fact-based arguments could have profoundly negative economic consequences for the U.S. economy and working Americans.
