United States: The Risk Retention Rule: LSTA's Victory And What It Means For CLOs And Other Securitizations

In its February 9, 2018 decision, The Loan Syndications and Trading Association v. Securities and Exchange Commission and Board of Governors of the Federal Reserve System (Court Decision), the United States Court of Appeals for the District of Columbia Circuit (DC Circuit) overruled the decision of a United States District Court and decided that collateral managers for open market collateralized loan obligation transactions (Open Market CLOs) are not subject to the risk retention requirements of Section 941 (Section 941) of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) and the risk retention regulation (Regulation) promulgated by the Securities and Exchange Commission (SEC), the Board of Governors of the Federal Reserve System (Board), and other regulators (collectively with the SEC and the Board, the Agencies) thereunder. Only the SEC and the Board (Defendants) were defendants in the litigation. The decision will not result in a change in the law until after the period for appeal within the DC Circuit has passed or any such appeal process has concluded.

The Court Decision

The Court Decision was rendered by a panel (Panel) of three judges of the DC Circuit: Circuit Judge Brett Kavanaugh; Senior Circuit Judge Douglas Ginsburg; and Senior Circuit Judge Stephen Williams, who wrote the opinion. The opinion analyzed Section 941, which requires the Agencies to issue regulations:

To require any securitizer to retain an economic interest in a portion of the credit risk for any asset that the securitizer, through the issuance of an asset-backed security, transfers, sells, or conveys to a third party.

Section 941 further defines a "securitizer" as:

(A) an issuer of an asset-backed security; or

(B) a person who organizes and initiates an asset-backed securities transaction by selling or transferring assets, either directly or indirectly, including through an affiliate, to the issuer ...

The Panel was considering an appeal, filed by The Loan Syndications and Trading Association (LSTA), of a District Court decision issued on December 22, 2016, rejecting a challenge to the Regulation and upholding the Agencies' conclusion in the Regulation that the collateral manager of an Open Market CLO is the party required to comply with risk retention requirements of Section 941 as detailed in the Regulation.

The Panel concluded that to be a "securitizer" under clause (B) of the definition an entity would have to have had a possessory or ownership interest in the assets that it then transferred, directly or indirectly, to the issuer. The Panel rejected the argument that a person could come within the definition merely by causing the transfer to the issuer without itself ever having had any ownership interest in the transferred assets. Accordingly, because the collateral manager of an Open Market CLO only directs and consummates asset acquisitions on behalf of the issuer through open market purchases, it would not be a securitizer and therefore would not be subject to the risk retention requirements. Although the decision did not address whether the issuer of an Open Market CLO may still be a securitizer pursuant to clause (A) of the definition, the discussion in the opinion indicated that, in the view of the Panel, the Regulation effectively eliminated the issuer from the definition.

Note that the Court Decision would not apply to a transaction where the assets come from a financial institution or asset manager involved in the organization and initiation of a securitization with its own assets (Balance Sheet CLO). The Court Decision did not specifically address, and it therefore remains unclear, whether risk retention requirements would apply to transactions in which a portion of the assets acquired in the open market are first acquired by the collateral manager in order to come within certain requirements for European Union risk retention, to so-called "call and roll" transactions in which assets in one Open Market CLO are transferred into a new comparable securitization transaction, or to a securitization of assets acquired in the open market but held by a party other than the issuer under a warehousing arrangement prior to securitization.

Effective Date; Appeal Period

The Court Decision will not become effective until after a period has passed without appeal within the DC Circuit, or an appeal process has been successfully completed. In the event the Defendants decline to appeal the Court Decision within 45 days after the date the decision was issued (such 45th day being March 26, 2018), the decision will become effective on or shortly after April 2, 2018, when the DC Circuit issues its mandate finalizing the decision and the Regulation (insofar as it imposes risk retention requirements on collateral managers of Open Market CLOs) will be vacated when the District Court enters a judgment consistent with that mandate.

Alternatively, the Defendants may petition the Panel to rehear its decision or petition all of the active judges of the DC Circuit for a rehearing en banc or both. In that case, the Court Decision would not become final until late April 2018, at the earliest, or several months after that, at the latest. The DC Circuit may summarily deny the Defendants' petition for rehearing without further briefing a few weeks after the Defendants file their petition on or before March 26, 2018, but if the DC Circuit grants the Defendants' petition or requests additional briefing, the Court Decision may not be finalized for several months after that.

In addition to or instead of filing a petition for rehearing in the DC Circuit, the Defendants could petition the US Supreme Court for a writ of certiorari. In that case, the Defendants must file their certiorari petition within 90 days of the Court Decision or denial of a petition for rehearing by the DC Circuit, whichever is later. Defendants' certiorari petition would thereafter take 44 days to brief and several additional weeks to decide. However, because a certiorari petition does not, by itself, stay the DC Circuit's issuance of the mandate finalizing the Court Decision, unless the Defendants petition the DC Circuit for rehearing or successfully move to stay the mandate pending a response to their certiorari petition to the Supreme Court, the Court Decision could nevertheless become effective as early as April 2, 2018.

The foregoing are only a few of the possible appeal scenarios. The Defendants' and the courts' decisions in the next few weeks will be critical for attempting to determine the timing of an effective date for the Court Decision. Until the appeal process is completed, there can be no assurance that the Court Ruling will stand.

The Regulation, to the extent applicable to collateral managers of Open Market CLOs, remains effective until vacated by the District Court as directed by the Panel. The District Court will not have jurisdiction to vacate the applicability of the Regulation to collateral managers of Open Market CLOs until the DC Circuit issues its mandate after the Defendants have exhausted their appellate rights (or the Defendants are unsuccessful in staying the mandate pending a petition for writ of certiorari).

A final decision in the DC Circuit will bind the Agencies, and accordingly there would be no opportunity for a contrary decision in the Court of Appeals of another Circuit absent further rulemaking action by the Agencies.

Impact on Open Market CLOs

If and when the portion of the Regulation applicable to collateral managers of Open Market CLOs is effectively nullified, absent new regulations, Open Market CLOs generally would not appear to be subject to the requirements of risk retention. This would appear to be the case since (i) the statutory requirement, on its face, is dependent on an implementing regulation being in effect, (ii) the portion of the Regulation imposing such requirements on collateral managers of Open Market CLOs will have been invalidated and (iii) under the remaining active components of the Regulation, no other party to a typical Open Market CLO would constitute a "securitizer" as that term was interpreted by the Panel. In respect of outstanding Open Market CLOs, a collateral manager currently holding such a risk retention interest would accordingly appear to no longer be required to retain that interest under the Regulation. Any collateral manager would, however, continue to be subject to the terms of any applicable transaction documents, which may continue to restrict the disposition, hedging and financing of such risk retention interest.

The Agencies would be free to promulgate new regulations consistent with the ruling, although it is not clear upon which other Open Market CLO transaction party the Agencies might attempt to impose an alternative risk retention obligation or what would be the statutory basis for doing so—possibly, the Agencies could promulgate interpretations that impose risk retention obligations on the issuer pursuant to clause (A) of Section 941 quoted above, and impose certain requirements on equity holders thereof or others to give substantive effect to such obligations. The procedural posture and timing of any new regulation is also not clear at this time, and it is not known if the Agencies might seek to issue interpretative guidance in the interim (or what form or substance any such guidance might take).

Possible Impact of Court Decision on Other Types of Securitizations

Although the Court Decision specifically addressed only the treatment of collateral managers of Open Market CLOs, the analysis of the Court Decision may be equally applicable to a number of other asset classes. For example, the Panel's argument may be applied to the following:

  • Sponsors of resecuritizations in which the underlying securities are acquired by the issuer in open market transactions rather than from a person holding such securities prior to the securitization who is involved in the securitization transaction;
  • Managers of commercial paper conduits that acquire assets in the open market or directly from their customers; and
  • Sponsors of conduit securitizations that acquire the assets directly from third party originators rather than hold any such loans on balance sheet.

In each case it would be essential that the issuer acquire the underlying assets directly from third parties, and that the organizer and initiator of the securitization transaction or program not be included in the chain of title. Removing the manager or sponsor of any of these securitizations as a securitizer would, of course, increase the risk that one or more parties transferring assets to the issuer would be characterized as securitizers. That risk would likely be substantially reduced to the extent that the assets so transferred themselves constituted asset-backed securities separately subject to risk retention (as is often the case with resecuritizations or commercial paper conduits).

The Court Decision relied on an interpretation of the language of Section 941, and rejected several policy arguments made by the Agencies, including the concern that the decision would create a loophole for many securitizations that were intended to come within the Regulation but could be structured in a way to come within the Open Market CLO model. The Panel recognized the concern, but nevertheless concluded that "[p]olicy concerns cannot, to be sure, turn a textually unreasonable interpretation into a reasonable one." The opinion further stated that any loophole so created "is one that the statute creates, and not one that the agencies may close with an unreasonable distortion of the text's ordinary meaning."

Notwithstanding the clear conclusions stated in the Court Decision, it should be recognized that the Court Decision, in what is arguably dicta, offered reasons why the decision was appropriate for Open Market CLOs, and that might be used by other courts to distinguish the case in making a comparable decision with respect to other asset classes that do not have a number of the features that are present in Open Market CLOs. The Panel, in particular noted the following with respect to Open Market CLOs:

  • The loans are generally large loans, limited in number (typically up to 100 to 250 loans), from companies that are public companies or for which credit information is otherwise available to investors, providing transparency not always available in other asset classes.
  • The loans are often portions of larger syndicated loans involving multiple parties as originators.
  • The loans are generally of a type actively traded in a secondary market.
  • The collateral manager is typically compensated in whole or in part with incentive compensation, and therefore in effect has skin in the game through its compensation structure. As such, it operates much like a mutual fund (which, though not stated in the opinion, is viewed as not subject to risk retention).
  • Open Market CLOs performed relatively well during the financial crisis.

Assuming the Court Decision is not appealed, or is upheld on appeal, there will be a desire to extend its applicability to other types of securitizations, to the extent they can be structured in a manner similar to Open Market CLOs. In light of the foregoing, transaction participants would need to conduct a thorough analysis of all the facts and circumstances present in any given transaction, and a careful consideration of the regulatory uncertainties involved, before relying on an extension of the Court Decision's rationale as a basis for not complying with the risk retention requirements in other types of securitizations.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Similar Articles
Relevancy Powered by MondaqAI
In association with
Related Topics
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
Up-coming Events Search
Font Size:
Mondaq on Twitter
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions