Structural Implementation of Risk Retention Seen in CLO Market; But CMBS Lags

According to research by S&P Global Ratings, so far in 2016 there has been a significant increase in the percentage of Collateralized Loan Obligation (“CLO”) transactions issued that are “structured with the intent to comply with risk retention regulations” that go into effect on December 24th of this year. Of U.S. CLOs issued in 2016, “over half (56%) of deals priced year to date were structured to comply with U.S. retention, European retention, or both” whereas in 2015 “just over 20 U.S. CLO transactions (representing 10-15% of total new CLOs by count) were structured with the intent to comply”.   

This is in contrast with the path to implementation seen in the CMBS market. According to the piece, “CMBS issuers' and originators' designs regarding risk retention compliance are more opaque.” For CMBS, the “B-piece option allows the CMBS sponsor to sell a horizontal strip to one or two third parties.” But due to risk retention requirements, “the size of the B-piece will increase substantially over what we currently observe in the CMBS market, in order to reach the necessary 5% of fair market value.” In addition, there is a 5 year holding period for the retained risk for CMBS. These factors contribute to lack of clarity in the market for determining “who could provide the additional capital necessary for B-piece investments when the risk retention rules become effective for CMBS transactions in December 2016.”

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