Turning the Corner on Risk Retention

Just as everyone seems to have made the adjustment to life in securitization with Risk Retention, comes the US Treasury’s announcement that they agree with what most industry insiders have been saying for years.  The 5% Risk Retention model for securitizations may not be necessary and very well could be artificially and unnecessarily limiting the size of the marketplace.

The report, which was released on October 6th, focused primarily on Risk Retention in the US CLO market; probably thanks to the steady effort by the LSTA over the last few years to get their views across.  It would appear that a reduction in the percentage, a partial exemption or even a full elimination of the requirement is on the table for serious discussion.  Momentum builds.

Ironically, all the doomsayers that several years ago predicted a complete collapse of the CLO market, particularly the small to medium-sized CLO manager marketplace, due to the burden of Risk Retention, have been proven wrong.  The US CLO market is actually quite vibrant and there have been plenty of recent news stories about numerous third-party risk retention investors being available to smaller CLO managers.  As we expected, smart people found a way to work with the new rule.  However, we would be the first to agree that there has to be some negative impact on market size that is directly attributable to the additional costs associated with 5% Risk Retention.

We have been on the record for several years about how unnecessary the Risk Retention rules are, as all they accomplish is to add an insignificant slice of skin-in-the-game for issuers or managers that already have much more to lose if their program fails.  Risk Retention sounded like a great sound bite during the post-crisis era but we think you would be hard pressed to find an investor (if they were being honest) who would tell you that they base a any significant portion of their investment decision on Risk Retention.

Maybe it has taken longer than we might have hoped but it would appear that we are in the process of turning the corner on Risk Retention.

About markferraris
Managing Principal Orchard Street Partners LLC

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