European CLOs: The Devil Is in the Details

Abstract

The collateralized loan obligation (CLO) product will always embody the tension between, on the one hand, managers continually striving for more flexibility in the documentation and, on the other hand, the concerns and sensitivities of investors. And both cases are acted out against the backdrop of the ebb and flow of rating agency criteria and regulation. This can result in a surprising number of differences in the documentation from deal to deal, some of which are considered in this article, which focuses on European CLOs. With regard to regulation, practice has evolved concerning which party to a CLO transaction acts as the risk-retention holder; the method of risk retention is not uniform; and there are divergent approaches to Volcker Rule compliance. There may be unexpected variance in the commercial terms of notes issued by CLOs, such as quarterly and semi-annual payment conventions, non-payment-of-interest covenants, note holder quorum and resolution requirements, repricing options, and trading restrictions triggered by credit rating downgrades. Restrictions on underlying assets vary in such areas as the reinvestment period; the flexibility to invest in categories such as “cov-lite” transactions; limitations in categories such as the amount of first-lien, last-out transactions; the percentage of assets in the portfolio originated by the manager; and the ability of the manager to extend the maturity of the notes. Manager provisions vary and have evolved in such areas as incentive fees, key-person clauses, and the roles of secondary managers.