As many in the CLO industry have been focused on FATCA and U.S. regulatory rules arising out of the Dodd-Frank Act, another potential regulatory issue has arisen from the other side of the Atlantic; namely, the European Union’s Alternative Investment Fund Managers Directive, or “AIFMD”, as it is more commonly referred to. So what do you need to know?
The first point is that AIFMD only applies where there is an offering of securities on or after July 22, 2013. As such, existing Cayman CLOs which are no longer issuing securities are essentially grandfathered.
Do you have any European investors?
If you are not looking to market Cayman CLOs to any European investors, then U.S. CLO managers can stop there as AIFMD is only applicable to the extent that marketing of securities takes place to EU investors.
Ok, but I don’t manage a hedge fund?
Fair point and, in part, that is why some participants may not have been aware of the potential impact. The answer is that while the AIFMD is fairly and squarely aimed at hedge funds and private equity funds, the definition of an ‘alternative investment fund’ (AIF) is somewhat wider than that in the directive: “…any collective investment undertaking, including investment compartments thereof, which raises capital from a number of investors with a view to investing it in accordance with a defined investment policy for the benefit of those investors and which does not require authorization pursuant to the UCITS Directive.”
On its face, a CLO could therefore fall within that definition.
Surely there must be an exemption for structured product SPVs such as a CLO?
Yes there is, but herein lies the crux of the issue. The directive contains an exemption for an ‘SSPE’.
An SSPE is defined in Article 4 of the directive as: “…an entity whose sole purpose is to carry on a securitization or securitizations within the meaning of Article 1(2) of Regulation (EC) No 24/2009 of the European Central Bank of 19 December 2008 concerning statistics on the assets and liabilities of financial vehicle corporations engaged in securitization transactions (ECB/2008/30) and other activities which are appropriate to accomplish that purpose.”
The ECB Regulation defines “securitization” as: “…a transaction or scheme whereby an asset or pool of assets is transferred to an entity that is separate from the originator and is created for or serves the purpose of the securitization and/or the credit risk of an asset or pool of assets, or part thereof, is transferred to the investors in the securities, securitization fund units, other debt instruments and/or financial derivatives issued by an entity that is separate from the originator and is created for or serves the purpose of the securitization, and:
- (a) in case of transfer of credit risk, the transfer is achieved by:
- (i) the economic transfer of the assets being securitized to an entity separate from the originator created for or serving the purpose of the securitization. This is accomplished by the transfer of ownership of the securitized assets from the originator or through sub-participation; or
- (ii) the use of credit derivatives, guarantees or any similar mechanism; and
- (b) where such securities, securitization fund units, debt instruments and/or financial derivatives are issued, they do not represent the originator’s payment obligations”.
Where “originator” means “the transferor of the assets, or a pool of assets, and/or the credit risk of the asset or pool of assets, to the securitization structure.”
Now you can probably see where the issue lies – a CLO does not clearly fit within that definition as a CLO does not have an “originator” in the classic securitization sense.
What about any guidance from the regulator?
Although many market participants spotted this issue early on, unfortunately there has not been any clear guidance from the European Securities Markets Authority (ESMA), which is the pan-European regulator.
Under EU law, Level 1 of the AIFMD is required to be implemented into national law in each member state and Level 2 of the AIFMD leaves certain leeway for national regulators, which means that regulators in EU countries have the opportunity to provide guidance during the implementation process.
Whilst none have addressed the point head on, the U.K.’s Financial Conduct Authority published helpful guidance, noting that “the AIFMD is aimed at funds” and, in providing a list of common fund types, did not include CLOs. However, the FCA guidance also states that while an issuance of debt securities does not generally mean that the issuer of such securities is an AIF, it does not appear to rule out such vehicles being an AIF where the “SPV is set up to invest in financial assets.”
Ok, so what is the market doing in the meantime?
In one word, disclosure.
MaplesFS, having had the benefit of our Irish office to guide them in relation to AIFMD and its potential applicability to the CLO market, reached out to managers and European and international counsel to seek their views on this issue.
The general consensus is that, pending any further guidance from ESMA, CLOs do fall within the securitization exemption and so are not AIFs.
However, many market participants have expressed the view that it would be sensible to include appropriate risk factors in the offering document disclosure to highlight the point, especially where arrangers are offering securities of the CLO to EU investors or want the flexibility to do so.