The onerous regulatory burden placed on US CLO issuers and sponsors in the EU, both from an administrative and legal perspective, combined with the relative ease, efficiency and legal certainty of the Cayman Islands as a jurisdiction, has caused a significant increase in Cayman Islands Stock Exchange (CSX) CLO listings.
US CLO note issuances have historically been listed on the Irish Stock Exchange (ISE). Various reasons are cited in the market for this, including the liquidity of initial and secondary markets, international outreach, certainty of EU legal systems and regulation, cost and the experience and expertise of the ISE in dealing with such listings.
As market participants will be aware, the adoption of Regulation (EU) No 596/2014 of the European Parliament and of the Council of 16 April 2014 on market abuse (market abuse regulation), otherwise known as MAR, by EU Member States in July 2016 introduced an additional barrier to the listing of CLOs on the ISE. Whereas previous market abuse directives (2002/92/EC and 2011/61/EU) applied the relevant legal framework in the EU for the regulation of market abuse, MAR contains rules on insider dealing, unlawful disclosure of inside information and market manipulation.
The concerns for CLO market participants regarding the impact of MAR have been well documented. It should therefore come as no surprise that since the adoption of MAR, the market has witnessed a growing shift of listing CLO note issuances away from the ISE towards the CSX.
The EU regulatory framework, MAR, and CLOs
Sponsors are often shocked to find that MAR will apply to them if the CLO issuer’s notes are listed on the ISE.
CLO notes have historically been listed on the Main Securities Market (MSM) or Global Exchange Market (GSE) of the ISE.
Prior to MAR, the MSM and GSE were carved out of the market abuse directive. MAR significantly broadens the scope of the previous market abuse regime in the EU. Now within the scope of MAR are financial instruments admitted for trading (or subject to a request for admission to trading) on an EU regulated market, multilateral trading facilities and organised trading facilities, not to mention the general catch all of “any other conduct or action which can have an effect on such a financial instrument irrespective of whether it takes place on a trading venue” (Recital 8 MAR and Article 2 MAR). The effect of this is that MSM and GSE markets now fall within the scope of MAR.
The geographical scope of MAR is global – Art 2(4) MAR states that “the prohibitions and requirements in MAR shall apply to actions or omissions, in the [European] Union and in a third country, concerning [financial instruments within the scope of MAR]” – meaning that non-EU entities, such as Cayman CLO issuers, are now subject to MAR in the event that they are dealing with financial instruments within the scope of the regulation, which they inevitably will be.
MAR introduced a number of important obligations upon CLO issuers, both when the notes are initially listed and on an on-going basis, including:
Public disclosure of Inside information (Art. 7 & 17 MAR): A CLO issuer (with securities admitted to trading on an EU regulated market) has an obligation to disclose inside information to the market as soon as possible; once disclosed, inside information must be available to the public for 5 years (Art. 17 (1) MAR). Recital 55 of MAR acknowledges the burdensome nature of the requirement for disclosure of inside information, particularly for small and medium-sized enterprises.
Control of inside information and insider lists (Art. 11 & 18 MAR): Insider dealing and improper disclosure of inside information are offences under MAR. CLO issuers are required to keep (and constantly and promptly update) insider lists in a prescribed format. Deviation from the prescribed format is not permitted and very detailed and extensive information is required to be included. Certain requirements also apply for the market sounding exemption to the disclosure of inside information – in the event that a CLO issuer wishes to apply this exemption, certain requirements apply (Art. 11 MAR), including records of the disclosure being retained for at least five years (Art. 11 (8) MAR). Once again, the recitals (Recital 56) acknowledge that the requirement to keep and constantly update insider lists imposes administrative burdens specifically on issuers in SME growth markets.
Managers’ transactions (Art. 19 MAR): Persons discharging managerial responsibility (PDMRs) within CLO issuers (the directors and the manager under the powers given to them in the collateral management agreement), and persons closely associated with them, are subject to additional specific requirements, including notifying the CLO issuer and the regulator (being the competent authority of the relevant EU Member State) in respect of every transaction conducted on their own account relating to debt instruments of that CLO issuer (subject to a de minimus threshold) (Art. 19 (1), (8) MAR), and not dealing when in possession of inside information or when in a certain closed period (30 calendar days before the announcement of an interim financial report or year-end report) (Art. 19 (11) MAR). These include the adoption of policies and procedures relating to inside information and notification requirements for manager’s transactions (Art. 19 MAR).
Sanctions and fines
CLO issuers breaching MAR will be faced with administrative sanctions and other measures. These include pecuniary sanctions of up to EUR15m in certain circumstances for infringements for insider dealing (Art. 14 MAR) and market manipulation (Art. 15 MAR). Upon the enactment of the new MAR rulebook, Vera Jourová, Commissioner responsible for Justice, Consumers and Gender Equality in the EU is quoted in a European Commission Press Release as stating “Administrative authorities will now have greater powers to investigate market abuse and to impose significant fines, while those found guilty of market abuse will be deterred by the prospect of facing jail.”
To add to this political rhetoric, the definitions in the regulation are so wide reaching that US CLO issuers and sponsors should take careful consideration of their legal position before voluntarily bringing themselves within jurisdiction of this regulation, such as by listing in Ireland. To demonstrate, “inside information” is defined in MAR as including: “information of a precise nature which has not been made public, relating, directly or indirectly, to one or more issuers or to one or more financial instruments and, which, if it were made public, would be likely to have a significant effect on the prices of those financial instruments ….”. This is a broad definition, and is focussed solely on price sensitivity. Importantly, it does not require an insider to actually know that she or he is in possession of insider information, nor to know that it is obtained from an inside source.
To make matters worse, being a relatively new body of regulation, legal precedent is scant. In the context of similar legislation in recent history, courts in the UK have taken a broad view in the interpretation of terms such as the meaning of “insider information”. The decision of the Upper Tribunal (Tax and Chancery Chamber) in David Massey v FSA (2 February 2011) has been a seminal case for the purposes of interpreting terms in the market abuse provisions in the preceding law in the UK prior to the EU market abuse directive, in particular section 118 of the Financial Services and Markets Act 2000 (FSMA). This legal precedent, together with the similar wording in Art. 7(4) MAR, leads us to conclude that the interpretation of “inside information” is likely to be a broad one, in line with the wording of MAR.
The legislative intention of MAR is clear – in the context of listings in the EU, MAR casts a wide net, requiring a significant amount of work and attention both to obtain and maintain initial and ongoing compliance. The consequences of non-compliance are serious.
The EU has undeniably created a robust framework for market abuse. But is this framework appropriate for US and other non-EU CLO managers and investors, particularly in the context of CLOs pertaining to US and other non-EU underlying assets?
Many market participants have already decided their response to this question, and have taken action by delisting their CLO securities from trading on GEM as a result of MAR. This shift has not gone unnoticed, with EU legal commentators themselves noting and expecting – even before the implementation of MAR – that the increased burden and cost of compliance would become so overly onerous that de-listings would be an inevitable certainty.
Notwithstanding the above, in 2018, 415 CLOs (US and European) were listed on Euronext Dublin, 286 of which were Cayman Islands CLO issuers.
Some sponsors have commented that this is down to the “word not getting out” about MAR, or their having received the advice too late to switch to an alternative exchange. Eyebrows have certainly been raised in the market, leaving some sponsors to question whether they have received balanced and impartial legal advice on the issue.
The alternative – the Cayman Islands Stock Exchange
The increased burden and cost of complying with MAR, together with the potential level of sanctions and fines that would apply under MAR in the event of non-compliance, has led many US CLO issuers to explore moving their listings away from the ISE. Given the sheer size of the Cayman CLO market, the CSX is the natural shift.
As a well-developed and well-operated stock exchange, which is internationally recognised by UK HM Revenue & Customs as a ‘recognised stock exchange’ under Section 841 of the Income and Corporation Taxes Act 1988 (UK) and International Organization of Securities Commissions as an affiliate member, the CSX provides a viable listing alternative.
As one expects to find in the Cayman Islands, a legal framework exists to protect against false or misleading market and insider dealing in Cayman Islands. Part IV of Securities Investment Business Law (2019 Revision) (SIBL), creates an offence at law for insider dealing and prohibits the misuse of insider information. Under section 35 SIBL, the maximum financial penalty for any person committing an offence under section 24 (Creation of false or misleading market) or 25 (Insider Dealing) SIBL is US$12,000, significantly less than that of MAR. Similarly to MAR, criminal sanctions may also apply.
However, with respect to SIBL, compared to MAR, very serious and important differences must be noted: firstly, there are no such objectively administratively burdensome requirements imposed by SIBL. There are no substantially equivalent requirements in the Cayman Islands such as those set out in MAR with respect to i) public disclosure of inside information (and keeping it disclosed for five years), ii) the maintenance of insider lists and iii) special notification requirements on PDMRs as found in MAR.
In addition, the definition of “insider information” in MAR as set out above is significantly wider than that in SIBL. Under s.33 SIBL, insider information is limited to situations where an individual knows that she or he is in possession of the insider information, and knows that such information has been obtained from an insider source. Cayman Islands law clearly acknowledges the point that improper dealing based on insider information is not permissible.
In contrast to MAR, however, SIBL does not create such a wide definition of “insider information” which could potentially catch activities that were not initially intended by the regulation.
Listings on the CSX have soared from a little over 1,000 listings in 2016 to over 1,700 as of February 2019. These listings were primarily ‘Specialised Debt’, which is defined by the CSX as “debt securities which are, as determined from time to time by the CSX, by their nature usually purchased and traded by a limited number of investors who are particularly knowledgeable in investment matters and which are credit linked securities or are asset-backed securities”.
Since April 2017, the CSX has adopted new listing rules for listing debt and equity securities issued by ‘specialist companies’ (Chapter 14), which is intended to capture CLO/securitisation special purpose vehicles. These new listing rules include comprehensive, but not overly burdensome requirements for listings which strike a balance and the need for flexibility for both CLO issuers/managers as well as investors. The listing requirements include; (i) providing independently audited financial statements (rule 14.2), (ii) the directors to have the appropriate experience and expertise (rule 14.7), and (iii) the securities must be freely transferable (subject to exceptions) (rule 14.10), among others.
To list or not to list?
Finally, is a listing needed at all? A number of market participants have chosen not to list at all. There is generally no legal requirement to list, and sophisticated investors who are accustomed to seeing CLOs represented in certain formats may not benefit from, or have any desire to see the securities listed. The decision whether to list or not will largely be driven by investor sentiment and familiarity with the product. Understandably, certain investors will want to take advantage of the certainty that a CLO product satisfying the conditions for listing on a stock exchange brings. In this regard, the knowledge of the satisfaction of the conditions to listing on both ISE/GEM and CSX can provide important due diligence efficiency savings for investors, most notably if the listing is on CSX.
With the on-going requirements of MAR, market participants continue to look for increased structural efficiency, competitiveness and ease of doing business when it comes to the listing of CLO securities.
While some market participants have highlighted a lack of liquidity in alternative markets as a barrier to issuances in non-EU jurisdictions, there are no significant legal issues which would represent an added hindrance to the liquidity of CLO notes listed on CSX. While there were concerns during the financial crisis (generally unrelated to the exchange upon which the securities were being traded), the CLO market in general is a very different landscape to what it was during the financial crisis, on account of various wide-spread international regulations such as the Volcker Rule (prohibiting banks from operating proprietary trading desks), various US and EU capital, liquidity and risk retention rules.
However, the on-going issues related to MAR, as well as the increased expertise of the CSX in dealing with CLO transactions, has caused market participants to show greater interest in listing their securities with CSX. Combined with the initial cost of listing on CSX being less than ISE and time efficiency and responsiveness of listing with the CSX, it is becoming an increasingly more attractive option for US CLO market participants.