CLO Retention Rules may have unintentionally stymied Business Development Companies (BDCs) that rely on CLOs as a mechanism for lending to middle market companies, an important engine of growth for the economy.
This Dechert attorney makes the point well about the conflict between Dodd-Frank and the Investment Company Act of 1940 governing closed-end vehicles, and a number of our clients are focused on this. Let’s hope the SEC can provide guidance that helps CLOs continue to play an important role financing enterprises.
Investment managers are trying to navigate their way through an overlapping web of rules and regulations, some of which have competing demands. Risk-retention rules are part of the Dodd-Frank Act and require managers to hold 5% of their funds. Managers seeking to raise Collateralized Loan Obligation (CLO) funds as part of their strategy to lend to smaller, middle-market companies are finding that their plans to use a Business Development Company (BDC) to hold the retention are falling foul of the Investment Company Act of 1940 that governs the specialized closed-end vehicles. “It’s a material conflict between two regulatory regimes,” said Sean Solis, a partner at law firm Dechert. “The provision in risk retention that allows for a CLO to use the BDC for risk retention conflicts with limitations on affiliate transactions set forth in the” Investment Company Act of 1940.