"Transfer" means transfer: LSTA CLO decision raises broader questions regarding U.S. risk retention rules
16 February 2018
On February 9, 2018, the U.S. Court of Appeals for the District of Columbia Circuit Court (the “Court”) issued a significant decision in the case of Loan Syndications & Trading Ass’n v. SEC, No. 17-5004, --- F.3d ---, 2018 WL 798290 (D.C. Cir. Feb. 9, 2018) (the “LSTA Decision”).1
In a unanimous decision reversing the district court’s ruling,2 the Court agreed with the arguments made by the Loan Syndications and Trading Association (the “LSTA”) and held that managers of open-market CLOs (“CLO Managers”) are not “securitizers” within the meaning of Section 941 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Statute”), and therefore the Securities and Exchange Commission and the federal banking regulators (the “Agencies”) who jointly promulgated the U.S. risk retention rules went beyond their statutory authority in imposing risk retention obligations upon them.3
In analyzing the statutory definition, the Court found that the Statute “refer[s] to an entity that at some point possesses or owns the assets it is securitizing and can therefore continue to hold some portion of those assets or the credit risk those assets represent.”4 The Court concluded that a securitizer “must actually be a transferor, relinquishing ownership or control of assets to an issuer” in order to satisfy clause B of the statutory definition,5 and, consequently, held that CLO Managers are not “securitizers” within the meaning of the Statute and should not be subject to U.S. risk retention obligations. In so holding, the Court noted that open-market CLO Managers do not originate the underlying loans, nor do they at any point hold such underlying loans.
By its terms, the Court’s holding in the LSTA Decision applies narrowly to CLO Managers.6 While the LSTA Decision has been praised by the CLO industry as a major victory for the open-market CLO sector, the Court’s reasoning may also have broader ramifications and may impact non-CLO structures that share certain structural features with open-market CLOs. In particular, in discussing the Agencies’ policy concerns that a recognition of the LSTA’s arguments may open up a loophole in the regulatory regime, the Court recognized that there may be transactions in which “those ‘organizing and initiating’ the securitization do not do so ‘by transferring’ the securitized assets to the issuer, while those that do transfer the assets are not the entities who organize or initiate the securitization in any meaningful way.”7 The Court thus appeared to recognize the possibility that, in such transactions, there may not be a “securitizer” who would be subject to U.S. risk retention obligations. In rejecting the Agencies’ arguments, the Court also highlighted that such a supposed loophole would be one that “the statute itself creates,” and is one that is “to a considerable extent a problem of the [Agencies’] own making” due to the Agencies’ interpretation of the statutory definition of a “securitizer.”8
The Court’s rationale and its rejection of the Agencies’ policy concerns call into question whether parties that act in a capacity similar to CLO Managers in non-CLO securitization structures are “securitizers” within the meaning of the Statute. The question is especially acute in transactions with similar structural features to open-market CLOs, where a party may facilitate the direct acquisition by the issuing entity of financial assets in the secondary market, but does not itself take ownership of nor transfer those assets to the issuing entity. For example, financial institutions in repack transactions or portfolio acquisition transactions may facilitate the issuing entity in directly acquiring the underlying asset without taking ownership of such assets or transferring such assets to the issuing entity. Applying the Court’s rationale may also call into question whether there is a “securitizer” subject to U.S. risk retention obligations in other structures that do not involve a party’s acquisition and transfer of assets, such as financing transactions involving a borrower entering into a loan facility directly with an issuing entity and where such borrower’s obligations under the loan generate the cash flows for repayment of the issuing entity’s securities. The analysis of a given structure in light of the LSTA Decision, and the viability of any arguments that a given structure does not have a “securitizer” within the meaning of the Statute, would depend on the specific facts and circumstances of such structure.
We caution that the LSTA Decision is not immediately effective and should not prompt a blanket conclusion that U.S. risk retention does not apply to structures similar to open-market CLOs. First, the Court’s decision that CLO Managers are not “securitizers” within the meaning of the Statute will not be final and effective until an appellate mandate is issued (which would be, at the earliest, April 2, 2018, in the absence of a joint motion to expedite the mandate), and such appellate mandate is subject to any decision by the Agencies to seek reconsideration by an en banc panel of the Court and/or petition the United States Supreme Court for review.9 Additionally, as noted above, the Court’s holding in the LSTA Decision by its terms applies narrowly to CLO Managers,10 and the Agencies may decline to apply it to structures that are not open-market CLOs. It is also possible that Congress may amend the Statute, or the Agencies may initiate additional rulemaking efforts or issue interpretive guidance as a result of the LSTA Decision. Finally, the facts and circumstances of a particular transaction may cause a party to satisfy the definition of “securitizer” notwithstanding the Court’s rationale under the LSTA Decision. As a result, market participants will want to consider what effect, if any, the LSTA Decision has on their particular transaction.
We are actively considering the relevant issues in this regard, and we encourage interested clients to get in touch with any questions. Please contact any of our partners or your usual contact at Allen & Overy.
 The LSTA Decision is available at https://www.cadc.uscourts.gov/internet/opinions.nsf/871D769D4527442A8525822F0052E1E9/$file/17-5004-1717230.pdf.
 The Loan Syndications v. SEC., 223 F. Supp. 3d 37 (D.D.C. 2016), rev'd sub nom. Loan Syndications & Trading Ass'n v. SEC, No. 17-5004, 2018 WL 798290 (D.C. Cir. Feb. 9, 2018).
 Id. at *4. See 15 U.S.C. § 78o-11(a)(3) which defines a “securitizer” to be “(A) an issuer of an asset-backed security; or (B) a person who organizes and initiates an asset-backed securities transaction by selling or transferring assets, either directly or indirectly, including through an affiliate, to the issuer.” As noted by the Court in the LSTA Decision, however, in promulgating the risk retention rules the Agencies have interpreted “issuer” in clause A to be the same thing as the substance of clause B, in effect dropping the actual issuing entity out of the statutory definition.
 The Agencies have 45 calendar days to seek en banc review by the Court, Fed R. App. P. 40(a)(1) & D.C. Cir. Rule 35(a). After the expiration of this time, the court must wait 7 days before issuing its mandate (for a total of 52 days). Fed R. App. P. 41(b). Separately or following any en banc resolution, the Agencies generally have 90 days to seek Supreme Court review. The Agencies may seek a stay of the appellate mandate during the course of this 90 day period and throughout the course of subsequent Supreme Court proceedings, if the cert petition presents a substantial question and there is good cause for a stay. Sup. Ct. R. 13(1); Fed R. App. P. 41(d)(2).