AN INDUSTRY NEWSLETTER FOR THE GLOBAL CLO MARKET SEPTEMBER 2020
Bringing You CLOserâ&#x20AC;¦
An Inside View on Buyside Approaches to Improving Workout Capabilities for US CLOs
Irish and EU Tax Developments Affecting Irish CLO Vehicles
Your Maples Group global CLO team provides Cayman Islands and Irish legal advice and CLO issuer / co-issuer and fiduciary services in the Cayman Islands, Delaware, Dublin, Jersey, London and the Netherlands. This edition of The CLOser includes1:
US and European CLO Market Reviews Global Listings Update
Crystal-Balling the Markets: Follow-up on Warehouse Report
Farewell to Mark Matthews
TALF 2.0: The Role of Cayman Islands and Delaware Vehicles
22 24 28
Bringing You CLOser… Avoiding an Accosting – Buyside Approaches to Restructuring Alternatives in Workout Capabilities in US CLOs
Bond Bucket / Volcker Rule Amendment Industry Focus – Irish and European Tax Developments Affecting Irish CLO Vehicles Your Global CLO Team – A CLOser Look
Data in this publication is derived from a variety of sources, including the Maples Group, Structured Credit Investor, LCD, Leveraged Loan, Creditflux, Moody's, S&P, Fitch, Euronext Dublin and Central Bank of Ireland. 1
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What's Inside The Maples Group is delighted to present our September 2020 edition of The CLOser! In this EXTRA SPECIAL edition: • We feature our first ever 'Bringing You CLOser…' article: an inside view from a recognised CLO industry expert. First up for this new spot is Jake Jamison, a capital markets attorney and business manager with extensive international experience in structured credit, corporate finance, bankruptcy, restructuring, and related litigation. Jake has very kindly shared with us some insights on 'Acosta' and buyside approaches to improving workout capabilities for US CLOs. • We present our usual US and European CLO market reviews. • We take a look at latest trends in global listings. • We reflect upon our mid-June US CLO Warehouses – COVID-19 Health Check report and delve into some of the latest statistics to give an updated view on warehouse performance and developments over the past couple of months. • We take a look at TALF 2.0 and how Cayman Islands and Delaware vehicles may be able to play a role in TALF 2.0-related fund structures. • We consider impacts of the Volcker Rule Amendment on US CLOs. • We reflect on Irish and EU tax developments affecting Irish CLO vehicles. AND… • Most important of all, we say a very fond farewell to Mark Matthews, who will be retiring from the Maples Group at the end of November. In true Mark-style, he leaves us with a parting joke to lift our spirits and bring a smile to our faces during these challenging times! We very much hope that you enjoy this edition and find the content engaging and informative! Stay safe and best wishes. The Maples Group CLO Team
2 | The CLOser
US CLO Market Review The Facts & Stats2 65% - the number of new CLOs issued to date in 2020 (109) vs. 2019 YTD (169). If we had been offered this statistic in March when deal volume fell off a cliff, we would gladly have taken it (and even then, with a fair amount of scepticism!). On an aggregate deal volume basis, the statistic is lower at 58% (US$47.56 billion in 2020 vs. US$81.93 billion in 2019 YTD), which reflects the lower average deal size we have observed so far. What is perhaps most encouraging is that the number of new deals has increased monthon-month since March, when only eight deals were issued, to July, when we had 22 new deals. While the new-issue market took a breather in August, with only eight deals pricing, the YTD numbers are encouraging and in June Wells Fargo issued an updated forecast of US$65 billion for 2020, which would bring us close to the activity level seen in 2016. The US CLO market continues to dominate the global scene, representing approximately 76% of global deal volume (please see European CLO Market Review below). The headline statistics are obviously important, but they do not tell the whole story: Single Tranche Refi / Resets
Fixed-rate tranche refinancings started to roll in around the start of August as CLO managers took advantage of the improving arbitrage with swap rates to achieve cost savings of 10bps or more. The Maples Group has completed 13 such refinancings and is currently working on another 15 partial refinancings. This extrapolates to an expected aggregate of 28, which would account for most of the fixed-rate tranche universe. We have also seen a handful of repricings.
Although the three leading rating agencies have yet to complete around 50% of their reviews of CLO securities, the initial indications are that the number of downgrades are notably lower than initially feared. Importantly, no AAA CLO Notes were downgraded by Fitch, Moody's or S&P. While many CLO securities remain on the downgrade watch lists of the rating agencies, the overall rating position is evidence of the resilience of the CLO product and establishes a clear distinction from the CDOs of the 2008 financial crisis.
As at / around the time of publication.
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Tax Blockers We have seen a fairly substantial number of tax blockers being set up over the course of Q2 and into Q3 to take defaulted assets out of CLO portfolios. Our best guess estimate is somewhere in the range of 40-50, with a substantial number of those being required to take assets exposed to the energy and mining sector.
Warehouses The market continues to look for new warehouse creation as an indicator for new-issue activity in the final third of 2020. While the Maples Group worked on only six new CLO warehouses that opened in July, we have had a steady stream of new incorporations and saw a further nine warehouses opened in August. Extrapolating those figures based on approximate market share tends to indicate an overall total in the region of 30+ new warehouses â&#x20AC;&#x201C; an increasing trend as we head towards Q4. Please see Crystal-Balling the Markets: Follow-up on Warehouse Report below, for an update on our US CLO Warehouses â&#x20AC;&#x201C; COVID-19 Health Check report.
The Arbitrage While AAA spreads have clearly been tightening over the last few months, we continue to see those managers with risk retention vehicles or access to internal equity as the primary constituents of the new issue market in 2020. This concentration is evidenced by the number of active managers in Q2 2020 (24) being 62% lower than the number of managers who priced a new-issue deal in Q2 2019 (63). However, based upon the managers we observed incorporating new warehouse vehicles in July and August, there would appear to be some interest from third-party equity investors.
For further details, please contact: Scott Macdonald
+1 345 814 5317 firstname.lastname@example.org
+1 345 814 5129 email@example.com
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European CLO Market Review 2020, business as usual, then… In January 2020, the European CLO market was predicting another strong year of issuance. An annual issuance level in excess of €25 billion for 2020 had been predicted by market participants, which was attributed to a strong pipeline of transactions in warehouse phase as well as an uptick in primary loan market activity. The initial positive market environment saw European CLO issuance levels, as of the beginning of March, slightly up when compared to the same period in the previous year with €5.4 billion from 13 deals (compared to €4.8 billion from 11 deals in the same period in 2019). This progress was, of course, stopped in its tracks in the face of COVID-19, which resulted in high levels of volatility across oil prices, stock markets and corporate bond and loan yields. Managers waited for the dust to settle and sought to gauge the new reality of the CLO investor market.
Low levels of CLO issuance persisted throughout March and April, but at the start of May the market reopened strongly and continued to build momentum through to August. The pressures of the pandemic have impacted on the nature of the CLO transactions themselves with issuance sizes dropping considerably, certain managers looking to opt for the 'print and sprint' approach and most recently a 'static' CLO being issued by Palmer Square as its debut Euro CLO offering. As it stands, the European issuance level for 2020 is €13.21 billion from 40 deals, versus €20.15 billion from 48 deals at the same point last year. Market commentators are cautiously optimistic for the remainder of the year, buoyed by the fact that many of their worst expectations for the CLO market have not come to pass. It remains to be seen whether issuance levels hold up in Q4 of 2020.
In Ireland, collateral management services provided to undertakings which are 'qualifying companies' … (such as CLO issuers) are VAT exempt
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Taxing timesâ&#x20AC;Ś..and not just as a result of COVID-19 On 1 January 2020, Ireland implemented the Finance Act 2019 into law. One of the changes introduced by this piece of legislation was an amendment to the definition of a 'specified person' for the purposes of section 110 of the Taxes Consolidation Act 1997. This amendment impacts the ability of a Section 110 company (which would include CLO issuer vehicles) to deduct results dependent interest payments to any specified person. The definition of specified person now includes an entity that: a. holds, directly or indirectly, more than 20% of the profit or results dependent debt instruments issued by the issuer; and b. has an ability to participate in the financial and operating decisions of the issuer ('significant influence'). In the context of a European CLO, this impacts transactions where the collateral manager of the CLO also holds the positions in the securitisation. Our Tax team examines this issue and the options available to clients to address it in more detail in this edition in Irish and European Tax Developments Affecting Irish CLO Vehicles.
Meanwhile in the Netherlands While the majority of European CLO managers elect to locate their issuer vehicles in Ireland, a number of managers (particularly those who had been involved in the CLO 1.0 market) have chosen instead to use the Netherlands as their jurisdiction of choice. In the Netherlands, CLO managers were somewhat caught off guard in April when Dutch tax authorities announced that collateral management fees should no longer be treated as VAT exempt. Furthermore, Dutch authorities indicated that VAT would be charged retrospectively on collateral manager fees paid since mid-2019.
Urgent engagement by Dutch CLO market participants with the Dutch authorities did not succeed in reversing this position. However, a 'grace period' was granted by Dutch authorities such that collateral manager fees will now not attract VAT until January 2021. In Ireland, collateral management services provided to undertakings which are 'qualifying companies' for the purposes of Section 110 of the Taxes Consolidation Act 1997 (such as CLO issuers) are VAT exempt under the Value-Added Tax Consolidation Act 2010. As a result Ireland remains an attractive option for any CLO managers looking to migrate any of their existing CLO transactions out of the Netherlands.
And finallyâ&#x20AC;Ś..an old 'favourite' Brexit, anyone remember that? Notwithstanding the ongoing pandemic, the United Kingdom's Brexit transition period is scheduled to finish on 31 December 2020. While both the EU and the UK are engaged in ongoing negotiations as to the nature of their future relationship, there is still no clarity as to the final nature of that relationship or as to whether any form of agreement will be reached at all. This, combined with the consistent position of the UK government not to extend the Brexit transition period beyond 2020, reignites the real possibility of a 'hard' Brexit and the associated market and legal uncertainty that could result.
For further details, please contact: Stephen McLoughlin
+353 1 619 2736 firstname.lastname@example.org
+353 1 619 2716 email@example.com
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Global Listings Update Irish Listings Update During the first half of 2020, 72 US and European CLOs, comprising new issuances, re-financings and resets, were listed on Euronext Dublin. Of these listings, 40 were by issuers domiciled in the Cayman Islands, 28 from Ireland, three from the Netherlands and one from Jersey. The Maples Groupâ&#x20AC;&#x2122;s Dublin office listed 37.5% of all Euronext Dublin listed CLOs and 47.5% of all Cayman Islands domiciled issuers listing on Euronext Dublin.
For further details, please contact: Ciaran Cotter +353 1 619 2033 firstname.lastname@example.org
Cayman Islands Listings Update CLO listings on the Cayman Islands Stock Exchange ("CSX") started strong during the first three months of 2020, holding steady and on track to exceed new CLO listings recorded during the same period in the previous year. Following the global outbreak of COVID-19, April, May and June proved to be relatively quiet for new issuance listings on the CSX. However, by the end of H1 2020, 24 CLOs, comprising new issuances, refinancings and resets, were listed on the CSX, being only marginally down from the 26 CLOs listed on the CSX during the same period in 2019. Of these 24 new listings, 23 (96%) were by Cayman Islands issuers with a Delaware co-issuer. The Maples Group listed 63% of all the CSX-listed CLOs and 61% of all the Cayman Islands issuers which listed on the CSX during this period. Our Delaware office completed the listing of a single class of notes of a Delaware issuer on the CSX. While the second half of the year started slowly with no new CLO listings recorded on the CSX in July, in August there were eight new issuance CLO listings, and we are already aware of at least two more in the pipeline for September with the Maples Group having listed or in the process of handling 50% of these listings.
For further details, please contact: Amanda Lazier +1 345 814 5570 email@example.com
September 2020 | 7
Maples Groupâ&#x20AC;&#x2122;s Dublin office listed 37.5% of all Euronext Dublin listed CLOs
Maples Group listed 63% of all CSX-listed CLOs in H1
8 | The CLOser
Crystal-Balling the Markets: Follow-up on Warehouse Report
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As many of our readers will be aware, back in mid-June we issued our US CLO Warehouses â&#x20AC;&#x201C; COVID-19 Health Check report. The research was based upon an extensive analysis of 70+ open warehouses administered by the Maples Group â&#x20AC;&#x201C; representing an overall market share of around 50% â&#x20AC;&#x201C; and its focus, first and foremost, was on the effects of the loan price decline curve and its particular impacts on US CLO warehouse performance, restructurings, amendments and ultimate mortality rate, during the earlier stages of the pandemic. Despite substantial disruption and downward pressures, our Research Highlights gave an overarching positive message and demonstrated signs of significant resilience to market adversities. Monitoring and data collection continued since publication and, in this article, we now seek to consider whether the resilience reported upon in mid-June is further supported by the new data and if there are any additional observations or trends that we are able to identify, or conclusions that we are able to draw.
10 | The CLOser
"To be, or not to be…that [was ] the question" Thankfully, in most cases, the answer was (and remains) "to be"! We reported in June that approximately 75% of warehouses appeared to be unaffected. Since then we have seen over 16% of those warehouses successfully reach CLO close and a small number of additional deals (~5%) among that group have priced or are looking to price imminently. Reassuringly, from June onwards we also saw very few additional warehouses enter into difficulty or terminate and, of the 25% of 'symptomatic warehouses' exhibiting signs of being 'underwater' during the first period of analysis, remedial actions or terminations have now, for the most part, occurred. The net result is an overall slight reduction in the mortality rate of 'open' warehouses to fewer than 5% of those subject of our study.
Remedial actions…fast! As noted in our previous report, symptomatic warehouses underwent a variety of remedial actions and amendments, including increases in commitments, equity injections and margin calls (~18%). A further 18% or so of those symptomatic warehouses were converted into static or short duration deals – thereby shortening their life – and 6% or so were merged or combined to create a viable CLO portfolio. Aside from the 'splitting' of deals (see Divide and Conquer! below) we have not observed any notable new trends established for the COVID-19 impacted deals since mid-June.
So, what has happened since the midJune Report? Rising of the Phoenix During the past couple of months all 'symptomatic warehouses' have, for the most part, continued to be subject to swift remedial actions, the vast majority of which
have been completed. Indeed, in excess of 35% of those warehouses that had appeared to be struggling have, through effective remedial action, nonetheless successfully reached a CLO close. Those that showed no outward signs of difficulty have also fared reasonably well, as noted above.
Divide and Conquer! One new tactic that has emerged over recent months is the 'splitting' of assets, in particular, with the effect of separating-out the bad COVID-19 impacted assets. In these circumstances, new vehicles have been incorporated to take the 'good' and leave the 'bad' with the old vehicle, the latter being renamed and thereby freeing up the original name for the new vehicle to utilise.
New COVID-19 Focused Provisions In warehouse transaction documentation we have observed mechanisms that allow for additional post-pricing stepwise increases in funding commitment levels and concentration limitations being extended to cover industries that have been specifically impacted by COVID-19. This has helped introduce additional levels of protection.
Steady Increase in New Incorporations and 'Open' Warehouses Since early June we have experienced a steady, continued, increase in new instructions and new warehouses opening. From early / mid-June onwards, those new instructions have led to an additional 15 or so 'open' warehouses.
Shortened Warehouse Periods A fairly striking development since mid-June are the number of new 'open' warehouses that have rapidly priced and closed. Shortened warehouse periods have become commonplace, with durations anywhere between 10 days to 1 month not unusual. The size of the ultimate CLO issuance in those instances has tended to be smaller than traditionally would be the case, with an average in the region of roughly US$400 million.
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We also note, as can be seen from the graphs below, that from early June onwards, the period of time taken to open a warehouse following initial instruction has been on a fairly steady decline.
Key Managers Dominating the Market Looking at the number of warehouses opened on a per manager basis we can see that, in terms of warehouse entities administered by the Maples Group, the key players appear to be those with internal equity / funds. Beyond those, however, we see a fairly even distribution among the top 40 or so most active managers in the market, as illustrated by the graphic opposite.
Conclusion While there has been very significant market disruption and pressures, the resilience of US CLO warehouse arrangements has continued to be apparent throughout COVID-19 as the impacts have rippled their way through the market and put considerable downward pressure on loan values and general collateral quality. Reassuringly few terminations have occurred and a good proportion of deals have weathered the storm thus far in order to achieve a successful closing. What has become clear is that participants have been quick to act and to find effective workout solutions. There has also been a quick adaption to the new environment, with the splitting and downsizing of deals or combination of deals to create viable portfolios. All of this bodes well for the uncertain times ahead and, with relatively little trepidation, we can conclude from our data that there are signs for optimism as the market adjusts.
Share of 'open' warehouses based on selection of most active managers
Duration of time for warehouse to 'open' based on entity incorporation date
Farewell Mark Matthews is retiring from the Maples Group at the end of November 2020. The jacket will also be permanently retired â&#x20AC;&#x201C; let's face it, nobody else could wear it with such panache! While the memories of the jokes and the jacket will live on, we are all sad to be saying farewell to 'Big Mark'. Mark has been a pillar of the Maples CLO team, having worked on CLOs since the inception of the 1.0 market, and his retirement marks the end of an era. Mark has planned for his retirement, with many exciting personal adventures in store, and his legacy leaves the Maples team stronger than ever. We sat down with Mark to hear about his plans for retirement and some of his fondest memories from his tenure at the forefront of CLOs. Do you have exciting plans for retirement? Yes, absolutely, although I am probably going to have to revise them slightly as all of the exciting travel I had planned may have to be delayed somewhat in light of current circumstances. I am hoping to take my family on safari to Africa and to visit a couple of places in Southeast Asia that have been on my bucket list for some time. In the meantime, I am going to learn to kite surf and sail, which are both something I can do here in the Cayman Islands, and to play a little more golf. My kids are both at University in the UK, along with my parents and sister (and her family) so I am looking forward to spending time over there and seeing some of the places in the UK that I have not yet visited. High on my list is some hiking in Scotland and in the English Lake District.
You have been at Maples since 1998 â&#x20AC;&#x201C; what are your fondest memories? Looking back on my time at the Maples Group I have worked on some fabulous transactions including some high profile deals and I certainly got a lot of CDOs and CLOs under my belt too but, if I am being really honest about this, my fondest memories are of the people I have worked with â&#x20AC;&#x201C; both at Maples and with industry colleagues at onshore law firms, banks and manager clients. I have made some really great friends during my time at Maples and have thoroughly enjoyed the camaraderie that goes with the hard work and long hours, being in the trenches together, so to speak. I also had a blast on marketing trips with colleagues and clients including some fun marketing events like skiing, flying fighter jets and driving dune buggies in Las Vegas and incredible times at some lovely restaurants.
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What will you miss most? Definitely the people. But I do hope to stay in touch with my friends in the industry and at the Maples Group and, now that I have more time on my hands, I can hopefully do that. My friends are always welcome to visit me in the Cayman Islands and I hope they will.
What advice would you give to (i) your younger self and (ii) to your legacy team? I certainly feel like I made a great decision in joining the Maples family and moving to Grand Cayman over twenty years ago so I definitely got that right. It has been a great place to raise my kids, has provided a fabulous work environment and is definitely now home for me. What I would say to my younger self is that people still matter and you need to build relationships. Don't avoid talking to people in favour of an email. I would also reiterate that there is no substitute for hard work either. We have a fabulous team in the Cayman Finance practice with a lot of dedicated and talented lawyers who I am confident will keep the team at the top. This group is experienced and they work hard. I am very happy to know that I am leaving the group in such great hands, both at the partnership level and with the crop of associates coming up the ranks. I wish them all the very best for their careers.
Tell us a final joke I hope it won't be my final joke. I think the world would be a poorer place if people didn't tell the occasional joke so, here goesâ&#x20AC;Ś....
A young man named Donald bought a horse from a farmer for $250. The farmer agreed to deliver the horse the next day. The next day the farmer drove up to the house and said, "Sorry son, but I have some bad news, the horse died." Donald replied, "In that case then, just give me my money back." The farmer said, "Can't do that. I went and spent it already." Donald replied, "Ok then, just bring me the dead horse." The farmer asked, "What are you going to do with a dead horse?" Donald said, "I'm going to raffle him off." The farmer replied, "You can't raffle off a dead horse!" Donald said, "Sure I can, watch me. I just won't tell anybody he's dead." A month later, the farmer bumped into Donald and asked, "What happened with the dead horse?" Donald replied, "I raffled him off. I sold 500 tickets at $5 each and made a profit of $2,495." The farmer asked, "Didn't anyone complain?" Donald said, "Yes, just one person. The guy who won. So I gave him his money back." You can probably guess where Donald is now! I was going to sign off with a COVID-19 joke but that's probably not a good idea. 99.74% of you wouldn't get it anyway.
Bringing You CLOserâ&#x20AC;Ś Avoiding an Accosting â&#x20AC;&#x201C; Buyside Approaches to Improving Workout Capabilities for US CLOs
Author Bio: Jake Jamison is a capital markets attorney and business manager with extensive international experience in structured credit, corporate finance, bankruptcy, restructuring, and related litigation. He lives and works in New York City.
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How can CLO managers improve deal documents to give CLOs the optionality necessary to more fully participate in distressed credit workouts and improve recoveries? Mention the word "Acosta" to a CLO manager in today's syndicated loan market, and you're bound to get your listener's attention, and potentially raise an eyebrow. The closely-watched restructuring of the eponymous sales and marketing agency, a sizeable borrower in the belowinvestment grade syndicated loan market, highlighted certain notable disconnects between the evolution of senior loan credit agreements and the structural limitations of cash-flow CLOs, which own in aggregate roughly 60% of the US$1.2 trillion senior loan asset class. In the Acosta matter, the borrower and its affiliates successfully negotiated the write-off of approximately US$2.7 billion of existing debt in exchange for a debtor-in-possession loan (a "DIP" financing) and a US$250 million preferred equity raise. Restructuring negotiations centred around the competing interests of a majority group of distressed credit managers and a minority group of first-lien lenders, the latter of which included a sizeable number CLO holders of the loan. The equity infusion and DIP financing were central to the majority's restructuring thesis; non-participating holders were offered a cash-out alternative with an estimated recovery well below the recovery expectations for the participating holders. CLOs, due to structural tax considerations and the quality and concentration thresholds set forth in their operating documents, are generally ineligible to participate in direct lending initiatives, including DIP loans. CLOs likewise typically cannot commit to capital raises that aid distressed borrowers. CLO managers may therefore find themselves pigeonholed in their ability to negotiate and participate in a broad variety of workout scenarios in which these types of lending schemes and capital infusions play a crucial role.
Well-aware of these structural limitations on CLO lenders, the majority holders of Acosta's debt structured and received approval for a plan of reorganization that favoured lenders that could participate in the equity raise and DIP financing at the heart of the deal. Acosta's CLO holders, organically and structurally prohibited from direct lending and supplemental equity raises, were ultimately dealt a comparatively bad hand, while lenders able to participate in the approved plan reaped a disproportionately lucrative piece of the restructured pie. Barclays estimates that, due to tax and indenture restrictions, CLOs could potentially realize recoveries on distressed credits nearly 30% lower than other similarly situated lenders. To complicate matters further, the aftermath effects of the public health response to the ongoing global coronavirus pandemic have left many belowinvestment grade borrowers and their lenders grappling with an economic situation that has extensively impacted businesses across sectors that, until recently, were perceived to be relatively buttressed against widespread and immediate disruption. This confluence of factors presents a threshold issue for CLO managers seeking credit-positive portfolio positioning in today's market.
16 | The CLOser
How can deal documents be improved to give CLOs the optionality necessary to more fully participate in distressed credit workouts and improve recoveries? Although 2020 US CLO issuance YTD represents a mere fraction of 2019's near-record levels, managers that have issued CLOs against the present backdrop of global economic dislocation are producing deal documents that reflect a more participatory role for CLOs in distressed corporate restructurings. This evolution is a timely one: the senior loan market is likely to experience high default activity through at least 2021. Recovery expectations are tracking an approximately 20% decline for first-lien debt versus prior historical downturns; the potential outlook for subordinated issuances is even more severe. Some CLO managers have approached these structural challenges by deploying CLOs' distressed exchange buckets more actively. Still others have amended their CLOs' operating documents to permit direct lending and other types of liquidity support for distressed borrowers, insofar as no expectation of default existed at the time of the loan's initial acquisition (this is among the most widely debated exceptions to the general prohibition on direct lending
engagement by CLOs). Nonetheless, these strategies still necessitate compliance and harmonization with the concentration limits and quality restrictions that serve as a CLO's guardrails against credit quality dilution from the very types of distressed assets at issue here. Other CLO managers are seeking to enhance workout participation optionality by amending their CLO operating documents in a bid to green-light capital contributions and allocations of interest proceeds to acquire, and hold, debt or equity issued and received incident to a restructuring. Some CLO managers are amending their operating documents to further clarify (and potentially expand) the types of workout assets to which interest proceeds may be permissibly applied. For example, when broadly construed, the 'exercise of a warrant' â&#x20AC;&#x201C; a common but undefined permissible use of interest proceeds in second generation CLO indentures â&#x20AC;&#x201C; could refer to a CLO applying interest proceeds toward participation in the exercise of any number of offerings, including right offerings, options, warrants, rights of conversion, pre-emptive rights, credit bids, or any other right received and exercisable as part of a workout action. Such an interpretation would permit CLOs to deploy interest proceeds toward a broad variety
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of offerings previously believed to be out of bounds under narrower interpretations of the exercising a warrant phrase. Managers are now crystalizing and defining that broader approach in amended and new issue deal documents.
a recovery at all. Indentures free of these requirements provide an opportunity for CLO managers and their investors to try something rather new for them in the distressed space: playing the long game.
Similarly, capital contribution language in CLO indentures is getting a revamp. Recent amendments that deal with this concept have displayed manager advocacy for an expansion of capital contributions that include new avenues for infusing cash, such as direct contributions from individual CLO note holders, or contributing capital in the form of interest proceeds that would otherwise be distributed to certificated note or equity holders. Further, in deals that did not already allow it, express permission is being set forth for the application of capital contributions in workout scenarios.
Some larger managers, taking seriously the potential negative side effects of these more restrictive document provisions, are considering platform-wide amendments to their entire CLO franchise to introduce these more favourable positions to their investors on a uniform basis. This preserves strategic cohesion across vintages, and demonstrates to their clients that these managers are taking distressed credit management seriously within the unique context of CLOs.
Significantly, there has also been a push to remove in its entirety the widely incorporated indenture requirement that a CLO must sell any non-collateral obligation assets received in a workout within three years of receipt; some indentures even require a forced sale of these assets prior to taking ownership. These forced sale provisions have hampered CLO managers' ability to benefit from longerterm recoveries, or in the case of a forced sale prior to taking ownership, of even benefiting from that portion of
With luck, and better operating documents at their disposal, a more versatile, unified, and proactive group of CLO managers may well avoid another accosting in the restructuring arena and deliver improved returns to their equity investors.
18 | The CLOser
TALF 2.0: The Role of Cayman Islands and Delaware Vehicles The launch by the Federal Reserve of the new Term Asset-Backed Securities Loan Facility, or 'TALF 2.0', on 23 March 2020, was certainly a welcomed development. Commentators were, however, quick to identify issues and lobbied for various clarifications and correction to ambiguities in early iterations of the Term Sheet. Updated versions presented gradual improvements but also had conflicting impacts, leading to an expansion in the range of ABS that could be financed through the program, while at the same time limiting the types of US companies that were both eligible to borrow and to be issuers of the ABS financed as eligible collateral. It was the way in which US companies for TALF 2.0 purposes were defined, though, that was widely considered problematic and a hindrance to the intended proper functioning of the program. It is likely that all of the above factors have contributed to what some have described as only a modest uptake to date, with overall lower demand being observed than had been anticipated upon the initial launch. With the extension of the TALF 2.0 program until at least the end of 2020 and with further revisions, including updated guidance issued through FAQs, the position may change. As we look ahead with positivity, we wanted to highlight some of the ways in which Cayman Islands and Delaware vehicles have played a role and reached out to Dan Beckett, a Partner in our Funds & Investment Management team, for some expert insight!
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20 | The CLOser
Dan, what are you generally observing so far in the funds space in regards to TALF 2.0? As with the original TALF program created in response to the 2008 financial crisis, Cayman Islands feeder funds can be set up to allow non-US and US tax exempt investors to provide capital to invest into eligible securities under the TALF 2.0 program, and therefore provide investment opportunities and capital to support this critical part of the US market. As with all Cayman Islands funds, they offer a wellunderstood and common vehicle for international investors with an ability to be incorporated quickly. They can be provided in various legal forms depending on investor preference (exempted companies, LLCs and exempted limited partnerships) with the backdrop of a well-known and respected court and legal system and an appropriate level of regulation for institutional investors along with a good level of corporate governance for investors. Additionally, as you'll know, James, off balance sheet structured vehicles can also assist with any bankruptcy remote elements needed for risk and leverage purposes. Absolutely, Dan â&#x20AC;&#x201C; and although not specifically in relation to TALF 2.0, we have seen, of course, funds setting up off balance sheet rated note issuance vehicles for certain types of non-US investors, in particular, where their interests need to be held in the form of debt rather than equity.
Dan, are you able to give our readers a bit of a flavour of the overall type of structures in which you see, or indeed foresee, Cayman Islands and Delaware vehicles playing a role? Yes, absolutely. A simple master-feeder structure, with management / voting shares held by a share trustee pursuant to a declaration of trust for charitable purposes, is set out overleaf. We have seen and expect to continue to see permutations of this sort of overall structure.
In addition to the Cayman corporate structure sketched out above, we have also seen many TALF offshore funds structured as a Cayman Islands exempted limited partnership ("ELP"). The benefit for managers in using an ELP is that the terms of the Limited Partnership Agreement can very much mirror the terms of the onshore fund Limited Partnership Agreement, which can save time and costs during the drafting process. As a closed-ended fund, the offshore fund is now subject to the provisions of the Private Funds Law, 2020 of the Cayman Islands. In summary, this requires the applicable entity to register with the Cayman Islands Monetary Authority, appoint a Money Laundering Reporting Officer, and appoint an approved Cayman Islands based auditor to approve the financial statements. The trigger for making the application is when capital is first called, rather than upon closing. There has been a steady stream of registrations of Cayman funds to allow non-US and US tax exempt investors to provide capital to invest into eligible securities under the TALF 2.0 program all summer. We estimate that we have assisted with around 45% of all such funds, which puts the Maples Group in a very good position to help other managers that are pursuing this as a strategy. If anyone should require further information or assistance with respect to the Maples Group's expertise and experience with TALF 2.0 feeder funds and / or structured vehicles, including formation services in respect of Cayman Islands and Delaware vehicles, please contact: James Reeve +1 345 814 5129 firstname.lastname@example.org Dan Beckett +1 345 814 5207 email@example.com Jeffrey Everhart +1 302 440 3657 firstname.lastname@example.org
September 2020 | 21
22 | The CLOser
Bond Bucket / Volcker Rule Amendment In the February 2020 edition of The CLOser, we flagged that United States regulatory agencies were proposing to amend the Volcker Rule, with one of the anticipated results being the return of the bond bucket for US CLOs. The US Commodity Futures Trading Commission, The Federal Reserve Board, the Office of the Comptroller of the Currency, the US Securities and Exchange Commission and the Federal Deposit Insurance Corporation have now released the final rule (the "Amendment") which modifies the regulations that implement Section 13 of the Bank Holding Company Act, commonly referred to as the "Volcker Rule". The Amendment becomes effective 1 October 2020 and has been making headlines as it is expected to have a positive impact on US CLO issuances.
Bond Bucket Amendment The Volcker Rule in its original form restricted banks from having an ownership interest in a "Covered Fund". Under the Volcker Rule, most CLOs are captured by the definition of a Covered Fund. However, many CLOs have used the loan securitisation exclusion under the Volcker Rule to enable banks to invest in them. This exclusion allowed a CLO not
to be classed as a Covered Fund if it only invested in loans and was prohibited from owning or holding any "security, including an equity or debt security or an asset-backed security". The use of the securitisation exclusion meant the end of the 'bond bucket', which was a feature of many CLOs that had allowed them to hold a certain amount of non-loan assets, primarily high-yield bonds. The Amendment enables the expansion of the types of securities that banks can invest in, paving the way for CLOs to once again be able to include bonds in their pools of assets. The Amendment modifies the loan securitisation exclusion to allow CLOs to invest in "debt securities, other than asset-backed securities and convertible securities" if the aggregate 'value' of such debt securities does not exceed five percent of the 'aggregate value' of all loans, cash, cash equivalents and debt securities held by it. This allows for the return of the five percent bond bucket for nonconvertible debt securities.
September 2020 | 23
Covered Fund Definition The definition of Covered Fund previously defined the term 'ownership interest' to include any 'interest' that includes "the right to participate in the selection or removal of an investment manager or an investment adviser" of the Covered Fund outside of the context of the exercise of a creditor's remedies upon the occurrence of an event of default. As the right to remove a CLO's collateral manager is one of the rights commonly associated with certain classes of CLO notes, this restriction often meant that banks were not able to invest in such classes of CLO notes. The Amendment removes this impediment by harmonising the Volcker Rule with the 'for cause' removal rights that typically appear in CLOs. The Amendment provides that an ownership interest will not include "the right to participate in the removal of an investment manager "for cause" .. or the selection of a replacement investment manager upon an investment manager's resignation or removal" and defines 'cause' by reference to a list of non-default-related events or circumstances and other similar events that constitute cause for removal of an investment manager that are not "solely related to the performance of the covered fund or the investment manager's exercise of investment discretion under the covered fund's transaction agreements". In addition, the Amendment provides that a 'senior loan or debt interest' in a Covered Fund is not an ownership interest in the Covered Fund if: a. the rights held do not include the right to receive a share of the profits, income or gains of the Covered Fund, but an restricted entitlement to receive: "interest at a stated interest rate, as well as commitment fees or other fees, which are not determined by reference to the performance of the underlying assets of the Covered Fund" and "repayment of a fixed principal amount, on or before a maturity date, in a contractually-determined manner"; b. the holders of the CLO notes "are not entitled to receive the underlying assets of the Covered Fund after all other interests have been redeemed or paid in full (excluding
the rights of a creditor to exercise remedies upon the occurrence of an event of default or an acceleration event)"; and c. the holders' entitlement to payments under the relevant terms "are absolute and cannot be reduced based on losses arising from the underlying assets of the covered fund, such as allocation of losses, write-downs or chargeoffs of the outstanding principal balance, or reductions in the amount of interest due and payable on it". On a practical level, and subject to the terms of the particular CLO Indenture, existing CLOs with indentures that do not expressly permit investment in bonds will not be permitted to take advantage of this new flexibility without entering into a supplemental indenture. In most cases this will require the consent of holders of one or more classes of notes. For new CLOs, it can be expected that managers will seek for the documentation to allow for a bond bucket. A collateral manager's experience in investing in such securities will be scrutinised by investors when considering whether or not to permit a bond bucket. Overall, the changes brought by the Amendment provide greater clarity and certainty around the application of the Volcker Rule to CLO transactions and give back to arrangers and managers the flexibility to include bonds and other nonloan assets in a CLO portfolio.
For further details, please contact: John Dykstra +1 345 814 5530 email@example.com Robin Harding +1 345 814 4404 firstname.lastname@example.org
DISCLAIMER: The information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice from qualified US counsel
24 | The CLOser
Industry Focus - Irish and European Tax Developments Affecting Irish CLO Vehicles Overview There have been significant Irish and European tax changes introduced in recent years, most notably international tax measures such as the OECD base erosion and profit shifting (BEPS) project and EU tax measures, including the EU Anti-Tax Avoidance Directive ("ATAD"), as well as domestic Irish tax initiatives, in particular, under the Irish Finance Act 2019. These tax changes impact Irish CLO vehicles and we have been navigating these changes on behalf of clients. In particular, we are actively working with the Irish securitisation industry group which we chair, the Irish government and international law firms and clients to address these new rules.
Irish Tax Developments The Irish Finance Act 2019 became effective from 1 January 2020 and introduced one key change that is relevant to CLO transactions. Specifically, a change in the definition of a 'specified person' for the purposes of section 110 of the Irish Taxes Consolidation Act 1997 and is relevant to the ability of a Section 110 company (securitisation company / CLO vehicle) to deduct results dependent interest payments which would include the 'equity tranche' of the notes. Interest will not be deductible if: •
it is paid to a specified person; and
at the time the instrument was issued, the Section 110 company was in possession, or aware, of information which could reasonably be taken to indicate that such interest would not be subject to tax in an EU member state or jurisdiction with which Ireland has a double tax treaty (a "Relevant Territory").
A specified person includes a company which controls the Irish Section 110 company, is controlled by the Irish Section 110 company, or where both companies are directly or indirectly controlled by a third company. It is the change to the definition of control in this context which will impact transactions. The definition of specified person now captures companies which hold: •
more than 20% of the profit or results dependent debt instruments issued by the issuer (i.e. the subordinated loans); and
have an ability to participate in the financial and operating decisions of the issuer (significant influence).
There is currently no officially published Revenue guidance on the concept. However, draft guidance, and general market consensus indicates that a collateral manager would have significant influence. Accordingly, one must scrutinise the percentage holding of any person with significant influence. This is particularly relevant to a CLO where the retention holder is holding a horizontal retention piece. However, the restriction on deductibility does not apply if either: •
the relevant noteholder can confirm that the interest payable on the subordinated notes is subject to tax in a Relevant Territory; or
at the time of issuance of the relevant instrument, the Section 110 company was not in possession of any information which could reasonably be taken to indicate that the interest payable was not subject to tax in a Relevant Territory.
Revenue Guidance Exclusion - CLO Exemption Revenue have released draft guidance following submissions made by industry and the Maples Group which provides that specified person "is a broad test which Revenue recognises may cause uncertainty for a small number of bona fide public securitisation transactions, which this test was not designed to capture". The net effect of the guidance is that a CLO manager, or an affiliated entity, will not be treated as a 'specified person' due to their holding of notes for risk retention purposes. The guidance is considered to be still under review, but is in substantially final form.
EU Tax Developments EU Anti-Tax Avoidance Directive Anti-Hybrid Rules ATAD requires the introduction by all EU member states of anti-hybrid rules and Ireland introduced these provisions in the Finance Act 2019. The anti-hybrid rules are intended to prevent arrangements that exploit differences in the tax treatment of a financial instrument or an entity under the tax laws of two or more jurisdictions to generate a tax advantage, i.e. a 'hybrid' situation. The rules apply only in certain circumstances: â&#x20AC;˘
arrangements between associated enterprises. For this purpose, an entity is associated with another entity if it holds a certain percentage (25% or 50% depending on the particular provision) of the shares, voting rights or rights to profits in that other entity, or if there is another entity that holds that percentage in both entities;
where two entities are included in the same consolidated financial statements;
where one entity has significant influence in the management of the other; and
September 2020 | 27
to a 'structured arrangement' that is not between associated entities, where a mismatch outcome is priced into the terms of an arrangement or an arrangement is designed to produce a mismatch outcome.
In the context of CLOs, these anti-hybrid rules may impact the deductibility of payments of interest by the issuer to noteholders in certain circumstances. However, noteholders are not generally expected to be persons who would be considered associated with the issuer, merely by reason of holding notes. On the other hand, a noteholder can be associated with an entity if it consolidates the issuer under its financial statements.
Interest Limitation Rule Although the date for introduction of the EU interest limitation rule in Ireland is currently unknown, it is expected that it will be implemented before 2024. Broadly, the interest limitation rules seek to restrict certain borrowing costs to a defined limit in the computation of the taxable profit of the issuer. In the context of CLOs, we expect that the impact of the interest limitation rules will be limited as the majority or all of the income of the company will be interest or income equivalent.
DAC6 EU Mandatory Disclosure Regime DAC6 is the new European Union tax mandatory disclosure regime requiring disclosure of certain cross border arrangements. Reporting is made by 'intermediaries' and in certain cases the taxpayer to the Irish Revenue Commissioners which is then shared with tax authorities across the EU. Certain reporting is also made to the European Commission. Reporting will commence in January 2021 and penalties will arise if reporting that is due is not made by the appropriate deadline. CLO transactions are cross border so may be in scope in certain cases.
We are working with CLO clients to assess the impact of these new rules on existing and new structures to determine whether transactions must be reported. We are also working with industry groups and international law firms to develop an industry consensus as to the approach that can be taken for market standard CLO transactions.
For further details, please contact: Andrew Quinn +353 1 619 2038 email@example.com Grainne O'Loughlin +353 1 619 2072 firstname.lastname@example.org
28 | The CLOser
Your Global CLO Team â&#x20AC;&#x201C; A CLOser Look Joe Jackson
Associate | Legal Services +1 345 814 5287 email@example.com
I joined the Maples Group in 2015 as an associate in the Finance Group based in the Cayman Islands office. My practice is predominantly focused around structured finance and CLO transactions as well as banking, fund financing and aircraft financing. I also advise clients on general corporate matters. How did you end up working at the Maples Group in the Cayman Islands? Growing up in Cayman in the 1990's is probably just what you would expect. Playing football on the beach with my cousins with the heat of the crackling midday sun on our backs was common place, climbing trees in my grandmother's backyard to find that perfectly 'turned'
mango was a skill easily honed and watching fish breach the sparkling cobalt water while vigorously reeling in that big catch (emphasis on BIG, of course) on the weekends was just what you did. That's right, island boy to the core. While the Cayman Islands is still considered the jewel of the Caribbean, the landscape and easy pace of life as it was back then is stark contrast to the bustling cosmopolitan which it has become today.
September 2020 | 29
Coming from a family of pilots with my father serving as training captain for the country's national flag carrier, Cayman Airways, it was just expected that either myself or my younger more 'adventurous' brother would take up the reins and follow suit. Well, you can just imagine the shock on my parents faces when I announced my intentions of becoming a lawyer and forgoing a soaring desk in the sky for one at Ugland House. The irony of all of this being that part of my practice does involve aviation finance so that's kind of in the same realm, right?! After completing my A-levels at Cayman Islands Prep School, I attended the University of Liverpool where I pursued my LLB Hons degree. I decided at a very early stage in my schooling that if I was going to join this age old fraternity, I was going to do it the right way and with the best, so I naturally chose to join Maples and accepted a summer student position. Then days turned to nights and before long, I was signing my training contract where I spent 18 months soaking in everything there is to know about Cayman Islands corporate law. I was called to the bar in 2015 and thereafter I joined the Finance team at the Maples Group as an associate.
What do you like to do outside the office? After spending a couple of years as a lawyer, you realise how vital physical activity is for maintaining mental stability! The gym and weight training is my outlet and something I try to make time for as often as I can (NB: quarantine snacking has presented its fair share of challenges with this, but I digress). Chasing after our one-year old son has now also become another effective form of exercise.
Tell us two fun facts about yourself My wife and I welcomed our first son in September last year which has been quite a journey, not to mention having to adjust to becoming a new parent all while in the throes of a global pandemic â&#x20AC;&#x201C; thanks, COVID-19! I was also an avid equestrian for many years and even attended the 2008 Beijing Summer Olympics as part of the junior delegation for the Cayman Islands Olympic Team.
Associate | Legal Services
30 | The CLOser
Senior Vice President | Fiduciary Services
September 2020 | 31
Senior Vice President | Fiduciary Services +1 345 814 5854 firstname.lastname@example.org How did you end up working at the Maples Group in the Cayman Islands? I am a graduate of the Australian National University with degrees in Finance and Law and I started my corporate career with National Australia Bank in the corporate banking group. Some years later, I decided it was time to head abroad and had my sights set on the well-trodden path from Canberra to London. By accident and good fortune, I met a group of accountants from the Deloitte office in the Cayman Islands, one of whom was joining what was then known as Maples Finance. So abandoning all UK plans, I was on a plane to Grand Cayman some three months later with the promise of sun and warm Caribbean waters. I started in the funds fiduciary group in 2007 providing directorship services to investment funds, structured finance vehicles and a wide variety of other companies. It was an amazing time to join the Maples Group and the Cayman Islands financial services industry. Back then, the fiduciary group was much smaller and I knew most of the people in the elevators. I now specialise in structured finance products, including CLOs, private equity structures and other note issuance vehicles.
What do you like to do outside the office? Being of Chinese background and an Australian, I love food and travel. Whenever I get the chance to leave Cayman, I head for the snow in winter with my husband and two daughters and somewhere fun in the warmer months, and when I get back, I enjoy going for runs, and hanging out on the beach with a good book in hand.
Tell us two fun facts about yourself. Despite my Australian accent, I was born in Fujian Province, China under the one child policy and moved to Australia when I was nine. My real date of birth is not on my passport. My grandmother was tasked with registering my birth with the local authorities in Fujian â&#x20AC;&#x201C; not great with literacy, she miswrote the date of registration as the date of my birth and, as a result, I will always be 20 days younger on paper.
What is your outlook for the market for the rest of this year and beyond? With the volatility in the markets, and uncertainty over what the post-pandemic world will look like, there is a lot of discussion going on as to the effects of this disturbance on the CLO market. One thing that most commentators seem to agree on, is that the lessons learned from the sub-prime crisis is proving valuable in dealing with the challenges faced by market participants. Although US CLO issuance numbers are down, we have seen positive signs with new warehouses and CLO closings during the months of March through August, as well as new issuers being formed.
A Global Team Our CLO team comprises 26 specialist CLO lawyers and 48 specialist CLO fiduciary professionals across our global network. Since the inception of the CLO market over 20 years ago, we have provided our clients with the benefit of our unparalleled depth of knowledge, experience and insight into what we see across the whole structured finance market, from the latest warehousing structures, to the latest regulatory developments and how they impact CLOs, to ongoing post-closing CLO issues.
For further information, please speak with your usual Maples Group contact, or the following primary CLO contacts:
Mark Matthews +1 345 814 5314 email@example.com
Stephen McLoughlin +353 1 619 2736 firstname.lastname@example.org
Guy Major +1 345 814 5818 email@example.com
Scott Macdonald +1 345 814 5317 firstname.lastname@example.org
Callaghan Kennedy +353 1 619 2716 email@example.com
Andrew Dean +1 345 814 5710 firstname.lastname@example.org
John Dykstra +1 345 814 5530 email@example.com
Andrew Quinn +353 1 619 2038 firstname.lastname@example.org
Tina Meigh +1 345 814 5242 email@example.com
Jonathon Meloy +1 345 814 5412 firstname.lastname@example.org
Stacey Overholt +852 3690 7441 email@example.com Jersey
James Reeve +1 345 814 5129 firstname.lastname@example.org
Chris Byrne +44 1534 495 311 email@example.com
Anthony Philp +1 345 814 5547 firstname.lastname@example.org
Amanda Lazier +1 345 814 5570 email@example.com
Jonathan Caulton +44 20 7466 1612 firstname.lastname@example.org Singapore Michael Gagie +65 6922 8402 email@example.com
James Lawler +1 302 340 9985 firstname.lastname@example.org Dublin Stephen Oâ&#x20AC;&#x2122;Donnell +353 1 697 3244 email@example.com Jersey Cleveland Stewart +44 1534 671 370 firstname.lastname@example.org London Sam Ellis +44 20 7466 1645 email@example.com Netherlands Jan Hendrik Siemssen +31 20 570 6820 firstname.lastname@example.org
Forthcoming Events Members of the Maples Group CLO team will be attending and/or participating in the following virtual industry events during H2 2020:
Global ABS Virtual Virtual
Opal European CLO Summit 2020 Virtual
Creditflux CLO Investor Summit
ABS East 2020 Virtual
Opal US CLO Summit 2020 Virtual