The international shoppers of Collateralized Loan Obligations (CLOs) are facing a hard time as a new tax bill is being levied on them owing to retention risk compliance rules. The retention rules that comes alive on December 24 demands managers to maintain 5% of their fund. CLOs collect loans having various credit quality and sell portions of the fund according to the seniority varying from Triple-A to B to institutional investors like insurance firms.
Creating a fresh standalone CLO firm known as capitalized manager vehicle (CMV), which is one among the options to comply the retention rules, might burden overseas investors with new tax bills and possibly impacting their gains. Reuters quoted a director of Deloitte Tax office in Houston Joelle Berlat, who said, "When looking at structures, one of the questions has been: how does it make sense for foreign investors, accepting the reality that they may pay tax on that income to invest."
The new rule is weighed as an additional hurdle for the US$428 billion CLO industry, which is the biggest purchaser of leveraged loans. Funds allocation is expected to decline over 60% in the current year, leading to the loss of interest for the leveraged loan industry that is worth $880 billion. The volume of CLOs allotted in the US declined 72.5% to $8.2 billion during the first three month period of 2016 from $29.8 billion in the corresponding period in 2015.
The fund management vehicle earns from both supervision fees for overlooking the CLO as well as gains from the acquired risk-retention securities, according to Craig Stein, co-chief of derivatives and structured finance at Schulte Roth & Zabel. He added that the CMV might manage tax matters for overseas financiers who have to directly invest into the administration vehicle.
While a CMV could be involved in trade activities, a CLO is designed as a company not to be involved in business so that it is untaxed in the US, Stein said. He also noted that the earnings of CMV are weighed as an effectively connected income (ECI) for a foreign investor. Stein continued that international investors have invested in theses administration firms regardless of the tax burden.
GlobalCapital reported that following a poor beginning in the first quarter of 2016, the CLO market improved with five fresh deals over the past six weeks that enhanced the volume of CLO issuance to EUR 3.47 billion. However, assets shortage might act as a risk factor for the industry.
Meanwhile, Moody's upgraded CLO notes of GSC European CDO I-R to EUR 32.5 million. While it elevated Class D Floating Rate Notes that is due till 2022 to EUR 20.3 million, according to MOODY'S INVESTORS SERVICE.
A survey conducted by Maples and Calder in February discovered that 47% of CLO controllers had risk-retention company. Meanwhile, 40% of CLO supervisors voted for capitalized majority-owned affiliate (C-MOA) criteria and 32% opted the CMV version.
