In this risk retention piece, we provide updates to how the final rule under Dodd-Frank applies to CLOs. We cover the permissible forms of risk retention and financing options for the risk retention obligation among other things.

1. CLO
Risk Retention
Update
Winnie Lam

2. © 2015 Black Swan Consulting LLC
1
December 24, 2015
Credit Risk Retention Update
On October 22, 2014, six federal agencies, the Board of Governors of the Federal Reserve System,
the Department of Housing and Urban Development, the Federal Deposit Insurance Corporation,
the Federal Housing Finance Agency, the Office of the Comptroller of the Currency and the
Securities and Exchange Commission, (the “Agencies”), jointly approved a final rule to
implement the credit risk retention requirements for asset-backed securities in the Dodd-Frank
Wall Street Reform and Consumer Protection Act.
The final rule takes into consideration comments received on the rule which was re-proposed in
of August 2013 and also the comments received on the rule that was originally proposed in April
of 2011.
How does the final rule apply to CLOs?
The final rule reflects the Agencies’ determination that the manager of a CLO is its “sponsor.”
The final rule requires the "sponsor" of the CLO to retain, and to refrain from transferring, selling,
conveying to a third party, or hedging, an economic interest in the credit risk of the securitized
assets in an amount equal to at least five percent of the CLO securities issued in the transaction.
When does the final rule become effective?
The rule will become effective for CLOs on December 24, 2016, two years after it was published
in the Final Register. The sponsor must determine its method of compliance as of the closing date
of the securitization transaction.
What are the permissible forms of risk retention under the final rule?
 Vertical risk retention.
o The sponsor may satisfy its risk retention obligation by retaining a portion of
each class of the ABS interests issued in the transaction (at least 5% of the face
value of each class of ABS interests issued as part of the securitization
transaction) or a single vertical security (that ABS interest must entitle the holder
to 5% of the cash flows on each class of ABS interests in the issuing entity) which
represents an interest in each class of ABS interests issued in the securitization.
 Horizontal risk retention.
o The sponsor may satisfy its risk retention obligation by retaining a first loss
eligible horizontal residual interest in the issuing entity in an amount equal to no
less than 5% of the fair value of all ABS interests in the issuing entity that are
issued as part of the securitization transaction.

3. © 2015 Black Swan Consulting LLC
2
o 5% fair value (determined using a fair value measurement framework under U.S.
GAAP) of all the ABS interests in the CLO.
 Eligible horizontal cash reserve account.
o The sponsor may establish and fund, in cash at closing, an “eligible horizontal
cash reserve account” in an amount equal to the same dollar amount… as would
be required if the sponsor held an eligible horizontal residual interest.”
 Combination or L shaped risk retention.
o Sponsors may retain risk through any combination of a vertical form and a
horizontal form provided that the total percentages of retained forms in the
securitization add up to 5%.
What are some options of financing the risk retention obligation? Who can retain the
required risk retention?
 The CLO manager as the sponsor of the CLO.
 A majority-owned affiliate of the CLO manager.
o A majority-owned affiliate of a person means an entity (other than the issuing
entity) that, directly or indirectly, majority controls, is majority controlled by, or
is under common majority control with, such person. For purposes of this
definition, majority control means ownership of more than 50 percent of the
equity of an entity, or ownership of any other controlling financial interest in the
entity, as determined under GAAP.
 A CLO manager or its affiliate may obtain debt financing for its required retention
interest.
o The final rule restricts a sponsor and its affiliates from pledging its retained
interests as collateral for any obligation, unless the obligation is with full
recourse to the sponsor or such affiliate.
o Allocation of risk retention to an originator.
o An originator is defined as a person that "(1) through an extension of credit or
otherwise, creates an asset that collateralizes an asset-backed security; and (2)
sells the asset directly or indirectly to a securitizer or issuing entity."
o The originator must acquire and retain at least 20% of the aggregate risk
retention amount otherwise required to be held by the sponsor, and must comply
with the hedging, transfer and other restrictions with respect to such interest as if
the originator were a sponsor that acquired the retained interest. The sponsor
would remain primarily responsible for compliance and would be required to
notify investors of any noncompliance by the originator.
o The originator is required to retain its interest in the same manner and
proportion (i.e., vertical, horizontal, or L-shaped interest) as the sponsor.

4. © 2015 Black Swan Consulting LLC
3
 Lead arranger option for open market CLOs.
o Under this alternative, CLO managers do not need to satisfy the risk retention
requirement for a CLO if the transaction meets certain conditions, most notably a
requirement that arrangers of underlying syndicated loans retain risk interests in
the loans as a condition to such loans being included in the CLO.
 To qualify as a “lead arranger,” an institution must:
 Be active in the origination, structuring and syndication of
commercial loan transactions and have played a primary role in
the structuring, underwriting and distribution on the primary
market of the CLO-eligible loan tranche;
 have taken an allocation of the funded portion of the syndicated
credit that is at least 20% of the aggregate principal balance at
origination and that equals or exceeds the allocation to any other
member of the syndication group that funded at origination; and
 be identified in the applicable agreement governing the CLO-
eligible loan tranche; represent therein to the holders of the CLO-
eligible loan tranche and any participation interest that the lead
arranger satisfies the first item above and, at the time of the
initial funding of the CLO-eligible loan tranche, will satisfy the
second item above; further represents that in its reasonable
judgment, the terms of the CLO-eligible loan tranche are
consistent with the requirements of the certain provisions of the
final rule; and covenant to the holders that it will fulfill the
requirements of the first item above.
Official copy of the Final Rules:
http://www.occ.gov/news-issuances/news-releases/2014/nr-occ-2014-139b.pdf

5. © 2015 Black Swan Consulting LLC
4
For any inquiries regarding this weekly newsletter, you can contact the author:
Winnie Lam (917) 338-2380 Winnie.Lam@BlackSwanConsultingGroup.com
For general inquiries regarding Black Swan Consulting you can contact the following individual:
Kristen Verberkmoes (917) 338-2380 Kristen.Verberkmoes@BlackSwanConsultingGroup.com
Jeremy Vandergoot (917) 338-2380 Jeremy.Vandergoot@BlackSwanConsultingGroup.com
Notice:
The materials in this newsletter and any related links are provided for informational purposes
only. The materials in this newsletter are not represented as being accurate, complete, or up‐to‐
date. Any links to other third‐party Web sites are only for the convenience of the user, and Black
Swan Consulting LLC does not recommend or endorse the contents of the third‐party Web
sites. Although this newsletter may provide information concerning legal issues, such
information is not intended to constitute or be a substitute for legal advice from qualified
counsel. Readers of this newsletter should not take, or refrain from taking, any action based on
any information contained in this newsletter without first consulting qualified counsel.
Black Swan Consulting LLC makes no express or implied warranty regarding any information or
material in this newsletter. Black Swan Consulting LLC hereby expressly disclaims all liability in
respect to actions taken or not taken based on any materials provided in this newsletter.