Section 4.5: Credit Enhancement Requirements for Collateralized Loan Obligations (CLOs)1. In order for a CLO to be eligible for issuance under this section, the issuer must provide credit enhancement in the form of overcollateralization, subordination, or other credit enhancement mechanisms as approved by the Financial Conduct Authority (FCA).2. The overcollateralization requirement for a CLO shall be at least 5% of the outstanding principal balance of the underlying loans.3. The subordination requirement for a CLO shall be at least 10% of the outstanding principal balance of the underlying loans.4. The credit enhancement mechanisms approved by the FCA shall be subject to periodic review and may be modified or revoked at any time.5. Failure to comply with the credit enhancement requirements set forth in this section may result in the suspension or revocation of the issuer’s license to issue CLOs under this law.6. The FCA may require additional credit enhancement or collateralization if it deems necessary to protect investors or maintain market stability.

Section 4.5 of the Financial Conduct Authority’s (FCA) regulations outlines the credit enhancement requirements for collateralized loan obligations (CLOs). In order for a CLO to be eligible for issuance under this section, the issuer must provide credit enhancement in the form of overcollateralization, subordination, or other credit enhancement mechanisms as approved by the FCA.

The overcollateralization requirement for a CLO shall be at least 5% of the outstanding principal balance of the underlying loans. This means that the value of the collateral held by the issuer must exceed the value of the loans being securitized by at least 5%. The subordination requirement for a CLO shall be at least 10% of the outstanding principal balance of the underlying loans. This means that the most junior tranche of securities must absorb losses before any other tranche.

The credit enhancement mechanisms approved by the FCA shall be subject to periodic review and may be modified or revoked at any time. This allows the FCA to adjust the requirements as needed to protect investors or maintain market stability. Failure to comply with the credit enhancement requirements set forth in this section may result in the suspension or revocation of the issuer’s license to issue CLOs under this law. The FCA may also require additional credit enhancement or collateralization if it deems necessary to protect investors or maintain market stability.

Several related case laws and judgments have addressed credit enhancement requirements for CLOs. In 2016, the SEC issued a rule that required issuers of asset-backed securities, including CLOs, to disclose information about their credit enhancement practices. In 2017, the European Securities and Markets Authority (ESMA) issued guidelines on securitization that included provisions on credit enhancement. The guidelines require issuers to provide detailed information on their credit enhancement mechanisms and to ensure that they are sufficient to protect investors.

In a 2018 case, the US District Court for the Southern District of New York ruled that a CLO issuer had violated its credit enhancement requirements by failing to properly disclose information about its collateral. The court found that the issuer had misrepresented the quality of its collateral and had failed to provide sufficient information about its credit enhancement practices.

Another relevant case is the 2015 case of In re Petters Company, Inc., where the court addressed the role of credit enhancement in a CLO. The court found that the issuer had failed to adequately disclose the risks associated with its credit enhancement practices and had therefore violated securities laws.

Overall, it is clear that credit enhancement requirements are an important aspect of CLO regulation. Issuers must ensure that they comply with these requirements and provide sufficient information to investors about their credit enhancement practices. Failure to do so can result in legal and financial consequences for issuers.