On March 31, 2025, a Joint Committee (JC) comprised of the European Banking Authority, European Insurance and Occupational Pensions Authority and European Securities and Markets Authority published a report (JC Report) on the functioning of the EU Securitisation Regulation. While the report contained a large number of proposals, which we will cover in a separate briefing, the immediate takeaway for CLO participants is that the JC has issued guidance regarding the interpretation of the sole purpose test. Some risk retention vehicles will need to reassess compliance with the sole purpose test in light of the new guidance; however, we expect properly structured manager/originator retention vehicles to meet the new interpretation.
The full report is available here.
Sole Purpose Test
- The EU Securitisation Regulation provides that a retention holder shall not be considered to be an originator where the entity has been established or operates for the sole purpose of securitising exposures.
- The Regulatory Technical Standards (RTS) regarding the retention requirements further expand on the sole purpose test. The RTS provides that an entity shall not be considered to have been established for the sole purpose of securitising exposures if, among other things, “…. the entity does not rely on the exposures to be securitised, on any interests retained or proposed to be retained in accordance with Article 6 of Regulation (EU) 2017/2402, or on any corresponding income from such exposures and interests, as its sole or predominant source of revenue”.
- In the JC Report, the JC further considered the meaning of the term “predominant.” In particular, they focused on the application of the risk retention rules to CLO third-party origination vehicles; however, the guidance will apply to all originators.
- The JC acknowledged that the term “predominant” gives room for interpretation and its original intention could be further clarified. As a result, the JC Report has stated that the term “predominant” should be interpreted as a threshold of more than 50% – meaning that more than 50% of an originator’s revenues must be derived from sources other than the exposures to be securitized or the risk-retained assets (or any corresponding income from such exposures and risk-retained assets).
- The JC confirmed that the “predominant” test looks at the income produced by assets (rather than, for example, the principal amount of such assets or any other capital support to the retention holder).
Grandfathering
- The JC Report provides that, going forward, any new issuance should apply the above interpretation of “predominant.”
- In our view, this means the above interpretation will not apply to any closed deals, including secondary market investments in closed deals.
- The position of deals which have priced but not yet closed was not specifically addressed. As investors have committed to purchase notes at pricing, there is a reasonable argument that issuance has occurred at pricing and so the above interpretation should not apply to any deals priced before March 31. We believe the market will likely take this approach.
Calculating Revenue
Neither the JC Report nor the underlying regulation provides a method for calculating the revenue of a risk retention vehicle, and so there is considerable uncertainty as to how revenue should be calculated. We suggest the following calculation as a starting point, but such calculation will be unique to each vehicle and the treatment of revenue derived from securitizations will need to be carefully assessed:
Changes to CLO Documentation
We foresee no significant changes to CLO documentation as a result of the JC Report. As the underlying regulation remains untouched, we expect no changes to the market standard sole purpose representations, which are typically provided by an originator. Disclosure regarding the JC’s interpretation of the sole purpose test will need to be included in offering documents.
UK Position
As part of the reforms introduced last November, the sole purpose test in the UK no longer treats revenue as the prime factor in determining whether the originator has a broader business model. The UK test only refers to “material support from capital, assets, fees or other income available to the entity.” Accordingly, an originator that does not have sufficient revenue to pass the sole purpose test on the basis of the JC’s interpretation could still pass the test in the UK.
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