Business Development Companies (BDCs) that rely on Collateralized Loan Obligations (CLO) as a part of their funding strategies are asking the federal government to reconcile conflicting legal guidelines that they argue place unrealistic, competing demands on them, according to reporting from Reuters.

BDCs are closed-end investment companies that have elected to be regulated as such under the Investment Company Act of 1940, and are therefore regulated by the SEC under the Investment Company Act of 1940 (1940 Act). Experts say that certain risk-retention rules put in place as part of the Dodd-Frank Act make it nearly impossible for BDCs issuing CLOs to follow both regulations.

“It’s a material conflict between two regulatory regimes,” said Sean Solis, a partner at law firm Dechert, in an interview with Reuters. “The provision in risk retention that allows for a CLO to use the BDC for risk retention conflicts with limitations on affiliate transactions set forth in the Investment Company Act of 1940."
 
“For [firms] that have traditionally used CLOs as a source of attractive, long-term balance sheet financing for portfolios of middle-market loans, this conflict presents a real issue,” he said.

David Golub, chief executive officer of Golub Capital BDC, says the combination of the [Investment Company Act of 1940] and the CLO risk-retention rules have "created a Catch 22" for externally managed BDCs.

"You can be in compliance with one or the other but not both,” he said. 

Lenders and Investment fund managers warned about the impact of risk retention rules under Dodd Frank on the CLO marklet long before they went into effect in December 2016, saying it would "dramatically shrink" the market for CLOs. In a 2013 survey published by Forbes, of 35 CLO managers that collectively manage $228 billion across 509 vehicles found that 22 of the 35 managers, or about 63%, could not, or would not, issue any new CLOs should the risk-retention rules take effect.

Read the Reuters story in its entirety here.