SFA Advocates on SEC’s Private Funds Proposal and Potential Impacts on CLOs

Background:

On February 9, 2022, the Securities and Exchange Commission (SEC) proposed new rules under the Investment Advisers Act of 1940 that includes new requirements concerning compliance obligations and new prohibitions on “private funds”.  In the structured finance market the proposal has implications on the CLO market as the rule would apply to any funds that rely on sections 3(c)(1) or 3(c)(7) for exceptions from the definition of “investment company” under the Act – which most CLOs typically do.

The proposed mandates, among others, include quarterly performance statements to investors, annual private fund financial statement audits, and restrictions on certain adviser activities. The SEC has stated its aim is to increase transparency to investors regarding the full cost of investing in private funds and performance of such funds.

Alongside a deadline extension request, SFA submitted two comment letters to the SEC in April and June 2022 on the Private Funds Proposal. These letters outlined market concerns of the rule’s application to CLO market practices and industry consensus recommendations for how to rectify them.

Key Points:

• SFA emphasized the challenge presented by the proposed 30-day comment period and requested that the SEC extend the comment period in order to provide time for the industry to adequately respond to the 341-page proposal.
  • Committed to supplementing our preliminary letter with a complete assessment within 30 days
• SFA underscored our support for a strong disclosure regime to provide investors with transparency and instill confidence in their ability to fully evaluate investment opportunities.

• SFA highlighted key differences between CLOs and other private funds such as hedge funds, private equity, and venture capital funds.
• SFA requested a grandfathering for existing CLOs given the difficulty of amending governing documents and altering transactions already agreed upon by investors and fund managers.
• SFA urged the SEC to exempt the mandated annual financial audits for CLOs, as financial statements are not material information for CLO investors and not SEC-required disclosure for CLOs.
• SFA stressed that the adoption of the proposal, in its current form, will likely result in unintended and adverse consequences in the CLO and corporate lending markets given the limited consideration to the unique aspects of these products in the proposal.

On August 23, 2023, the SEC released a final rule, exempting securitized assets and CLOs from compliance, which is in line with SFA’s advocacy. SFA commends the Commission for its decision and for recognizing the unique features that make CLOs characteristically different from private funds that were intended to be the focus of the rule. Additionally, noting that the application of the new disclosure requirements to CLOs would not be material to investors.