How can CLO managers navigate the current LIBOR changes?

How can CLO managers navigate the current LIBOR changes?

How can CLO managers navigate the current LIBOR changes?

Author: Eliana Boyd, Liqueo Senior Consultant
  
In the last few months, there has been a race to the LIBOR finish line. 1-week and 2-month LIBOR will be discontinued by December 31, 2021. By June 30, 2023, 1-month, 3-month and 6-month LIBOR will be discontinued or phased out. So, what should a CLO Manager do to prepare and stay ahead of these industry changes -specifically in their Back Office and Middle Office Functions, ahead of the projected uptick in CLO Refinancing? Read on to find out Liqueo’s suggestions.

Robust technology and people

 

There are two primary areas which need careful consideration to stay current with the ARCC Best practices and LSTA Guidelines:
 
1. Robust Technology 
A typical CLO manager has a Front, Middle and Back-Office Function that supports their day-to-day operations (irrespective of whether it is kept in-house or outsourced to a third-party). The majority of small-to-large tiered managers invest in financial software that serves as their books and records for the above functions - which provide metrics and other financials to their investors.  

As 2021 ends, we should ask: is the current technology equipped to compute compounding reference rate interest calculations for syndicated loan bookkeeping? A CLO Manager should stress-test their internal systems to ensure all reference rate options recommended by the ARCC are available and feasible using their in-house technology. Additionally, the flow of these reference rates should also streamline to other dependent systems that handle CLO specific Collateral Quality Tests, as defined by the CLO Indenture.  
 
2. People 
There is a significant urgency to train middle and back-office analysts on new language and definitions in Credit Agreements of Loans brought into the CLO vehicle - as well as Benchmark Triggering Events. 

As each agent rolls over existing contracts into new non-LIBOR contracts, a loan’s administration becomes critical for interest projections of a CLO - which could cause downstream effects to the Interest Coverage Test. More than ever, training and development need to be up-to-date across teams.

Some examples of these development areas are: 

  • The need to familiarise with new fallback language and Benchmark replacements 
  • Understanding the CLO 2.0 Indenture itself and reference to the Benchmark reference rate 
  • Understanding the impact of asset-liability mismatches and any impact on required Tests defined as “Collateral Quality Tests” (“WARF,” Weighted Average Rating Factor, Overcollateralization Tests, Interest Coverage Test, Diversity Score) 

Summary


As the industry changes, it is imperative that a company’s support functions understand the implications and mechanics of underlying benchmarks a product like a CLO utilises. By staying up-to-date with publications and investing in systems equipped to handle the volume and calculations of evolving needs, a CLO manager will see minimal impact in their day-to-day operations. 
 

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