Citigroup Global Markets has brought to market a collateralized debt obligation giving equity holders prime voting rights for the potential substitution of the CDO manager, a move designed to avoid the threat of consolidating the CDO's assets and liabilities on its balance sheet. Speaking at the 6th Annual CDOs and Credit Derivatives Conference in New York last Wednesday, Amanda Angelini, v.p. at Citigroup, said the structure was created after conversations with the firm's accounting counsel as a means of sidestepping the threat of CDO consolidation under a recent Financial Accounting Standards Board rule.
Financial Interpretations accounting rule number 46, known as Fin 46, raises the specter of CDOs being required to consolidate should they act as a facilitator to a transaction on behalf of another party, a legal structure called Variable Interest Entities (VIEs). David Thrope, partner at Ernst & Young, in New York, explained that one criterion that must be met for a CDO not to be classified as a VIE is that the equity holders in the transaction must have the unilateral ability to make significant decisions. One of the few significant powers an equity holder may have in a CDO is that of replacing the collateral manager and as such some firms have focused on giving the equity holders this power, he noted.
Transferring unilateral decision making powers to equity holders is problematic however, with many players noting that they would face an uphill battle in marketing such a structure to note holders. Many CDOs currently are consolidated onto another entity's financial statements, known as Voting Interest Entities. CDOs have historically been considered Voting Interest Entities, because both note and equity holders have joint decision making powers relative to replacing the collateral manager, explained Thrope. Voting entities are not subject to the same threat of consolidation under Fin 46.
Citigroup structured the transaction as a combination Variable Interest Entity and Voting Interest Entity as a means of ensuring the participation of noteholders in important decisions, said Angelini. The deal was forged so that if the note holders do not agree to a management change that has been mandated by equity buyers, the managed structure would convert into a static pool. In this event the manager could continue on the deal, receiving reduced fees in line with its reduced responsibilities, or the product could be transferred to a different static manager, she explained.
Eric Bothwell, v.p. at Goldman Sachs, also speaking at the conference, noted the importance of making CDO managers comfortable with the empowerment of equity buyers. Goldman has not as yet structured any deals of this type, he said.
