The importance of key man provisions and the ability to remove managers is taking center stage after a burst of merger activity and performance-related issues at some funds. "Investors are increasingly looking at the collateral management agreement," said Vandana Sharma, director CDO Manager Focus at Standard & Poor's. The CMA document describes the relationship between the manager and the CDO issuer and outlines the rights of investors with regards to termination. "There have been situations when investors have had a difficult time replacing managers on actively managed deals, generally for performance reasons," she said.
Sharma said there are many studies that demonstrate that two identical portfolios can produce different results for investors depending on the decisions of asset managers. She added that investors are better off with the provisions. "The urgency to report and disclose key organizational changes would not be there if the key man provision was not included," she stated.
But there is also a belief that the provision is antiquated and makes it harder to sell CDO businesses. "It's hard to argue that some people need a key man. The idea that if one person quits is a huge issue is pretty antiquated or it should only be around start-up managers," said one buysider. He also said that as more CDO firms become subject to being bought and sold, "It definitely impairs the ability to do things on an economic, free-market value."
Drew Dickey, managing director and head of the structured credit team at Babson Capital Management, which manages over 43 CDO funds but also invests in CDOs, disagrees that the market has moved in this direction. "The predominant reason key man provisions exist is because investors want them in a CDO. Babson, for example, is very focused on the actual individuals because the styles of managers can be very different. There are a few big organizations that can claim to have an institutional style, such that it can source and rotate different human beings; but this is a minority of the industry today. Those institutions can sell themselves as an institution. But the trend in the CDO market is toward more smaller firms, where the character of the firms reflects the founders and there are relatively few institutions where the style is not directly dependent on the manager."
The buysider also said a more liquid market in selling the debt and equity tranches of CDOs is another new factor that supports a reduction in key man provisions. "I disagree that there is liquidity in the market to that extent," countered Dickey. "If I am an upfront equity investor, why should I not ask for the key-man provision. If I do not, I may have to sell my investment for potentially less than is it worth at the time that the manager's shop is in play."
