Your skin in my game
Blackstone has devised a novel definition of ”skin in the game”: other people’s money. The buyout and debt management firm is taking advantage of newly relaxed rules on how much risk needs to be retained in securitisations, to improve its returns. Its structure looks acceptable – but regulators and investors should still watch for sharp practice from future copycats.
European skin-in-the-game rules were introduced to prevent a repetition of the 2008 mortgage crisis, which saw lenders make dud loans and flip them to bond markets. Creators of assets that are securitised now have to keep 5 percent of the risk. That hampered the issuance in Europe of collateralised loan obligations, a kind of investment vehicle funded through securitised debt. Few of the asset managers who oversee the vehicles can finance one euro for every 20 they manage.
The European Banking Authority last December tweaked the rules so that asset managers can avoid retaining the risk in the CLO – so long as another entity does, and that entity originates half the CLO’s loans. Blackstone is among the first to notice. It has set up an originator to make loans and repackage them as CLOs – managed by Blackstone, naturally. The twist is that the skin in the game will mostly come from public equity markets.
It looks a robust model: the company is a long-term lender; investors benefit from an independent and experienced board, and the shareholders themselves don’t look like yield-hungry hotheads: one of them is the Church of England. Moreover, it’s debatable how appropriate the skin-in-the-game guidelines are for CLOs anyway, where managers are incentivised through long-dated fees and don’t get paid upfront for making bad loans.
The bigger question is whether the purpose-built origination vehicles that look set to spring up will all meet the spirit as well as the letter of the retention rules. The danger is a return to pre-2008 structures where investors don’t properly understand the risks, or where the funds no longer qualify for risk retention. If the regulators get an inkling this is happening, they may tighten the rules again.