Fair Oaks Capital said the ability to launch an ETF share class of its existing collateralised loan obligation (CLO) UCITS fund was the reason it domiciled in Luxembourg.
The move highlights yet another “practical divergence” between Luxembourg and other European jurisdictions.
The Fair Oaks AAA CLO UCITS ETF (FAAA) ETF captures euro-denominated AAA-rated CLOs and is an ETF share class version of an existing Luxembourg-domiciled Fair Oaks fund, the Fair Oaks AAA CLO fund, which currently houses €161m assets under management.
No 100% CLO fund has been approved since 2019, which could suggest regulatory barriers in Europe, especially as European issuers may be eager to replicate the huge success of CLO ETFs in the US.
Miguel Ramos Fuentenebro, co-founder and partner of Fair Oaks, said the advantages of domiciling the ETF in Luxembourg came from launching it as an ETF share class version of its existing UCITS fund, which is domiciled in Luxembourg.
Fuentenebrosaid this would boost investor confidence in the product if there is a diversified portfolio from the offset, rather than investing in a highly concentrated manner during the initial days and weeks.
“It ensures that even if growth is slower than expected, the fund remains operationally feasible,” he added.
Fuentenebro added that gaining regulatory approval was a “very detailed process” but was similar to the regulatory process undergone for its Fair Oaks AAA CLO fund.
(More) regulatory divergence
However, Sergey Dolomanov, Partner at William Fry noted that it should be possible to domicile a CLO fund in Ireland.
“The difference must be in the practical application of the rules here,” he said.
Dolomanov added the Central Bank of Ireland does not officially impose any limits on CLOs, as they are considered UCITS eligible instruments.
“However, due to the additional scrutiny from regulators, including Luxembourg, the practical outcome is that we have not seen any CLO ETFs in Europe. In practice, the Central Bank of Ireland applies fairly conservative limits to CLO exposure,” he added.
“This recent launch in Luxembourg shows that this was not the case on at least one occasion, highlighting that supervisory convergence has not been fully achieved. Although regulators aim for a consistent rulebook, this is evidence of practical divergence.”
However, Matthias Kerbusch, partner at Dechert Luxembourg, said according to their understanding, the CBI does not allow CLO ETFs, with exposure capped at 20%, "so Luxembourg is the natural domicile for these types of funds," he concluded.
In addition, Sergio Venti, partner at Deloitte Luxembourg noted since the US-Ireland double taxation treaty primarily benefits US equity ETFs, CLOs don't gain from this advantage, which makes Luxembourg an "equally viable option".
Extra control welcome
Fuentenebro said Fair Oaks is “not unhappy” that regulators exercise extra control.
“It assures investors that this isn't an untested asset class or a sudden trend. The asset has undergone significant scrutiny before being approved, which should help investors to be confident in the product.”
However, Kerbusch noted that given the review of the UCITS Eligible Assets Directive, there might be "further liberalisation" for CLO ETFs.
Dolomanov noted the Central Bank of Ireland (CBI) has an enhanced scrutiny regime for CLO UCITS funds, targeting instruments perceived to be higher risk and those that require additional investor protection and stress testing by managers.
The final word
Dolomanov concluded that it is “not in the regulator's interest” to create exceptions.
“They want the same rule book, and the rule book is on paper the same, but this is just evidence of practical divergence,” he said.
“What we have seen so far suggests that it is not in the regulators' interest to create an exception and it seems there should not be a different rulebook. The implementation should be consistent across the board."
