CLO transition to SOFR gets riskier on volatility from Omicron variant

CLO transition to SOFR gets riskier on volatility from Omicron variant

Bloomberg/New York

The surge in Covid cases linked to the Omicron variant adds another complication for managers of existing US collateralised loan obligations (CLO) that have some discretion over when they start using SOFR as a benchmark for their liabilities.

A potential increase in financial market volatility as the variant makes its way through the US and other corners of the world could widen the difference between the London interbank offered rate and its preferred replacement, the Secured Overnight Financing Rate (SOFR), according to Bank of America Corp strategists. That in turn could change funding costs for asset management firms that funded their loan portfolios by selling CLOs.

Investment firms that manage CLOs issued this year or earlier generally can change the benchmarks of their liabilities when at least 50% of the loans they invest in are tied to the new benchmark, although they will have to adopt the new benchmark in mid-2023. That gives the money managers some discretion as to when they switch over, because they can decide how many loans tied to SOFR to buy. If switching will make funding much more expensive, firms will probably be slower to change, or they may choose to refinance the