By Huw Jones
LONDON (Reuters) - The coronavirus pandemic poses significant risks to the collateralised loan obligations (CLOs) market as the creditworthiness of the debt deteriorates, the European Union's securities watchdog said on Wednesday.
CLOs are securities backed by a pool of loans taken out by companies that have high levels of debt and typically a non-investment grade credit rating.
With economies entering deep recessions following lockdowns to fight the COVID-19 pandemic, many companies are struggling to stay afloat and repay loans to banks.
The European Securities and Markets Authority (ESMA) said in a report on how Moody's (NYSE:MCO) Investors Service, S&P Global Ratings and Fitch Ratings credit rating agencies rate CLOs that it had a number of supervisory concerns.
"With the COVID-19 outbreak, the credit quality of the CLO loan portfolio has started to deteriorate, with CRAs downgrading or issuing negative outlooks on some leveraged loans included in CLO portfolios," ESMA said in its report.
The watchdog, which authorises and regulates rating agencies in the EU, said it would monitor their response to COVID-19 and continue to assess the potential risks posed by CLOs, their ratings and associated rating processes to investors, markets and financial stability.
"The COVID-19 pandemic poses significant risks for CLO instruments, which will test the rigorousness of CRAs rating methodologies to respond to changing circumstances," ESMA Chair Steven Maijoor said in a statement.
The Financial Stability Board has estimated that the leveraged loan market was worth $1.4 trillion to $3.2 trillion in 2018, with just a few global banks in the United States and European Union accounting for 86% of CLOs issued.
ESMA said it expected rating agencies to continue to perform regular stress-testing simulations and to provide market participants with timely, granular information on the sensitivity of CLO credit ratings to key economic variables affected by the pandemic.