Cautious confidence in the CLO market: a conversation with Alfonso Pagano

Tell us about yourself and your current role at TMF Group.

I am Commercial Head of Capital Markets Services for the British Isles, Ireland and Luxembourg. I lead a team of business development directors and managers working with arrangers, asset managers, law firms and other participants across structured finance, private credit and collateralised loan obligations (CLOs).

Our role is operational rather than advisory. We support clients with transaction and entity management, governance, regulatory reporting, and middle and back-office services. That gives us a close view of how managers are responding to changes in the market and where their operational priorities are shifting.

Despite significant geopolitical and economic uncertainty, the CLO market has remained relatively stable. What has driven that stability?

One of the biggest surprises this year has been how positive sentiment has remained. When you attend industry conferences, people are still talking about new issuance and new CLO platforms despite everything happening globally. While activity has moderated compared with the exceptionally strong levels we saw last year, there is still healthy demand for high-quality CLO paper and continued confidence in the asset class.

At first glance, that might seem inconsistent with the slower pace of issuance we’ve seen this year. However, in reality, the slowdown is less about weakening demand and more about changing transaction economics. Compressed arbitrage and higher liability costs mean that not every transaction makes economic sense, so managers are being far more disciplined about when and how they come to market. Timing and execution have become much more important than simply bringing deals to market.

At the same time, the underlying fundamentals have remained strong. Certain sectors, including software and energy-related businesses, have experienced pressure, but defaults have not materialised at the levels many expected. The structural protections built into CLOs continue to provide investors with confidence, institutional demand for floating-rate assets remains strong, and supply and demand have stayed relatively balanced.

We're also continuing to see a good level of underlying activity, including new managers preparing to launch CLO platforms. In fact, we haven't seen this level of interest in launching new platforms for quite some time, and that's happening on both sides of the Atlantic. To me, that's an encouraging sign because it suggests firms continue to have confidence in the long-term outlook for the asset class, even if they're being much more selective about when and how they execute transactions.

How have recent geopolitical events changed the way CLO managers and investors think about risk and why has manager quality become more important?

The biggest shift has been in how risk is assessed rather than whether firms are willing to take risk at all. From what we're hearing across the market, investors have become much more selective. There is greater focus on downside scenarios, sector exposures and the overall resilience of portfolios, particularly in industries that may be more sensitive to energy prices, supply chain disruption or regional instability.

That increased scrutiny is naturally influencing how managers approach portfolio construction and risk management. They’re placing greater emphasis on liquidity, diversification and stress testing portfolios under different macroeconomic scenarios. It's less about avoiding risk altogether and more about understanding it, pricing it correctly and actively managing it throughout the life of the transaction. As a result, we’re seeing much greater differentiation between managers.

The biggest differences we're seeing today come from the quality of the underlying loan portfolios and how actively managers respond when credit conditions begin to change. Stronger credits are separating more clearly from weaker ones, and competition for the best assets remains intense. Performance isn't determined solely by the initial credit selection anymore. It's also about ongoing portfolio monitoring, disciplined trading and the ability to respond quickly when individual credits begin to weaken. That’s why investors are placing much greater importance on a manager’s track record, consistency and overall approach to risk management.

We’re continuing to hear about new managers looking to establish CLO platforms, including firms that haven’t traditionally operated in private credit. That tells us the market still sees long-term opportunity, even if participants are approaching it with a much more measured mindset.

As managers navigate widening liability spreads, compressed arbitrage and the potential for rising loan defaults, how are they adapting their strategies, and what aspects of CLO resilience do investors sometimes overlook?

Today's market is demanding much greater discipline from managers. Higher liability costs and tighter arbitrage mean firms are being far more selective about the transactions they pursue. Rather than bringing every potential deal to market, they're carefully evaluating whether the economics justify execution or whether it's better to wait for more favourable conditions. We've seen that reflected in periods where transaction closings and resets become concentrated over a relatively short period, as managers time the market more carefully and look for the right execution window.

That same discipline extends beyond transaction timing and into portfolio management. Rather than seeking higher returns by taking additional risk, managers are focusing on stronger credit selection, active portfolio management and operational efficiency. Tighter margins leave far less room for unnecessary costs, so protecting returns increasingly comes down to better execution, stronger portfolio construction and more efficient operating models.

It's also important to remember that rising loan defaults don't automatically translate into CLO underperformance. CLOs are designed with multiple layers of structural protection, including diversification across a broad pool of loans, credit enhancement mechanisms and coverage tests that can redirect cash flows to protect senior investors if portfolio performance deteriorates. Because CLOs are actively managed, managers also have the flexibility to reinvest proceeds, rebalance portfolios and manage exposures over time rather than being forced to sell assets during periods of market volatility.

Operational capability becomes increasingly important in that environment as well. During periods of market stress, managers may need to run portfolio tests, analyse hypothetical trades and respond quickly to changing credit conditions. Having timely reporting, accurate data and a robust middle and back-office infrastructure allows firms to make faster, more informed decisions when markets become more volatile.

How has the current environment changed the operational priorities of CLO managers, and what trends are you seeing behind the scenes that investors may not fully appreciate?

This is probably where we've seen the most significant change over the past few years. In our conversations with heads of operations and CLO managers, the discussion has shifted beyond simply supporting today's transactions to building operating models that can support future growth. Firms are asking how they can make their platforms more efficient, scalable and controlled while continuing to meet growing investor expectations and regulatory requirements.

That has led to a much greater focus on operational infrastructure than many investors probably realise. Managers are investing more time in improving data quality, strengthening controls, enhancing reconciliations and reporting, and making sure their operating models can scale as their businesses evolve. Rather than continually expanding internal teams, many firms are reassessing which activities are fundamental to the investment process and which can be supported more effectively through outsourcing or co-sourcing arrangements.

The objective is to create a more flexible operating model that allows investment professionals to remain focused on managing portfolios while specialist providers support the operational functions that sit behind them. As firms expand across jurisdictions and into new areas such as private credit CLOs, having infrastructure that can support multiple asset types, increasingly sophisticated reporting requirements and future regulatory change is becoming just as important as the investment strategy itself. Ultimately, operational infrastructure is becoming another source of competitive advantage.

As firms prepare for the future, what factors are shaping their operating models, from outsourcing decisions to regulatory change?

Every manager has different requirements, so flexibility is probably the most important consideration. Whether a firm is launching its first CLO, expanding into private credit or looking to co-source certain operational functions, operating models need to be able to evolve alongside the business.

That's one reason we're seeing growing interest in co-sourcing and lift-and-shift arrangements, particularly among more established managers. Rather than replacing existing teams, firms are increasingly looking for specialist partners who can integrate with their existing operating model and provide support where it's needed most. Responsiveness, experience and a deep understanding of the CLO market are becoming increasingly important, particularly as managers look for ways to scale without creating additional operational complexity.

One capability that often differentiates providers is in-house modelling. Very few operational providers can model transactions internally, but that capability can provide significant value when managers are evaluating new opportunities or responding quickly to changing market conditions.

Regulation is another important consideration. The proposed changes to the EU Securitisation Regulation are generally being viewed positively because they demonstrate a willingness to reduce unnecessary complexity and strengthen the regulatory framework surrounding securitisation. That's helping reinforce confidence in the long-term future of the asset class, particularly as policymakers recognise the role securitisation can play in supporting Europe's Capital Markets Union and broader economic growth.

That said, most market participants are still taking a wait-and-see approach. Until there's greater clarity around the final rules, firms aren't making major changes to their structures or operating models. While the reforms are supporting positive long-term sentiment, they're not yet driving significant changes in day-to-day operations.

Looking ahead over the next 12 to 18 months, what indicators should investors and managers monitor?

The fundamentals won't change dramatically. Managers will continue to watch leveraged loan default trends, liability spreads and the supply of new loans because those remain the key indicators influencing transaction economics. Refinancing and reset activity will also provide a useful measure of overall market health, while regulatory developments across Europe will continue to shape sentiment and long-term planning. Taken together, those indicators provide a balanced view of both the underlying credit environment and the technical conditions influencing the CLO market. They will remain the key signals to watch over the coming year.

What is the key takeaway for market participants?

The market remains resilient, but it's also becoming more selective. Capital is still available and demand for quality assets remains strong. What has changed is the level of discipline. Investors are placing much greater emphasis on manager quality, operational strength and consistent execution than they were a few years ago.

For me, that's the defining characteristic of today's market. It's not a period of easy conditions, but one of cautious confidence. The managers that continue to succeed will be those that combine strong investment capabilities with operating models that can adapt as markets, regulation and investor expectations continue to evolve.

It's less about taking more risk and more about protecting returns through better execution and smarter operating models.

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Whether you are launching a new CLO platform, expanding into private credit or reviewing your operating model, our specialists can help you build an operating framework that supports long-term growth. Get in touch to learn how TMF Group can support your CLO operations.