(Bloomberg) — The $1.3 trillion US CLO market is taking its cues from Tokyo as much as Wall Street.
Japanese banks have for years been among the biggest buyers of collateralized loan obligations, making the cost of swapping yen into dollars a key driver of both the price and pace of issuance. But the strength of that influence isn’t constant, according to new research.
At the heart of the connection is the so-called cross-currency basis, a measure of the extra cost Japanese banks pay to obtain hedged dollar funding beyond what interest-rate differentials normally imply. When that premium falls, banks are willing to buy more AAA CLO bonds at tighter spreads, encouraging managers to bring additional deals to market. When it rises, the process moves in reverse.
In recent years, however, shifts in Japanese regulation and monetary policy have reshaped who the key buyers are and how aggressively they step in or pull back as funding costs change, rippling through to the financing of heavily indebted American companies.
“If you’re an investor in CLOs, you should pay close attention to how policies in Japan are changing,” said Shohini Kundu, an assistant professor of finance at the UCLA Anderson School of Management and, along with Wharton’s Amy Huber, one of the authors of the working paper. “Decisions made in Tokyo are quietly steering how forcefully foreign-exchange shocks hit US corporate credit.”
As part of their analysis, the authors examined how CLOs, bundles of leveraged loans carved into slices of varying risk and return, responded to two major shifts in Japan: new securitization rules in 2019 and the Bank of Japan’s policy normalization beginning in late 2023.
Before 2019, Japanese demand was dominated by Norinchukin Bank, known as the “CLO whale,” which at its peak held 55% of Japanese banks’ CLO investments and acted as a relatively steady buyer. Tougher capital and due-diligence rules introduced that year reduced Nochu’s dominance, the authors argued, shifting buying toward banks that reacted more sharply to changes in funding costs.
Afterward, a 10-basis-point improvement in the basis tightened new-issue AAA CLO spreads by roughly 22 basis points, versus about 3 basis points before. Deal sizes became more responsive to funding conditions as well.
The dynamic shifted again in late 2023 as the BOJ moved away from years of ultra-low interest rates, making domestic assets more attractive and giving banks less reason to swap yen into dollars in search of higher returns. That made Japanese demand less sensitive to dollar-funding costs, the authors wrote. After normalization, the same move tightened new-issue AAA CLO spreads by only about 15 basis points, and the boost to issuance weakened, too.
Because CLOs are a major source of demand for leveraged loans, the findings suggest shifts in Japanese funding conditions can ultimately filter through to borrowing costs for heavily indebted US companies.
The five-year yen-dollar cross-currency basis has narrowed to around minus 0.29 percentage point, its least negative level in years, according to data compiled by Bloomberg, as rising Japanese rates and reduced need for currency hedges have eased the rush for swapped dollars.
CLO demand from Japanese banks, meanwhile, has held steady in recent years and remains firm in 2026, traders and collateral managers say. That’s broadly consistent with the paper’s framework: a less negative basis supports CLO buying, while higher domestic yields blunt the extent to which shifts in funding costs drive demand.
“Changes in Japanese prudential regulation, BOJ monetary policy, or balance-sheet capacity reshape how forcefully funding shocks transmit to the pricing of new US CLO deals,” the authors wrote.
–With assistance from Carter Johnson.
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