Moves are under way to cut the delays in settling deals that dogged the leverage loan market in 2007. A working group established by the Loan Market Association (LMA) is set to publish a paper setting out an agenda to shift from paper transfers to a more automated market.
LMA chairman David Slade, head of the European syndicated loan group at Credit Suisse, says the association’s working party includes representatives from a range of stakeholders including agency teams, operations and settlements as well as capital markets and sales.
Calls to modernise market practice have come as the growth in the number and scale of deals has overwhelmed traditional methods. The result has been delays of up to three months between the allocations of loans and the transfer of paper as agency banks were unable to maintain an efficient level of service in completing transfer certificate documentation.
“We have an ink and quill system,” said David Bassett, head of loan markets at RBS Global Banking & Markets. “At the moment, loans documentation is highly customised and transfers are manually intense. The system as it stands is non-scalable and that’s where the backups are coming from.”
Under the existing system, certifying the transfer of loan assets is paper-based and requires counterparties to commit considerable human resources to ensuring documents are correct and properly signed off, with individual documents for every allocation of every deal.
The increased pressure from the rising number of deals has been exacerbated by the changing investor base for loan products.
“The rise in the number of institutional investors in particular has increased the number of documents created per deal – at the same time as the number of deals was increasing,” said RBS’s Basset.
“Institutional investors require a greater number of documents per deal because they tend to take smaller tickets than the traditional bank market and also because they will often spread their hold across several funds, each requiring individual documentation and settlement.”
Where a €500m deal might have had 25 to 30 individual participants a couple of years ago, the same deal in 2007 might have 40 to 50, some of them splitting their allocations over three or more funds for a total of as many as 200 entities.
With essentially the same system and personnel used to process secondary transfers, the growth of an active secondary market further compounds the problem.
Myles Llewellyn-Jones, head of loan trading at ING, sees the problem as symptomatic of the loan market falling behind practice in other markets. “Bonds and other securities came into the 20th Century after Big Bang, but it is now the 21st Century and loans have been left behind,” he says. “The loan market is as sophisticated as any of the financial markets, but its infrastructure has not kept pace.”
The impact of systemic problems is offset to some extent by the use of LMA approved Standard Transfer Certificates, which are simpler and faster than bespoke documentation, while the situation in the secondary market is alleviated by delayed T+10 compensation rules, which ensure the buyer of paper does not suffer an economic loss from not holding the paper.
More than a nuisance
While delayed transfer settlement is at best a nuisance, at worst it impedes both efficiency and ultimately profitability.
“The result of the delay in settlement is that arrangers carry their exposure for longer, and until transfer certificates are signed there is always a risk they may not be signed, although this rarely happens. Arrangers have limits to how much exposure they can carry in total: undue delays do affect the ability to do new business,” according to Basset at RBS.
For Llewellyn-Jones, not only is the market for existing products affected, but the situation also retards the innovation of newer instruments.
“Transfer delays also hold back the development of derivatives,” he says. “A bank can buy paper and then have to wait 30 days to receive documentation, which makes it difficult to knowledgeably invest in derivatives and to understand the reference asset.
“This in turn delays new product growth and hinders the level of sophistication in the market going forward. At the moment it can be difficult to tell whether someone is short a loan or if they are simply waiting for their deal to settle.”
The quick-fix solution has been for banks to increase headcount in middle and back offices. That had some impact in working through deals more quickly: the impact of the credit crunch on issuance played a bigger part, but did nothing to address underlying problems.
Despite broad agreement that the current system is not fit for purpose, a speedy resolution is highly unlikely, according to LMA chairman Slade.
“The move towards change does have momentum but something like this cannot be rushed. The working party is due to deliver a best practice paper by the end of 2007 or January next year but it is likely to be final quarter 2008 before that leads to actual changes in practice.”
Slade added that there was no easy way to create electronic market infrastructure, saying: “The European leveraged loan market is multi-jurisdictional, multi-currency. Capital markets-type solutions do have some relevance, but the loan market is a private market so it is not a question of importing practices.”
A first step towards automation will be to introduce loan identifiers to deals, as already seen in the bond markets and recently introduced in the US loans market under the auspices of the LSTA (the sister organisation to the LMA). That can be begun before a wider solution is reached and put in place even before a new system is up and running.
While no model exists that can simply be applied to the European loan market, a number of institutions, including US-based ClearPar and TSI, and European bond settlement and clearing agency Euroclear, have expressed interest in working with the LMA.
Not finding a solution is no longer an option: even with the fall-off in volumes since July, banks are struggling to work through paper efficiently; there are still delays of 30 and even 40 days; and an upturn in the market will see back offices clogging up again.