June 24, 2020 - On June 23rd, the LSTA hosted another “Tuesday Talks” session, “Don’t Stress; Get Ready for Distressed”, the third installment of the LSTA’s Operations Conference Webinar Series. With the default rate rising to a ten year high last month, the market has seen a commensurate increase in distressed trading volume. Although that volume is far lower than the peak of $45 billion experienced during the 2008-09 “Global Financial Crisis”, the volume of distressed trading in May 2020 nevertheless increased very significantly, by 84% to $2.5 billion — and the trajectory is likely to continue upwards. Our panel of operations and legal experts highlighted key LSTA distressed trading documents, market practices, and the role of automation in distressed trading and settlement. Like the LSTA’s Par Confirm, the LSTA’s Distressed Trade Confirm serves to memorialize a prior oral trade between parties; best practice provides that parties should sign such a confirm, because voice recordings are sometimes misplaced or recorded over. The Distressed Confirm has some features, however, that are unlike the Par Confirm: notably, for example, the Distressed Confirm has no default interest treatment, so the parties must make this determination at the time of trade. With more bankruptcies and related court orders to consider, the Confirm’s Other Terms of Trade section is often used to address the kind of credit-specific issues that are more likely to arise in a distressed context. Owing to the relative complexity of distressed trades, they have a longer trade settlement time goal of T+20 – nearly three times as long as par. These complexities include the need for more time in gathering information (such as seller determining the value of prior purchases), compliance with any transfer restrictions (e.g. in a Restructuring Support Agreement (RSA)), and the need to settle not only on an Assignment Agreement but also the LSTA Purchase and Sale Agreement (PSA). Depending upon what is listed in the PSA’s Annex of the PSA as the chain of title (the loan’s ownership history), there can be many additional documents that need to be reviewed. Although the buy-side is aware of an increased level of KYC requests in distressed trades, it was recognized that this is a bank-specific issue and not one that is necessarily required under US law and regulations.
Lessons learned during the 2008-09 Global Financial Crisis still resonated with loan market participants, and counterparty risk borne by the parties while a trade is open was high on the list of concerns. Counterparty risk is sensitive, because open trades are executory contracts, and the debtor can take its time during bankruptcy to modify, reject, or accept the terms of the contract/ confirm. In addition, institutional investors today are focused on the risks associated with trades done by second and third tier dealers trading more frequently as “riskless principal.” (In this respect, a party may specify in the Confirm that it is acting as a “riskless principal” if it has on or before the trade date agreed with the other party that its obligation to complete the transaction is subject to successful completion of the purchase from, or sale to, a third party of the loan being traded).
The key takeaways for the session were: (1) be prepared and understand what you are selling or buying so your lawyer can properly plan and draft; (2) address as much as possible at time of trade (particularly with respect to RSAs and other credit-related issues); (3) involve your lawyers early – this will save time and money; and (4) familiarize yourself with the tools that are available. Click here for the slides and here for the replay.