April 6, 2017 - On Tuesday, the LSTA hosted 430 attendees at its annual Operations and Settlement Conference. The message? There have been significant wins in the past year – thanks to Delayed Comp, settlement times are down – but there’s a long way to go. We recap key findings below and offer the presentations here.
Kicking off the day was a review of the secondary loan market. The key takeaway? Following the new Delayed Comp regime, median settlement times have compressed to T+11 and more than 29% of trades are settling within the LSTA’s T+7 business day goal. Still, there’s certainly room for improvement. The SEC’s new Open End Fund Liquidity Risk Management Rule basically requires managers to put loans into Category 3 “Less Liquid Investments” due solely to their settlement times. However, loans that can be sold and settled in 4-7 calendar days might qualify as Category 2 “Moderately Liquid Investments”. This may be a worthy goal to consider.
So how have we gotten down to T+11? In part because the market is conforming to the new Delayed Comp rules, with buyers meeting the T+5 requirements by an average of T+3.3; sellers are ready on average by T+5.8 and most lead times have been eliminated. Agents make the trades effective an average of 5 business days later. And it’s working: The delayed comp forfeiture rate is just 3%.
Next up: Delayed Comp in the Primary Market. Basically, primary delayed compensation is expected to commence at Funding Date +7 business days for buyers, who by Funding Date +5, sign the confirm and assignment and acceptance agreement and choose a settlement date of no later than Funding Date +7 and Persist, and fund the purchase price on the settlement date.
So clearly we’re putting the standards in place, but can Blockchain help the technology side of the process? Yes! Using smart contracts built on a database should make blockchain/distributed ledger technology impactful. Moreover, the blockchain solution need not be wholly baked to be helpful; gains can result from automating processes, storing information, protecting data and integrating existing technologies. Synapse and Markit estimate having market-ready solutions within two years.
Agency functions also are critical for better settlement. Speakers noted key issues that slowed settlement (and proposed solutions that could expedite it). First, attaching an affiliate letter or making counterparties and agents aware that borrower consent is required should have been included in the basic secondary delayed compensation requirements. Settlement platforms should include the ability to track the date when borrower consent is requested. And, due to the increased volume of calls, an Escalation Matrix could provide a list of contacts at each agent bank and counterparty.
Getting behavior and tech right is key, but sometimes the market intervenes. Case in point? Refinancings were the market theme of 1Q17 – and 1Q17 settlement times. And so, the trials and tribulations of (and definitions around) refinancings were dissected. First, whether something is a “Cashless Roll” is determined by the definition of a new facility in legal documentation; in a cashless roll, a new CUSIP should be issued. With “Yank a Bank” scenarios, the facility stays intact; there is no newly defined facility in legal documentation and no new CUSIP issued. In both cases, new lenders entering a new facility or replacing existing lenders in the original facility do so via a primary trade. For “Amend and Extends”, the non-extended facility stays in place with the existing CUSIP; the extended facility is a new separate facility, with a new maturity date and new CUSIP. When an incremental is fungible, the existing facility remains in place with no new CUSIP. When an incremental is non-fungible, a new facility is defined in loan documentation with a new CUSIP issued.
So we learned a lot of nitty gritty stuff on Tuesday – but what’s on deck? In the next two to five years, the market will evolve through a combination of behavioral and technological changes. Successful change will result when the process/behavior drives the tech side to build effective technology solutions. Collaborating on best practices, eliminating redundancies, structuring clean data, and issuing CUSIPs and MEIs are critical. When they are combined with technology such as FpML messaging and Distributed Ledger/Smart Contracts, we can achieve standardization, interoperability of systems and transparency. But will we? The looming question is, “what is the ROI?” This needs to be fully evaluated if we are to implement true regime change.