Next plan to speed up settlement targets new leveraged loans issued

Settlement times for leveraged loans are notoriously long. Weeks can pass between the time a buyer and seller agree on a price and the time the buyer takes possession of the asset and begins to earn interest.

Investors who acquire loans in the secondary (post-issuance) market have long been compensated for this lag. If trades are not settled within seven days, buyers begin earning what the industry calls “deferred compensation” until the trade is finally settled.

This is not the case for investors who acquire loans on issuance. If the bank that underwrites the loans takes its time in allocating them, the buyers – and the brokers who buy loans on behalf of clients – are out of luck. They earn no interest on the funds they have committed until the transaction is settled, which in some cases can take weeks due to documentation and the complexity of reaching agreements with hundreds of attendees.

The Loan Syndications & Trading Association plans to change that. Under a protocol to be launched just over a year from now, in January 2020, buyers who buy loans on issuance can also receive deferred compensation on late settlement allocations from agent banks. .

The idea is not only to encourage the agent banks to go a little faster in allocating loans from the primary market (which has 1,000 billion dollars of new issues this year), but to continue to reduce the settlement window on outstanding secondary market loans of $1.12 trillion – through which many of these loans are “under-allocated” through brokers.

“By instituting it at this stage, the idea is to again improve settlement in the primary market, which would then ensure timely settlement in the secondary market as well,” said Ellen Hefferan, vice president. -Executive President of the LSTA. operations and accounting.

The trade group announced the adoption of the protocol on October 29.

The LSTA will not say how long it takes to settle transactions in the primary market. But a lawyer who represents buying firms says client brokers and investors often complain about waiting two or three weeks to get the documentation needed to make primary asset allocations.

Not only do they not earn interest during this period; they can also dip into their own pockets to pay for receipt coupons – and can themselves pay deferred compensation to secondary market trades they have committed to as sellers.

“I’ve had customer operations staff complain that weeks after a credit agreement came into effect on a primary transaction they had committed to, they still hadn’t committed. started earning interest and fees,” said Steve Kieselstein, founder and managing member of Kieselstein Law Firm, a boutique law firm specializing in trading in the syndicated loan market. “The argument is that it’s a free option for the agent/seller.”

“The gripe is that there shouldn’t be an extended period in which a buyer is designed to legally engage in installation and yet is not entitled to receive anything,” until until the settlement takes place, Kieselstein added.

The new protocol comes two years after the LSTA created guidelines that tightened the deferred clearing window for secondary par transactions. Prior to 2016, secondary loan settlement periods were governed by “no-fault” guidelines that often stretched settlement periods to between 18 and 21 days after a trade agreement. Buyers could rack up weeks of interest without committing capital, prompting companies to slow trade settlements.

The changes removed the no-fault concept and required buyers to commit capital within five days to be eligible for deferred compensation.

Prior to the guidelines, settlement times for secondary market trades averaged 17.7 days, according to IHS Markit data at the time.

By the end of 2016, under the new guidelines, more than 90% of at-the-money trades settled within the seven-day window, according to LSTA data. (The guidelines exclude more complex transactions for distressed loan assets, which often take more than 20 days, according to the LSTA.)

New issue market rules also require buyers to commit capital. Under the protocol, deferred compensation comes into effect six days after a credit agreement is fully documented, which includes a three-day “onboarding” process to qualify buyers under Treasury know-your-customer requirements. American.

The purpose of the protocol is essentially to expedite the settlement period in order to avoid the need for deferred compensation. “As long as the trades settle in a timely manner, the compensation will not pass as buyers, now lenders, will earn the coupon directly,” Hefferan said.

The LSTA believes that encouraging faster settlement of loan allocations in the primary market will also help to reduce settlement times for trades in the secondary market. The faster banks fill allocations to brokers, the faster these fund managers can fill frequently used sub-allotments to fill the secondary loan market pipeline.

The protocol calls for the secondary trade’s deferred clearing schedule to “align” with a fund manager’s deferred clearing protocol, so a manager should not have to pay more in deferred clearing to a buyer of the secondary market than the manager received from the primary allocation.

“The point of all of this,” added Lee Shaiman, executive director of LSTA, “is to expedite this and make it fair to all parties so that the buyer who sets aside the capital doesn’t have to wait an excessively long period of time to settle the transaction and begin earning interest on the asset.”

The longer-term development of the deferred clearing protocol for the primary market is due to the complexity of this segment of the market, Hefferan said.

The bank agent allocation involves building a lending pool that funds a corporate loan and involves setting up a syndicate of perhaps hundreds of fund managers – who in turn associate hundreds of other lenders to the deal through sub-allotment in the secondary market.

“Technology has caught up to the point where we can settle these transactions faster and we need technology-equal behavior,” Shaiman said.

The LSTA has not compiled data on the average settlement times for transactions in the primary market, nor on the number of transactions carried out in the allocation and the sub-allotments that would make it possible to estimate the amount of remuneration that the buy-side firms could gain in deferred compensation.

But in an effort to speed up settlement times, it is more likely that companies on the buy side will not need deferred clearing since they will earn coupon directly at a faster settlement rate.

“At the time of primary syndication, the agreement, facilities, contracts and documentation must be integrated into the agent bank and settlement platforms for the first time,” Hefferan said. “The technological improvements that have been developed over the past few years will be helpful in implementing the protocol and thereby improving overall market liquidity.”

Rosemary S. Bishop