A New Turn in CLOs' Tech Quandary

Sometimes, ancient technology changes about as quickly as it moves.

CLOs = no longer scary. Their settlement is a different matter.

Tim takes a new look at the classic question of technology investment in the context of surging collateralized loan obligations.

Should technology investment chase burgeoning markets, or should technology investment create the environment for markets to really thrive?

The question is always a fun thought exercise, because whenever that subjunctive should is involved there isn't an absolutely correct answer. Some markets are always chock full of liquidity, always on-screen; others will always be so specialized that forcing technology into them requires a crisis and 2,300 pages of regulation. And in reality, there's no chicken-or-egg causality here; it's all fluid.

So the ones in between are those that demand our attention, then, and I've personally always had a fascination with CLOs. They're an interesting mark of financial engineering, both in the problems they look to solve (for both issuer and investor) and in their tranches' structure. No two are quite the same, and in most cases the risk-return involved is quite serious — which, as long as you understand what you're getting into, is quite useful.

CLOs Rising

That is evermore the case as liquidity and opportunities in high-yield bonds haven't quite satisfied investors' appetite, and CLOs have filled the gap — producing record high issuance in the past year and attracting new types of market participants.

Put it this way: people complain about the massive number of CUSIPs to cover in corporate bonds, but simply having a CUSIP-style identifier would be a huge step for CLOs.

Of course, technology problems in illiquid bonds (and corporates in general) are very well-documented; new solutions are bubbling up all the time to cope with those issues.

CLOs face a different but still stubborn problem: they simply take forever to process, and the basic data infrastructure still isn't there to communicate about them in an automated way. Put it this way: people complain about the massive number of CUSIPs to cover in corporate bonds, but simply having a CUSIP-style identifier would be a huge step for CLOs.

Now, I say 'style' because, as previously mentioned, loan obligations are far more complex and diverse than a corporate bond, and that is surely understood by those who are trying to pull the manual execution, reconciliation, and settlement times down in the space. There will be limits to what can be practically accomplished here.

Still, there is a potentially massive cost to having so much operational and balance sheet uncertainty shuffling around the industry as these instruments become more popular. Just look at how many years it's (still) taken to sort out the Lehman Brothers estate — for that matter, using CLOs as a vehicle. If it can be avoided, even marginally, it should be.

This Time's The One! (Maybe)

All of which is why the recent news highlighting Bloomberg's FIGI identifiers moving to CLOs — for starters, at US Bank — is important. Having a solid way of communicating about CLOs up and down the investment stream is a requisite first to start moving this forward. It is also doubly interesting that US Bank took up the project with Bloomberg simultaneously with its own work developing the firm's new Pivot platform for CLO asset and collateral manager clients.

David Keys, from US Bank, told me that he expects the rest of the CLO space to follow suit on both fronts — figure out a common ID, and get their own internal technology working faster and more digitally. Of course, I heard all of this a couple years ago, and we hear it all the time: serious change is just around the corner, right?

And then, the market dies down a little, and it isn't ... and the buy side is still left complaining.

But when millions are being spent by custodians, and years of time are now invested by firms like Bloomberg that don't give up easily and can leverage their position, you have to figure this time — with the massive issuance numbers in tow — could be different. It should be exciting to hear more about this as the year goes on.


Random (Mostly Sports) Thoughts

  • As a Flyers fan I'll always hate the Rangers, but their series with the Tampa Bay Lightning has been very entertaining, and even moreso, extremely confusing from one game to the next. The more you think you know, the less you actually do — other than that Hank Lundqvist is ridiculously good in elimination games. Part of me hates the idea of having a potential Cup Final with two teams in cities with "one-season" (i.e. summer) weather; having an Original Six final with two teams I hate is far worse. Wow, I used 'hate' three times in the past three sentences. Someone's bitter.
  • Moving to hockey with a ball (and without sticks and ice), we have confirmation that the manager's job at Real Madrid must be the most thankless in the world, with Carlo Ancelotti getting his walking papers on Wednesday. Win La Decima and getting fired just a year later? Those must be some high expectations. Meanwhile ...
  • In a far more deserved case of football karma: The bombshell arrests and investigations announced yesterday into bribery at FIFA come as no surprise, though it's still fascinating to see the hubris involved. Every criminal, the world over, should know by now not to wire transfer funds through US-based banking entities. Who said extraterritoriality was always bad, right? Then again, as Dan DeFrancesco pointed out to me, apparently one of the arrested officials keeps a second apartment in New York's Trump Tower, next to his own — occupied solely by his cats. So I guess we're talking about a different breed here.
  • Since I know that my darling mother — a Rangers fan — is one of about ten people who reads this column regularly (let's see if she reads down this far), I'd like to wish her a happy birthday this weekend! Hopefully I'll get to visit and celebrate on Bethlehem's stylish Main Street with her soon enough.


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