Tim Bourgaize Murray: Syndicated Loans: Getting the Dominos Lined Up

When I tell people that I completed a degree in financial regulation at the London School of Economics, they usually tell me one of two things: ‘Wow, that’s fascinating; I didn’t know they even offered those!’ or ‘Wow, how did you stay awake?’ Now, the LSE isn’t exactly known as a bastion of neoliberal orthodoxy (quite the opposite), but what I found most interesting about the course was learning the contexts and reasons why light-touch, self-regulation can actually be incredibly effective—doing more with less, in other words.

Indeed, regulators don’t always dive into a broken market. Sometimes they feel they’d only make the problem worse or don’t have the domain expertise to do so; other times they assess the risk to the broader ecosystem they oversee as too little to bother, or too expensive given the fix. And especially in financial services, they’ll often see the industry backlash and counter-lobbying as too strong. None will admit it, but it’s true: Sometimes they just give up before even trying.

Syndicated loans and their securitized collateralized loan obligation (CLO) versions are unique in that they land a bit in each of these buckets: It’s a highly complex, trilateral market from both an asset standpoint and in terms of workflow. It’s historically been limited to trading desks at major banks and buy-side specialists (though this is changing). And it’s an area that the buy and sell side are keen to see remain as flexible and old-fashioned as possible. The nature of these instruments is bespoke. Building a SEF-like execution facility for loans, even at par, is more pipe dream than possibility.

With regulators’ hands off, it’s been broadly left to the industry to fix the market’s myriad, longstanding operational problems, often via negotiation and debate at the Loans Syndication & Trading Association (LSTA) industry group, and in concert with a handful of key providers, consultancies and utilities.

It’s fair to say that progress has come in fits and starts. When I wrote an article for Waters on this same topic in early 2013, Markit Clear was a “lightning rod,” the settlement process was described by one buy-side CEO as “archaic” and another buy sider called the idea of generating competition in the space among agent banks “ridiculous,” adding that “it’s still unclear exactly what the goal is, what the final product is, and why the buy side pays for it,” with respect to Markit Clear.

Though I’m not quite convinced the dominos are ready for settlement automation to finally happen, they’re now being carefully lined up.

Ton of Sunshine

There wasn’t a ton of sunshine in that article, and in writing the follow-ups to that piece this month, I didn’t find sentiment had changed much. Investment managers are still quibbling with the agent banks over cost and inefficiency; the banks (as ever) are still dragging their feet—blaming budget constraints and competing priorities—while protecting their turf as much as possible, and the tech firms in between, try though they might, can’t really do much about the core issues without both sides buying in.

Still, I did find a shift in strategy that admits more space could be made for these sticky issues to get ironed out if the little things—documents, confirms, systems integration with trustees and front-end streamlining—are solved first. There was a sense of “let’s move on from 2011, straighten out the peripheral stuff, and come back to the table” and that was refreshing. It’s one aspect of covering this market that’s more interesting than most: The mindset matters almost as much as the mechanisms.

Though I’m not quite convinced the dominos are ready for settlement automation to finally happen, they’re now being carefully lined up, rather than thrown down a flight of stairs. And with so much painstaking work required to do so, we all know how fun it is to watch the first one tumble, the next, and then the next.

One could certainly argue that record or near-record trading in the space has something to do with this, and that getting as much done as possible before demand begins to ebb will be crucial. It may well be. But I’m intrigued to see where this goes, and anyone with an interest in regulatory processes—see, for example, the complete opposite approach in swaps modernization—should observe this with interest, too.