Nineteen days and counting.
That’s the average time it takes to settle a US syndicated loan. It’s a far cry from the two or three days for other asset classes, but fund managers, broker-dealers, agent banks and even regulators are waking up to the fact the gap must be closed to reduce risks and costs.
Markit’s latest acquisition of a middleware application from JP Morgan, one of the leading agent banks for syndicated loans, represents an important milestone in the industry leader’s multi-year effort to provide straight through-processing to the syndicated loans market. Its far smaller rival, Trade Settlement Inc. purchased by Virtus Partners in December 2014, claims support from fund managers, which are among the largest investors in syndicated loans. By some industry estimates, buy-side firms hold over a third of the value of US outstanding loans.
Representing over US$2 trillion of committed lines and outstanding loans, syndicated loans are a key source of financing for many large and middle market companies. Fund managers, in particular, have good reason to want the settlement cycle shortened. In a September 2015 proposal to improve liquidity risk management for registered investment funds, the US Securities and Exchange Commission suggested that the long settlement time for syndicated loans could make it difficult for registered funds to meet redemption requests within the required seven-day timetable. The US trade group Loan Syndications and Trading Association (LSTA) is also supporting a seven-day cycle for par syndicated loans.
The unique characteristics of syndicated loans makes settlement far more difficult than other asset classes. None of the loan servicing specialists contacted by FinOps Report were willing to predict by just how much they could reduce the time it takes to close a deal, given the tremendous amount of information that must be exchanged between buyers, sellers and agent banks. Markit and Virtus report that some of their respective clients have participated in deals that settled well under the typical 11-day timeframe and both operators of syndicated loan platform platforms are hopeful that evolutionary steps in automation can help buy- and sell-side firms make even more progress.
Reducing settlement time obviously helps increase market liquidity for syndicated loans and reduces the potential for default by one of the counterparties. Automation could even lower the high costs of syndicated loan settlement, which can come to several hundred dollars or even several thousand dollars per trade depending on the amount of manual work required, say operations specialists.
Syndicated loans are loans made by a consortium of institutional investors and/or banks to a corporation in exchange for interest payments. In the primary market, the corporate borrower uses a bank agent to make certain that the borrower and lenders complete the necessary paperwork, so that each lender owns a part of the total loan. In the secondary market, investors wanting to trade their parts of the loan with other banks or institutional funds must also exchange purchase and sale agreements. The agent bank needs to know which lender bought which percentage of the total loan, so that it can know how much to pay the final owners and when. The agent bank must verify that the lender has sufficient position to cover the trade, as well as identify relevant trades are ready to be settled, so it can complete the transfer of ownership on its books.
Markit’s Strategy
Markit acknowledges that it needed JP Morgan’s middleware to jumpstart the adoption of Markit Clear, an upgraded version of its legacy Clear Par system, which relies on FpML messaging. Designed in 2011, Markit Clear has yet to win any users — a scenario Markit attributes strictly to market delays. “Large agent banks have first needed to build the integration and upgrade their systems,” says Scott Kostyra, head of loan settlement for Markit. “Vendors providing asset servicing applications have had to upgrade their solutions to provide for electronic messaging and straight-through processing.” Inertia and budgetary constraints have clearly hampered progress, agent banks admit.
Markit Clear represents the latest incarnation of a platform bought in February 2010 from Storm Networks. Markit bought its legacy ClearPar platform from Fidelity Information Services the previous month. Kostyra acknowledges that ClearPar is a “workflow management tool” which is not fully automated, but would not specify when, if ever, Markit will shutter its ClearPar platform in favor of Markit Clear. For now, it appears that both can easily co-exist. “We have an integrated interface to make it easier for users to use both platforms while migration from ClearPar to Markit Clear takes place,” says Kostyra.
Syndicated loan operations managers contacted by FinOps Report, would not discuss any plans for migrating to Markit Clear but acknowledge some frustration over the operational limitations of the ClearPar platform. Although it relies on the electronic exchange of documentation, it also requires some manual intervention. Here is how the new middleware will help the adoption of Markit Clear, according to Kostyra. So far, agent banks must rely on their loan desk staff to research into in-house loan-servicing applications to verify whether lenders have sufficient position to cover the trade and locate trades that are ready to settle. With Markit’s new middleware, agent banks can automatically link their position databases with Markit Clear. Trades entered on Markit Clear can then query the agent’s database to validate that the seller’s position and quantity. Once that takes place, the agent bank can update its position database and change ownership of the asset.
Yet another benefit to the middleware which is FpML-enabled, says Kostyra: financial firms can become more efficient in handling the data associated with managing loan portfolios. With FpML, data on loan assets such as paydowns, interest payment, and rate resets can flow from agent banks directly to asset manager systems and reduce reliance on emails and file transfers.
It remains to be seen just how much Markit’s middleware will help Markit Clear win industry support. What is certain is that Virtus Trade Settlement (VTS) is a long way from matching Markit’s trade volume. Neither Markit nor Virtus would provide comparable figures, both both agree that Markit is far ahead. When it comes to market share, Markit says that ClearPar has 800 fund management firms, and 200 bank lenders and agent banks as customers. A press release issued in late 2014 during the time of Virtus’ takeover of Trade Settlement said that Trade Settlement was used by more than 600 buy-side firms and “all of the major agent banks.” The Houston, Texas-headquartered Virtus wouldn’t provide updated figures.
Markit Alternative
Founded in 2005 by a group of former JP Morgan executives, Virtus is best known for helping hedge funds and others during the financial crisis buy groups of loans from troubled banks. It has since grown to provide middle office services and data for similar complex fixed-income portfolios run by traditional funds, alternative funds and separately managed accounts. Therefore, its decision to heavily promote VTS to fund management firms makes sense. It is also understandable that Virtus would try to capitalize on the need for an alternative to Markit.
“We believe that investors in the loan space have seen the need for alternatives, understand the risks of a single-player option and are aggressively voicing their support for competition,” says Robert Tomicic, a partner at Virtus. “If market competition is completely eliminated and the ability to settle electronically is ruled by a single for-profit body, we are at risk of creating a monopolistic environment that shuns innovation, while controlling pricing.”
However, the support of fund managers alone may not be enough to move marketshare over to VTS. Sell-side firms and agent banks generally call the shots on which platform is used. Regardless of any gripes with Markit, they are still sticking with the larger provider that they use for other services, such as swaps processing. Tomicic remains hopeful that the tide will eventually change in his firm’s favor.
“While it is true that buy-side firms have been more open to the adoption of the new VTS platform, we have had acceptance from some progressive and forward-thinking sell-side institutions, and their feedback has been extremely positive,” he says. “We are also committed to work with any institution to leverage its existing technology to minimize or eliminate any tech spend it may have to incur to establish more STP on its end.”
Rhetoric aside, just what functionality and cost benefit does VTS bring to the table that could attract users away from Markit? Tomicic would not comment on Markit Clear’s capabilities, but insists VTS has operational benefits over ClearPar because of its better workflow that “allows the two counterparties to the trade to work with each other directly to amend, update, execute and settle all aspects of both par and distressed loans.” He also claims that the VTS interface offers better reporting and visibility into all aspects of the trade lifecycle. Kostyra vehemently disputes Virtus’ claims of any technological superiority to ClearPar.
Neither Tomicic nor Kostyra would provide specifics on how much they charge participants. so no apples-to-apples comparison of VTS, ClearPar or Markit Clear can be made. Markit Clear, unlike ClearPar and VTS, does not process distressed loans. However, given that par loan settlement represents more than 95 percent of trade volume, argues Kostyra, Markit opted to follow industry demand to focus Markit Clear on par loans first. Though Markit Clear offers FpML messaging, Kostyra also disagrees with any suggestion that the lack of full adoption of the FpML protocol in the syndicated loans market may hamper Markit Clear’s growth. “We are not dependent on adoption of FpML [by our users], and have built our own messages in the meantime,” says Kostyra.
Perhaps the most telling indication of just how Markit dismisses any potential threat from Virtus is the following statement from Kostyra: “Markit believes that market participants see significant benefit to operating on a single network. That is the one reason, among many others, why the market has chosen ClearPar as the platform of choice.”
Without providing specifics, Kostyra and Tomicic say they are evaluating how blockchain technology used in the Bitcoin market may be used for syndicated loans. But such a move would clearly be revolutionary. For now, it appears the current evolution in the syndicated loans market needs to be focused on squeezing days — and cost — out of the settlement cycle.
This “Evolution” has been coming for 5 years now. Laid bare, the facts are that this is an incredibly fragmented asset class from the operational perspective, and it will take an effort tantamount to having a Trump supporter and a Sanders supporter engage in a calm, reasonable political discussion. to get all players on the same page. Reality is that it will likely take government regulation to make it happen, and the most obvious downside (of many) to that is that Markit Partners’ solution will likely win out due to sheer volume of transactions already covered. That is not a good thing, as many market participants have expressed their concern at Markit’s attempts to corner the market on numerous aspects of the back-and-middle office processing that supports the leveraged loan asset class. As the TARP 8 have learned the hard way over the past 7+ years: bigger is not always better.