Delays to settlement in the Loan Market Association’s (LMA) secondary loan market remains a significant issue. Jacqui Allen, partner at Mandel, Katz & Brosnan, considers some of the most frequent causes of delay, and outlines the steps that are being taken to help reduce settlement times.
How big an issue are settlement delays in the LMA’s secondary loan market at present?
The issue is significant and warrants the attention it is being given by the LMA. Delays in settlement prolong exposure to counterparty credit/market risk regarding price and the delays limit the attractiveness of loans as an asset class when loan settlement times are compared with other types of financial asset.
What are the factors which are currently causing delays to settlement in the secondary loan market?
- lack of pre-trade due diligence on the asset (eg not having signed a non-disclosure agreement to obtain the documentation so it must be negotiated post-trade date, looking at how the trade fits into minimum transfer amounts/minimum holds frequently found in the transfer provisions of credit documents, multiple borrowers/tranches, whether there are stapled shares or rights of pre-emption/first refusal)
- know your customer (KYC) on the counterparty
- regulatory issues in the jurisdictions in which the borrower may be located (eg do you have to be a bank to hold the asset, or what is a ‘financial institution’ in the relevant borrower jurisdiction?)
- issues relating to investigating the security package and whether there are formalities in relation to perfecting its transfer
- obtaining borrower and issuing bank consents if so required by transfer provisions in the credit documents and negotiating participation agreements or alternative forms of settlement where transfers are not possible
- tax analysis of how to buy the loan asset most efficiently
- restructuring events/lock-ups/settlement freeze
- brokers waiting on an upstream delivery which may, in turn, be held up by a prior trade, so magnifying issues through the system, and
- negotiation of non-standard representations/warranties by legal advisers where relevant—after all, loans are bespoke and there may be specific asset-by-asset points for which a seller/buyer should be protected
How big a factor is KYC?
I think KYC is the most significant cause of delays to settlement. Often, the broker-dealer counterparty will have to KYC a new fund before signing documents with a seller/buyer. The next hold-up will be that settlement cannot take place until the third-party agent has also cleared the buyer and, to conserve limited manpower, the agent frequently will not start the KYC process until it is presented with a signed transfer document (as at this point they know the trade is real). The biggest bugbear is the lack of any standard approach as each financial institution will implement the principles upheld by the Joint Money Laundering Steering Group (which defines anti-money-laundering/KYC governance in the UK) in a different manner. Also, the KYC regime varies with the jurisdiction of the new lender and the jurisdiction in which the agent is based. This means that a ‘standard’ KYC pack doesn’t really exist, and no industry organisation has sufficient international coverage or funding to liaise with regulators to the extent that would be needed for standardisation. Also, as the fines for regulatory breaches are ever higher, who would want to step forward and take responsibility for telling an institution, say, that a KYC step or process could be dropped/simplified?
What is the LMA—and the loan market as a whole—doing to try to reduce loan trading settlement times?
The LMA has committees that focus on different aspects of the loan market and each has had settlement times at the top of their ‘to-do’ list. I am a member of the secondary documentation committee and, as an example, we have been involved in developing the standard form documents so there are more default fall-backs for topics that should be but are often not discussed at the time of trade. Also, we have been considering amendments to the suite of documents for claims so that frequent additions negotiated on an ad-hoc basis for each trade are adopted into the standard form.
How is the Loan Syndications & Trading Association (LSTA) attempting to reduce settlement times, and is this likely to have any impact on, or be implemented in, the LMA’s secondary trading market?
The LSTA has been very focused on attempting to reduce settlement times in the US secondary market. Most recently the LSTA has rolled out a new Par/Near Par Delayed Compensation regime to try to substantially shorten settlement times to T+7. The new rules change the long-established ‘no fault’ system to a ‘requirements-based’ model by having a buyer forfeit its compensation for delayed settlement when the buyer neglects to complete all the necessary steps in order to settle, including executing and delivering the trade confirmation and the assignment agreement and being ready and able to fund. The success of the new rules has yet to be seen and so any impact on the LMA secondary trading market is unclear. The issues in the LMA market regarding KYC, borrower consent, different jurisdictions, etc may make it unlikely that this model will be adopted with the same timelines or requirements in the UK market.
Interviewed by Jenny Rayner.
The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.