by Edward C. Kelleher
Mathew Keshav Lewis, DTCC Vice President, Global Loans Product Management, recently met with @DTCC to discuss the syndicated loan market, DTCC Loan/SERV’s products and partnerships and how the market is faring in today’s global economy.
Loan/SERV is an evolving suite of services that automates and streamlines processing in the syndicated loan market. In 2008, DTCC introduced a Reconciliation Service to help banks and lenders reconcile loan positions. It launched a second-generation service (Contract Reconciliation) in 2009, followed by a delivery-versus-payment platform for secondary loan trading called Cash on Transfer Service in 2011.
How have syndicated loans fared since the 2008 economic crisis and what does the market look like today?
In the last six months, we’ve seen a real rebound in terms of trading volume and a steady flow of new debt issuances, along with the reemergence of collateralized loan obligations [CLOs]. The U.S. market for syndicated loans posted $151 billion in volume for the first quarter of 2012, an increase of 46% over the fourth quarter of last year.
With the turmoil in 2008 and 2009, both new issuance of syndicated loans and secondary market activity took a big dive in 2009 and 2010. There seemed to be a bit of a start in 2011, not dissimilar to what we saw in the equity space, but the second half of the year went quiet again.
We still have not recovered to the levels of 2007 when the market peaked, with industry estimates for the year putting global syndicated lending in the US$4.5 trillion range, but we are seeing clear signals of an upturn.
Mathew Keshav Lewis, DTCC Vice President, Global Loans Product Management/
What is a CLO and why is it important to the industry?
A CLO is a collateralized loan obligation – a special-purpose vehicle holding a portfolio of underlying syndicated loans. CLOs slice the loans into tranches that are then rated by the major ratings agencies. Each tranche provides a payment stream linked to the riskiness of the tranche. Before 2008, CLOs were the primary funding mechanism for the U.S. loan market, with a market share exceeding 60% for much of the 2000s.
A CLO is similar in structure to a collateralized debt obligation [CDO], a financial instrument made up of varying debt instruments rather than just syndicated loans. CDOs did not fare well during the economic crisis whereas the vast majority of AAA-rated tranches of CLOs have performed well over the past four years. I don’t believe any AAA CLOs defaulted during the market downturn. And the fact that they’ve come back in significant numbers this year is a very positive sign.
What did the syndicated loan market look like before the industry and DTCC took steps to automate and streamline it?
During the boom times for syndicated loans and right up to 2007 when trading was going through the roof, the market just wasn’t focused on technology. It was a very people-intensive business, and the manual process was reaching the breaking point. As volumes increased, firms added more people – another closer to help with secondary trade settlement or another operations person to help with processing – it just wasn’t a scalable model. Other examples of manual processes include communication methods. Agent banks, acting as the liaison between borrowers and lenders, transmitted information back and forth between parties primarily via fax and email. An estimated 25 million faxes and emails supported the loan business in 2008.
This lack of automation meant an immense amount of paperwork and human error, which slowed down trade settlements as well as the ongoing loan administration. If you send out two million faxes to market participants each month, it means there are two million opportunities for manual errors when rekeying information into different systems.
What were the first steps DTCC took to help resolve this lack of automation?
Working with the industry, we realized we had to provide more transparency to market participants to improve data accuracy. We had to make sure that both agent banks and lenders were looking at the same information, tracking the same positions, the same transactions and identifying the same exceptions or disputes and resolving them before they became problems.
We achieved these goals with our Loan/SERV Reconciliation platform, which enabled agents and lenders to view and reconcile loan positions and transactions on a daily basis. We’ve since introduced Contract Reconciliation – a second-generation service – that includes 30 new data fields with information on interest rates, margin and fee calculations, and drawn and unutilized balances to further improve transparency.
Today, along with all the leading agent banks, we have more than 3,600 investment funds and lending entities using our reconciliation services, ranging from pension and retirement funds to individual bank branches around the world.
How do the reconciliation services reduce risk?
Our reconciliation platform reduces risk by giving agents and syndicate members robust tools to identify discrepancies that could lead to erroneous cash movements. Lenders log in daily or weekly to review transactions and positions or to research historical data. Users can run exception reports and identify transactions and positions that need to be corrected or updated. This timely access to data reduces operational risk for all Reconciliation users.
Can you talk about the Loan/SERV Cash on Transfer Service?
Cash on Transfer [COT], developed with Markit, is the first – and only – delivery-versus-payment platform for secondary loan trading. Before COT, there was no assurance that cash would settle simultaneously with the change of ownership by the agent bank at the time of trade settlement.
COT links the buyer, seller, agent bank, trading processing platform and counterparty accounts, allowing for cash and legal ownership of the asset to move simultaneously on the agreed trade settlement date. Right now, we settle U.S. dollar trades, and as we sign on more banks and market participants, we’ll introduce additional currencies.
All the agent banks and most of the leading investment funds in the U.S. are working with Loan/SERV. How is the syndicated loan market in Europe responding to Loan/SERV?
Since launching our reconciliation services in Europe, we’ve focused on the major leveraged-loan players, onboarding a number of leading institutions including Barclays, Citibank, Deutsche, JPMorgan and Royal Bank of Scotland, as well as a number of local custodians and major fund managers. In total, about 1,800 non-U.S. funds are now taking data from our website to reconcile their loans. It’s good progress but there is more to do.
Local jurisdictional and confidentiality issues have slowed down adoption of reconciliation in continental Europe, but we are working closely with partner banks and the Loan Market Association to address local issues and bring more of the market onboard.
Going forward, we are looking to strengthen our European footprint with a strong local partner. In discussions with Clearstream we found a strong partner with a shared vision and a willingness to put its existing relationships to work for us. So this year, Clearstream will begin introducing our reconciliation services to customers throughout Europe as a joint service offering.
Beyond reconciliation, we are looking at some uniquely European solutions to support bilateral loans and ways to use these loans as collateral for central bank pledges. Clearstream, with its extensive collateral management experience, is an ideal partner as we build out these services.
Heading into 2013, what are your plans for Loan/SERV?
We’ll continue working with our Loan/SERV advisory committee and other industry members to plan and develop new services. We are currently evaluating a new model for streamlined principal and interest payment processing – and we’ll carry on with our global expansion and add to the more than 40 countries where lenders are now using Loan/SERV. @