Leveraged loan market participants will have to wait a little longer for a big change meant to speed up trade settlement.
Originally slated to start on Monday, July 18, the new “delayed compensation” policy will change how buyers of syndicated corporate loans that are below investment grade earn interest on loans they have agreed to purchase but not yet taken possession of.
The Loan Syndications and Trading Association said Tuesday that it was postponing implementation until Sept. 1 in order to address a potential loophole benefiting international buyers.
Under the new rules, institutional buyers of speculative-grade loans (including collateralized loan obligation managers) would need to show they have available funds to complete a trade by the seventh day after a trade is completed (“T+7”).
Without the funds commitment, the buyers would be ineligible to receive the delayed compensation covering the earned interest they would have accrued between the trade agreement and settlement dates.
The revision now under discussion will require buyers to also deliver the funds for settlement by the 7th day, in order to qualify for the single week of delayed compensation the new rules will permit them to receive. The change is necessary, says an LSTA executive, to account for the extra two- to three-day “lead time” period that’s needed to transfer the asset funds cross-border.
“The counterparties are going to have change their behavior, and they are going to have to get their money here within” the T+7 time period, said Elliot Ganz, executive vice president and general counsel for the LSTA.
Without the cash-up-front policy change, a loan buyer using foreign-based assets to purchase loans will stretch the settlement period to a 9th or 10th day – an issue that was drawing concerns from market participants.
“What the postponement is doing is trying to address the issue of lead times, and make some changes to do away with lead times over time,” Ganz said. “There need to be some changes to [trade document forms] , and there may need to be some tweaks to the platform.”
The LSTA enforces rules and standards for its electronic loan trading platform used by the industry.
The loan industry trade group has worked over a year to devise changes to a labyrinthine loan-settlement process, which can stretch to three weeks for non-distressed trades.
Under the existing trade settlement regime, buyers can now accrue earned interest on loans they purchase for weeks on end, beginning on the seventh day after a trade agreement is reached, without having to commit funds. The average settlement time has stretched beyond three weeks in recent years.
Critics argued that the long delays give loan buyers an incentive to drag their feet on loan trades, since they collected interest for weeks without committing funds to the deal.
Delayed compensation is an automatic “no fault” process for loan trades extending beyond seven days, regardless of which counterparty is responsible for delays beyond a seven-day settlement period.
Buyers argue the delays are not entirely their doing – intermediary agents have to complete arduous compliance tasks such as verifying borrower consent to the trade, for instance – but the long delays in leveraged loan trading creates counterparty risk and forced sellers to retain loans until documentation and funds settlement procedures wrapped up.
The LSTA overhaul is intended to shave settlement times to under a week, and will also reduce the compensation levels buyers have received under prolonged settlement periods in the $600 billion leveraged loan market.