By Patricia Tessier, Managing Director, IHS Markit

Settling LSTA distressed loan trades in the secondary market is complex and time-consuming.  Unlike the par loan market, distressed features additional requirements for inventory management, due diligence and documentation.  As a result, the average settlement time for distressed loans in 2018 was more than four times greater (T+67) than that of par/near par loans (T+16).

This is unsustainable for a market seeking to provide necessary liquidity and attract new participants. Moreover, with a growing chorus predicting a turn in the economic cycle, the likelihood increases that a larger portion of the loan market, perhaps substantially so, might soon begin trading distressed.  The time to rethink distressed loan trading operations – both settlement efficiency and transparency – is now.

Technology already has reduced the burden of managing distressed documentation, such as the LSTA distressed trade confirmations, purchase price calculations and assignment and acceptance agreements (A&A).  Bringing more technology and automation to the market, however, is a prerequisite for systemic change in distressed loan settlement.

Three Harsh Realities of Distressed Loan Settlement

Part of the challenge is distressed loan settlement carries with it three extra – and substantial – burdens not found in par loan settlement.

The first is creation and negotiation of the LSTA Purchase and Sale Agreement for Distressed Trades (PSA).  The PSA is not without complexity, but at its core it is a template document with limited scope for free-form changes.  It is a natural place to introduce automation.

Next, are two distinct but related areas of workflow: inventory management by the seller, and review of upstreams (the chain of ownership of the traded loan) by the buyer. These are the most time-consuming tasks in distressed settlement – particularly upstream review – and they take place entirely offline, in highly repetitive workflows.

Why is upstream review so time-consuming?  Consider all that goes into the due diligence.  For each distressed trade, the seller must identify and describe the chainsof title (often there are many) from first transfer all the way into the seller’s hands.  The seller then delivers these bulky upstreams, usually in PDF format, to the buyer, who commences review of each link in every chain for each and every allocation.  Extended negotiation ensues until both seller and buyer are satisfied they’ve reflected the terms of the trade.  It’s an onerous task, and it must be improved.

Three Simple Rules for Changing the Game

It’s time to bring the full standardization and automation that define the par loan marketplace to distressed loan settlement.  How does this happen?  It’s more straightforward, and more within reach, than ever before.

Make no mistake, being a change agent within distressed loan settlement requires work and commitment to a better way.  It also requires marketwide fidelity to three proven rules for driving change in the loan market:

Rule #1: What can be standardized must be standardized.

Rule #2: What has been standardized must be automated.

Rule #3: Go back to Rule #1, and then to Rule #2.

Standardize and automate. It’s the future of finance and that future is finally here for distressed loan settlement.  Working off the foundation laid in par loan settlement, we’ve followed these three rules in building the distressed loan settlement solution, once and for all.

How does distressed loan settlement begin to feel more like par? We’ll be back soon with the next chapter in this exciting story for the loan market.