Market participants often complain about the longevity of equity trade settlement, particularly in emerging markets where trade life-cycles can be as long as T+5 or more.
The internationally accepted T+2 settlement time-frame for equities is becoming more commonplace, particularly with the US transitioning from T+3 to T+2 for equities, corporate and muni bonds and unit investment trusts in September 2017.
Spare a thought then for market participants transacting in syndicated loans, and its associated trade settlement process…….
A typical syndicated loan will settle on T+19 or T+20. Syndicated loans are a critical source of funding to the real economy, with beneficiaries including major governments, large corporates or small-to-mid-sized enterprises (SMEs). There is also a sizeable secondary market with various financial institutions trading these loans.
Enabling syndicated loans to settle immediately in a Blockchain framework would bring about huge benefits. Blockchain – by facilitating real-time settlement and providing an immutable database of transactions – would bring an unparalleled level of automation and transparency to the asset class in both its primary and secondary markets.
Transparency is crucial, particularly because the syndicated loan debt is often shared between multiple underwriters. The volume of documentation – given the number of participants involved in the syndicated loan trade cycle – is significant, even by the standards of today’s post-trade environment.
So how could Blockchain boost transparency in this market? Blockchain could enable – through permissioned access – for market participants to pull syndicated loan transaction data from the ledger in real-time.
This not only helps mitigate operational risk, but can assist with regulatory reporting requirements, as the data can be easily identified and consolidated. Regulators want information increasingly in real time or near-real time, and a Blockchain system can help financial institutions track their exposures across all asset classes and instruments in real-time. This will make it easier for firms to report their positions to regulators quickly.
Automation and straight-through-processing (STP) is something financial institutions including banks, fund managers, brokers, industry consortia and regulators are demanding for in the syndicated loan market. This is evidenced by the Loan Syndications and Trading Association (LSTA), an industry body, warning purchasers they could face penalties if they take too long to settle loan transactions.
Reducing settlement time-frames ultimately helps mitigate counterparty risk, while automation has its own cost-efficiencies. It would allow financial institutions to rationalise their middle and back offices, something which many firms are trying to achieve given the rising regulatory costs in today’s marketplace.
Hastening the trade settlement cycle of syndicated loans will free up liquidity in the financial system. Liquidity constraints are a growing problem for financing institutions due to regulatory capital costs. However, fund managers are facing their own liquidity challenges, as regulators seek assurances that mass redemptions by investors will not lead to a liquidity freeze.
The US Securities and Exchange Commission (SEC) is recommending mutual funds introduce swing pricing (whereby transactional costs of trading are passed onto buyers or sellers into the fund) and liquidity buckets. These buckets will comprise of investments deemed highly liquid; moderately liquid; and illiquid. Having a syndicated loan market that can achieve real-time settlement on Blockchain would help fund managers meet their liquidity obligations, and it could soothe regulators who are worried about the impact that mass client redemptions could have on market prices if panic selling ensued.
Critics of Blockchain technology have asked whether it can suitably process illiquid or high-volume transactions. The technology is already being trialled by financial institutions to see if it can quicken the transfer of illiquid securities, while scalability concerns have also broadly petered out.
Blockchain is certainly going to play a part in the syndicated loan market, and will bring efficiencies and automation to the asset class. This will help firms manage their counterparty risk and operational risk, and bring about significant improvements to market best practices in the syndicated loan space.