![]() ![]() The good news is that there are several factors that could assist traders to better quantify and manage their trade settlement process. Given these potential challenges, it is no surprise that traders would want to factor time to settlement risk into their decision-making process. As alternative debt managers continue to gain better insights into the timing of loan settlement, they could further improve their overall fund operations. Loans sold will lead to an inflow of cash that could be used to meet those commitments. Loans committed to be purchased or fund investor redemptions require cash to complete the transaction. Anytime a given loan trade settles, cash reserves are affected. Similarly, loan managers face additional challenges regarding cashflow management. During a prolonged settlement period, risks could emerge – for example, market conditions could shift, interest rates could change beyond expectations, or the borrower's risk profile could change. As such, even in the secondary LSTA market, loan settlements in the 60-90 days range are not rare. At this point, the still open trade is now at 45 days, and may not close for another week or more as the factors contributing to the delay are resolved. Sometimes these challenges occur as the quarter is nearing its conclusion and the Agent puts all transfers on hold for several days due to scheduled principal or interest activity. Sometimes the process is near completion, only to have the agent point out that the key parts of the signoff are still pending, such as KYC or Borrowers’ Consent. Sometimes the process is initiated, but then stalls immediately. A well-behaving trade might close in a little under 20 business days. Consider a secondary, non-distressed loan on the LSTA market, the most common loan type traded. While public equity and bond traders can confidently expect that the trades initiated on a given day will close in a narrow and predictable time span, private loan traders have no such luxury. As already noted, one of the most notable traits of loan trade settlement is the wide variation in times to settle. ![]() In a nutshell, delayed and unpredictable trade settlement imposes costs and operational challenges and risks to the front, middle and back offices of sophisticated alternative debt investors. Delayed settlement could also pose significant incremental administrative challenges and costs to trade counterparties. These longer time periods pose challenges to buyers and sellers to forecast and manage their cash flows – an important consideration for fund managers looking to satisfy, for example, (i) investor redemptions (seller), (ii) commitments to purchase other loans (seller), or (iii) investment objectives (seller and buyer). ![]() Trades could take a relatively long period of time to settle. Trade settlement exposes buyers and sellers to several risks. With the anticipated continuing growth of the private debt markets, we expect trading volumes to maintain their current upward trajectories, further highlighting the importance for investors to better understand and manage the risks associated with loan trade settlement. At Alter Domus, our Loan Trade Settlement group continues to see significant growth in trading volumes, well in excess of the LSTA volumes, as we continue to maximize efficiency, flexibility, and reliability for our clients. ![]() And as more investors turn to private debt as a viable asset class, we expect trading to continue to grow in tandem. In just the first half of 2022, $459B has been traded on the LSTA secondary market alone, increasing 12% over the same period in 2021. Trading in private loans continues to grow. Loan Trade Settlement – Not A Transitory Consideration However, there are certain factors that could assist private debt investors to better assess and manage the risks associated with trade settlement. At times, trades could take months to settle, exposing buyers and sellers alike to significant risks around volatility, losses and cash flow management. Trade settlement in the private debt market is a complex process and is often subject to the unique characteristics of the traded facility. A contributing factor to the liquidity premium in the private debt market is the cost and related risk of trade settlement. The favorable risk-return characteristics of private debt are attributed to a variety of factors, including compensation to sophisticated investors for accepting limited liquidity and increased complexity relative to the liquid public markets. ![]()
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