- Transactions currently take as long as three weeks to complete
- Buyers will be required to commit to closing within a week
The leveraged-loan market is preparing to implement new rules that penalize investors who hold up trades as the industry seeks to ease liquidity concerns.
Investors, who typically receive interest on loans when trades take more than a week to settle, would be forced to forfeit that compensation if they fail to comply with the new requirements approved by the Loan Syndications & Trading Association. The LSTA sent a letter to market participants last month after its board approved the measures, three people with knowledge of the matter said, asking not to be identified as the discussions are private. The rules may be implemented by the second quarter, one of the people said.
The loan market has been under intensifying pressure to speed up transactions amid concern that settlement delays could exacerbate losses for money managers seeking to meet redemptions when sentiment sours. A $788.5 million bond fund run by Third Avenue Management was forced to freeze withdrawals in December amid a market rout and regulators have sought to insulate the mutual-fund industry from heavy redemptions.
"This is just the first step of many that need to be taken to improve settlement times," Bram Smith, the LSTA’s executive director, said in an e-mail. "The change in delayed compensation, which incentivizes both dealers and investors to settle quicker and free up balance sheets, is one of many ongoing projects that are aimed at speeding up settlement times and further enhancing liquidity.”
Under the new rules, buyers would have six days after agreeing to buy a loan to sign documents that indicate that they have the cash available to close the deal by the seventh day, two of the people said. They must also be ready to pay every day after that. Failure to meet these conditions could mean investors forfeit compensation received during a delayed settlement process.
The finalization of the new guidelines comes after more than a year of consultations, which included complaints from investors concerned they will be unfairly penalized for delays and be forced to keep cash ready for a trade that could still get dragged out through no fault of theirs, people familiar with the discussions said.
Last year, SEC Commissioner Kara Stein questioned whether some funds, including those that principally invest in bank loans, are buying too many hard-to-sell assets. The SEC unveiled a set of proposals in September that would require funds to hold more easy-to-sell assets to meet withdrawals amid market tumult.
While high-yield bond trades are settled in three or fewer days, loans can take seven times as long. The reasons for the delays include the requirement for consent from a borrower for trading its loan, borrowers banning some lenders from purchasing its debt, and the back-and-forth of paperwork in a market still working toward standardization of documents. There are also cases where a bank administering a loan might deliberately delay settlements if an investor asks another dealer to broker a trade, investors have said in the past.
The new rule marks a shift in the industry’s approach to tackling the issue. It seeks to move away from a system that assigned no fault for trade delays and help free up dealer balance sheets with faster trade settlements, two of the people said.