Perhaps antiquated markets must truly wither before they can be revived in an electronic era.
So it seems with two opaque over-the-counter debt markets: leveraged loans and derivatives contracts tied to individual companies’ creditworthiness.
These asset classes, which trade in phone conversations and emails, have both struggled in recent years, shrinking for somewhat different reasons. And both took steps recently to make themselves more transparent and easier to adapt to electronic systems.
The U.S. leveraged-loan market, which provides about $800 billion of financing to risky companies, is moving to speed up trades that now routinely take weeks to complete. Its main trade organization, the Loan Syndications & Trading Association, is preparing to adopt rules that would penalize investors who hold up the settlement of trades. It’s a long-awaited step that will help reduce risk in loan transactions and make it easier for mutual and exchange-traded funds to own the debt.
Meanwhile, the single-name credit-default swaps market, which allows traders to place bets on the likelihood of specific corporate defaults, is laying the groundwork for broader adoption on electronic marketplaces. Big Wall Street banks have agreed to pay about $1.9 billion to settle claims of preventing competition in this market from 2008 through 2015. As part of the agreement, the International Swaps & Derivatives Association, the industry’s trade organization, had to allow a committee of bankers and investors to rule on whether to disseminate crucial trade information.
The release of this data, which had been kept proprietary for years, has set the stage for single-name credit-default swaps to be traded on electronic systems, according to Daniel Brockett, a lawyer at Quinn Emanuel Urquhart & Sullivan who represented the plaintiffs.
Last year, after a preliminary agreement was reached to settle the derivatives case, the Intercontinental Exchange announced plans to begin offering an anonymous, all-to-all trading platform for single-name CDS, according to Darrell Duffie, a finance professor at Stanford University’s Graduate School of Business. The formation of this computerized marketplace “is a remarkable shift that I attribute, in part, to this litigation and its favorable resolution,” he wrote in court documents last year.
Regulators may try to claim some credit for these development, but the reality is more complex.
Investors have steadily withdrawn cash from mutual funds that own leveraged loans, in part because of the opaque nature of trading in the underlying loans and in part because of general concerns about credit quality. New leveraged-loan issuance fell 25 percent in 2015 compared with that year in the previous year, to $322.4 billion, the lowest annual tally since 2012, according to data compiled by Bloomberg.
Volumes are also diminishing in the single-name swaps market. Net wagers in these derivatives declined to $649 billion at the end of last year from more than $1.58 trillion in late 2008, when the Depository Trust & Clearing Corp. started reporting outstanding positions in the market.
Some of the biggest banks can no longer maintain robust trading operations in this market because of higher capital requirements. While these derivatives used to be highly lucrative for Wall Street firms, their waning popularity helped pave the way for greater transparency as different parties have less to lose and more to gain at this point.
Both of these markets are struggling to attract new investors by maintaining their old ways, especially as markets become more volatile and central bankers slow their efforts to bolster asset prices. While regulators have certainly required greater transparency, it took this change of fortune to truly push these debt markets into the modern world.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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