Internet marketplaces - notably, business-to-business exchanges - have provided new outlets for financial institutions and technology suppliers to peddle their wares.
By Tom Groenfeldt
May 2001
Institutional Investor Magazine
Internet marketplaces - notably, business-to-business exchanges - have provided new outlets for financial institutions and technology suppliers to peddle their wares. Now Depository Trust & Clearing Corp., a custody and settlement powerhouse, wants to get in on the e-action.
DTCC subsidiary Depository Trust Co. is hooking up with media giant Reuters Group to try to sell Wall Street on an electronic exchange for trading syndicated commercial loans. Reuters and Depository Trust aren’t the only ones vying to automate this $1.8 trillion market. But they contend that Reuters’ electronic network coupled with Depository Trust’s depository, custody and payment services make a hard-to-beat combination.
Like most of its financial institution owners, New York City-based DTCC views e-business - for secondary loan trading in particular - as a natural extension of its existing activities. Says Donald Donahue, managing director of customer marketing and product development, “The commercial-loan-participation market is a unique one, with its own professionals, but the institutions are pretty much the same ones we have as members.”
As in their other lines of business, leading loan syndicators - such as Bank of America; Credit Suisse First Boston; Goldman, Sachs & Co.; and J.P. Morgan Chase & Co. - are increasingly insistent about ridding themselves of responsibility for physical document management. “A number of [DTCC] members are saying, I do not want to have a vault; I do not want to have responsibility for maintaining security over pieces of paper,” says Donahue.
Momentum for an online loan-trading market is gradually building. The Loan Syndications and Trading Association, a nonprofit organization whose standards for paper loan documentation helped to promote the development of an active and liquid secondary market, asked vendors about a year ago to suggest ways to improve the trading mechanism electronically, that is, move it online. After receiving several responses, the association has decided to step back and let open competition determine the best solution.
Besides Depository Trust and Reuters, the current contestants to establish an electronic loan market are Trade Settlement, a year-old company based in New York, and Clear Par, an offshoot of Mandel, Katz, Manna & Brosnan, a Rockland County, New York, law firm that deals with distressed loans.
Each takes a slightly different approach, but all agree that the complex process of transferring and settling loan trades is ripe for modernization. “These deals tend to be large ticket - perhaps $1 billion - unique and highly customized to meet a specific need, like an acquisition financing,” notes William Bradway, an analyst at Meridien Research in Newton, Massachusetts. A single syndicated loan can consist of 15 contracts in multiple currencies.
A loan sale usually requires three parties: the buyer, the seller and the agent bank, which is often the originator of the loan. It may also need a sign-off from the borrower. The process involves several distinct legal documents, the exchange of which - whether in person or by fax - typically takes ten days. Moreover, when a loan is sold, the pro rata interest that accrued before the closing must be paid by the borrower to the buyer, which then must pay that sum to the seller. The current automation projects revolve around loans that trade at or near par value, but future efforts may extend to distressed loans, which are even more complicated.
Reuters, advised by several of the top syndicated lenders, has spent the past nine months working on a prototype for its system. The Reuters marketing manager responsible for the effort, Amy Woehr, previously worked in loan trading at Citigroup and served as co-chairwoman of the LSTA electronic settlement committee with J.P. Morgan vice president Michael Ambler. Reuters’ priority has been to automate the existing paper flow by taking advantage of the ability of XML, or extensible markup language, computer code to tag banks’ loan-data files so they can move electronically between participants’ computer systems.
“The goal is to eliminate the need to rekey information [from loan accounting systems],” says Woehr. She adds that Reuters expects to cut the settlement time from ten days after a loan sale to three to five days. Reuters expects to begin trials in about a month, which would lead to a rollout over the summer.
Trade Settlement, Reuters’ loan exchange rival, has not revealed its availability timetable. Pat Loret de Mola, president and CEO of the privately held firm, says only that its Web-based settlement method will be ready in the near term. She also is aiming to cut the ten-day span from trade to settlement at least in half, to T+5, in trading parlance. It remains to be seen how transactions would finally settle - who might play the role that Depository Trust will with Reuters - but Depository Trust could get this business, too, if the users so desire.
Michael Mandel, a partner at Mandel, Katz, Manna & Brosnan, says that Clear Par is primed for T+3 settlement, but he views that as only an interim step toward a fully automated platform. “We think it is going to take two to four years to go all electronic,” he explains. “With our system, a trader enters the ticket from his desk; all the documents are posted in the system so that everyone can go online and settle.”
Mandel readily admits that this is “not as good as a full electronic system where you can settle and net off at the end of the day, as you can with bonds.” But he says Clear Par, with a market test set for this month, has a timing advantage over its rivals. Asserts Mandel: “The others, especially Reuters, are putting together advisory boards, forming partnerships and trying to raise money. They want to go from A to C. We are ready now to go to B.” Reuters disputes that; Woehr says that it is tackling a finite challenge - documentation - first and plans a carefully phased implementation of the later clearing steps and, ultimately, settlement.
Meridien’s Bradway agrees that total automation simply can’t happen overnight because syndicated loans are much more varied in format than stocks or currencies. “Perhaps in another five or ten years, we will wind up with debt instruments that are more standard from deal to deal, although that takes away some of the creativity that has been a hallmark of agents,” says Bradway. “But we are getting to the point where the market is mature enough to wring out some of the process inefficiency.”
Other emerging marketplaces are on a similar track. They are aiming for so-called straight-through processing, or STP. That means handling transactions from start to finish with little, if any, manual intervention - which is considered a prerequisite to maximizing the efficiencies of any Internet trading platform. These online networks include Atriax and FXall in foreign exchange and cpmarkets.com, the commercial paper system developed by White Plains, New York-based Prescient Markets. Says Prescient CEO Laurent Paulhac: “People want the total experience - transaction and credit data, market data and news, and interconnections with custody banks, paying and clearing agents, cash management and accounting capabilities. This has to be much more than a trade execution engine.”
STP is just now surfacing in the mortgage marketplace, the largest in fixed income. The mortgage-backed securities market is still plagued by “a lot of human intervention and faxing,” concedes Brian Robertson, CEO of Boston-based e-mortgage platform Visible Markets. But with support from clearing agents, such as Fidelity Investments and State Street Corp., Visible Markets participants are gradually moving toward STP. “We see most people getting started [on end-to-end automation],” says Robertson. “But it will take five years to standardize.”
Robert Fanelli, a vice president of managed loans, syndication and trading operations at Goldman Sachs, contends that the halting march toward automation of the syndicated loan market will make these sui generis loans look more like other standardized financial products - with positive implications for the marketplace. “What we are all trying to do is make the process work better so that the players can do things more efficiently,” he says. The hoped-for result: more liquidity and better, more transparent pricing.
