However, it remains to be seen whether either of the two new blockchain-based platforms, separately developed by Synaps Loans and Finastra, can solve all of the paper-based ills that plague the syndicated loans market. Neither firm would comment in any detail about the advantages of its respective platform over the incumbent ClearPar platform, operated by derivatives data giant IHS Markit, which also plans to enter the blockchain arena.
Synaps and Finastra claim additional efficiency and tout some brand name banks as potential users. Announcing its successful proof-of-concept, Synaps credits Credit Suisse, Barclays and US Bank as agent-bank promoters with AllianceBernstein, Eaton Vance, KKR and Oak Hill Advisors as buy-side backers. Finastra lists BNP Paribas, BNY Mellon, HSBC, and ING as among its supporters. State Street is cited by both Synaps and Finastra.
Both the Synaps and Finastra platforms are set to go live next year. The platform operated by Synaps, a joint venture backed by blockchain-startup Symbiont and Ipreo, a fintech and analytics firm co-owned by Blackstone and Goldman Sachs Merchant Banking, appears to be far more comprehensive in its functionality than Finastra’s FusionComm. Finastra, created through the merger of fintech firms Misys and D+H, is promoting FusionComm as an extension of its Loan IQ asset-servicing application used by agent bank administrators of syndicated loans.
The US $1 trillion syndicated loans market is one of several targets for blockchain implementation discussed at a recent event hosted by the Wall Street Blockchain Alliance at New York Law School in New York. “Any time you have a large amount of capital that cannot be put to use all you have to do is shave off a small percentage and a business case emerges for blockchain,” says Benjamin Jessel, managing director of global financial services consultancy Capco in New York. “Such is the case in the syndicated loans market where capital is tied up for over two weeks because of delayed trade settlement.”
Syndicated loans are tendered by consortiums of institutional investors and/or banks to corporate borrowers in exchange for interest payments. Corporate borrowers use agent banks to handle the administrative work such as making interet payments, overseeing the paperwork that ensures each lender owns a part of the loan and transferring ownership of the loan asset. Investors wanting to trade their parts of the loan with each other must also exchange assignment agreements through the agent bank.
The goal of Synaps, like IHS Markit’s ClearPar platform, is to reduce the time it takes for a syndicated loan to settle or the time it takes to transfer ownership of the asset — part of the loan owned — on the books of record of agent banks who serve as administrative middlemen. Unlike the US equities and fixed-income markets where settlement of trades must take place two days after the trade is settled, the syndicated loans market has an open-ended timeframe. The term “failed settlement” isn’t part of the terminology.
The Loan Syndications & Trading Association (LSTA), the trade group representing the US syndicated loans market, has recommended a seven-day settlement timetable, but the industry is far from accomplishing that ideal. Because of the number of approvals and quantity of information that must be exchanged between counterparties and agent banks, it could be than two weeks from when the counterparties agree to the trade to the date it settles. Insisting it is vendor agnostic, the LSTA has lent its support to both the Synaps and Finastra initiatives.
“Shortening the settlement cycle benefits large banks and broker-dealers by reducing the regulatory capital they have to set aside for unsettled trades and reducing funding costs,” says Joe Salerno, chief executive officer for Synaps Loans at the Wall Street for Blockchain event. “Fund managers investing in syndicated loans benefit from increased liquidity to meet a large redemption.” Increased liquidity has become a concern for fund managers who face new requirements from the US Securities and Exchange Commission’s requirement to implement liquidity programs to assess their liquidity risks and categorize their assets by range of liquidity. Syndicated loans fall under the “less liquid” category.
Sizing Up Competitors
Synaps’ syndicated loans platform will rely on smart contracts to handle the administrative work between buyers and sellers of syndicated loans and agent banks necessary to complete settlement. The smart contracts will automate the current manual process whereby agent banks must review each pending trade to ensure it meets the transfer restrictions of the credit agreement on which the loan trade is based.
The smart contracts, says Salerno, will also be used by agent banks and lenders to eliminate the data reconciliation involved in the asset servicing phase of a syndicated loan trade which occurs after the trade is settled. Because the smart contracts will execute workflow based on shared business logic against shared data on the distributed ledger, all of the lenders can achieve consistent results on all calculations including position, interest and fees. As a result, syndicated loan operations staff at agent banks can allocate more time to settling trades, reasons Salerno.
So far, IHS Markit has the first-starter advantage. Buyers and sellers of syndicated loans can use its ClearPar platform to electronically agree to the terms of the trade after reviewing digitized contracts, digitally signing the required paperwork which the agent bank can also review and approve. IHS Markit says that over 850,000 syndicated loan allocations were settled in 2016 using ClearPar.
The ClearPar platform, an enhanced version of a platform IHS Markit bought from Fidelity Information Systems in January 2011, is one of two designed by IHS Markit. The second called Markit Clear never went live, says John Olesky, IHS Markit’s managing director and co-head of its loans platform. Instead of migrating users of ClearPar to Markit Clear, IHS Markit has now decided to incorporate Markit Clear and ClearPar’s functionality onto a single ClearPar platform. Middleware purchased from JP Morgan in 2016 will help agent banks integrate their internal systems with ClearPar so they can more quickly complete the transfer of asset ownership on their books. Previously agent banks had to manually verify each transaction’s characteristics against the terms of the credit agreement underpinning the syndicated loan to determine whether the lender had a significant position to cover a trade or whether a buyer of a loan can actually own the debt.
Based on Synaps and Finastra’s descriptions of their blockchain platforms, it appears that the broader scope of Synaps could pose a greater threat to IHS Markit than Finastra. “The distributed ledger-platform Fusion LenderComm will work alongside Misys’ Loan IQ platform which keeps track of the amount of the total loan each lender owns and calculates the amount of interest that must be paid by a borrower to each cash lender,” explains Ian Morris, head of product management for corporate and syndicated lending at Finastra.
Agent banks can publish loan data such as commitment amounts, pricing details, payment schedules, accrual balances and events such as drawdowns, rollovers and repayments onto the Fusion LenderComm platform for lenders to review. Because the data is located on the DLT platform, individual lenders can drill into the data across different agents and deals without needing to discuss lender positions with agent lenders on the phone or via email. Removing the need for such reconciliation can reduce servicing expenses for agent banks and prevent potential errors.
Although it remains uncertain whether lenders will reap the benefit of lower fees, they will flock to the Fusion LenderComm platform by virtue of the fact that their agent banks are populating the platform with important loan data, asserts Morris. He declined to compare Fusion LenderComm’s functionality to IHS Markit’s Notice Manager application, which also connects to Loan IQ and other agent bank systems. Notice Manager delivers agent bank notices in multiple formats and standards to lenders through web portal, email, FpML and other protocols.
IHS Markit’s Olesky acknowledges that DLT is “transformational”, but insists it has shortcomings. “It cannot change behavior nor can it be used in all circumstances,” he says. A change implemented by trade group LSTA on its “delayed compensation” rule for buyers of syndicated loans has had some success. Buyers who agree to the new policy must commit to finishing the administrative work in five days so that the syndicated loan can settle in seven days. Buyers that don’t meet the five-day timetable will not earn the loan interest that would otherwise accrue between the seven-day settlement timetable and the day the trade actually settles.
Before the LSTA’s new policy was implemented in 2016, the median trade for settling a syndicated loan was about 13 days. That fell to 11 days after the practice was implemented and now stands at about 12 days, by the LSTA’s estimates. The benefit of the new LSTA policy was eroded by a record number of loan refinancings late last year. Refinancings must be completed manually between borrowers and lenders with lenders consenting to any change in the terms of the credit agreement for the syndicated loan. Still, say syndicated loan operations managers, the new 12-day median timetable is shorter than it would have been without the LSTA’s change to its “delayed compensation” rule.
The LSTA is also trying to reduce the time it takes to settle a trade in the primary market — or the time it is first issued and allocated to the original lenders. That reduction could ultimately help buyers and sellers settle their trades faster in the secondary market because they could get their hands on the loan asset faster to meet their settlement requirement.
Not all causes of settlement delays can be addressed by DLT or through any automated system, says Olesky who cites two prime examples — the need for agent banks to fulfill know-your-customer policies and handle borrower consent. Agent banks wanting to verify the identity of a lender or borrowers wanting to veto a particular lender from owning part of its loan could stall settlement. Other syndicated loan operations managers also point out the need for the seller of a loan to often acquire a position in order to make timely deilivery to a buyer as potentially delaying settlement. However, Salerno says that Synaps’ platform is equipped to handle that scenario, which could go a long way to helping buyers and sellers of syndicated loans settle a trade in as little as two days. IHS Markit says that some trades on ClearPar can settle in three days.
IHS Markit Response
Although Olesky downplays the ability of blockchain to eliminate all of the paper-based interactions in the syndicated loans market, IHS Markit is also dipping its toe into the new technology. Rather than using blockchain to handle the settlement or asset servicing elements of syndicated loans processing, IHS Markit has opted to introduce DLT into “settlement finality” or the movement of cash in exchange for the transfer of ownership of the loan asset. Using the Quorum blockchain technology developed by JP Morgan based on the Ethereum ledger system, IHS Markit can net payments and eliminate individual wire transfers. Holders of tokens transferred between counterparties can redeem them for real cash.
“Through the use of smart contracts, our platform will allow parties to settle trades throughout the day using tokenized cash rather than traditional wires, thereby preventing the need for daily reconciliation of payments with the receipt of assets by lenders and agent banks,” says Olesky. “Subsequently, we expect to apply the same model to payments associated with servicing events, which are simpler.” IHS Markit’s new payments-oriented blockchain platform, to be integrated with ClearPar and Notice Manager, will be launched next year.
Despite its disruptive nature as shown by its potential impact on market share for syndicated loan servicing providers, blockchain also provides new business opportunities for those who take the time to learn how it works, agree panelists and attendees at the Wall Street Blockchain Alliance-hosted event. Because transactions are time-stamped and irreversibly recorded on blockchain, auditors can spend less time testing the validity of financial transactions, according to Erik Asgeirsson, chief executive of CPA.com, a New York firm specializing in accounting technology. “The future role of the auditor will be less based on verifying transactions and more focused on testing the controls and configuration of systems,” he says. Auditors, believes Asgeirsson, could also play an important role in providing third-party attestation services related to both public and private blockchains.
Smart-contract engineers and security specialists will be in demand to provide guidance on security best practices. “The financial industry does not have an idea of what a risk framework lools like for smart contracts,” explains Dan Guido, chief executive of Trail of Bits, a New York firm specializing in verifying the security soundness of smart contracts. Using smart contracts can be far riskier than firms think. While improper coding can end up costing a firm a wrong payment or an entire payment, hacking couldend up costing every participant in the smart contract the theft of millions of dollars.
Meanwhile, the scope of blockchain applications is continuing to expand. One example: Boise, Idaho-headquartered ULedger, one of the exhibitors at the Wall Street Blockchain Alliance-hosted event, claims that its DLT platform can create a permanent record of any kind of data by allowing a company’s existing technology to become “blockchain-enabled.” Financial firms don’t have to throw out their databases and legacy operating systems because ULedger’s platform will mathematically certify the integrity of the original data and create an audit trail. So far, its platform has been used by one Tier-One bank for asset securitization.