Breaking New Ground on a Well-Trodden Path: Emerging trends in Credit Risk Distribution

Amelia Slocombe
LMA
Market Outlook

September 4^th is an important date. Over time, it has marked the founding of Los Angeles, the incorporation of Google and as of last week, the hosting of the LMA’s inaugural CRI/SRT seminar.

This event, hosted by Amelia Slocombe, Managing Director at the LMA, was designed to showcase the growing importance of both CRI and SRT. With over 200 in attendance, it was also a chance to bring together senior stakeholders from across the entire breadth of the loan market: on the banking side originators, syndicators and credit portfolio managers; on the distribution side NBFIs, insurers, reinsurers and asset managers. Hence panels were focused not only on CRI and SRT as individual asset classes (trends, outlook, challenges, investor base etc.) but also the broader loan markets which underpin them and provide the underlying liquidity.

From the LMA’s perspective, hosting a credit risk distribution event for the first time, it was a chance to meet with specialists from across the industry willing to share their expertise and experience. More importantly, however, it was an event intended to interconnect, educate, inform and also, crucially, to find innovative solutions to market-wide challenges.

Some key takeaways from the event included:

The Supply: Bank Strategy Indicates No One Size Fits All Approach

What an outsider to credit portfolio management might not realise is the extent to which motivations driving product use from a bank perspective differ from institution to institution: there is truly no one size fits all approach. However, whether it be to optimise lending and overall profitability, manage concentration limits, mitigate risk, make the most of capital or simply create a new source of loan distribution outside the realms of secondary trading and CDS, all are directly impacted by the underlying regulatory environment in which those banks operate. This also goes some way to explaining the differing use of both products between US vs. European banks (the latter being the dominant users of both CRI and SRT).

The Demand: Opportunity Knocks for both CRI and SRT

Increased issuance. Growing investor base. Diversification of the underlying asset pool. Three key themes underpinning both products and all pointing to one thing: opportunity. No longer the preserve of investment grade and large corporate loans, both CRI and SRT are now growing by volume. CRI is now the second most common credit risk distribution tool after secondary trading, whilst the SRT market has seen year-on-year growth of 35% from a clamoring investor base keen to benefit from high risk-adjusted returns and a predictable risk profile. Both also operate across a broadening range of loan asset classes, whether that be mortgages, SME loans, asset finance, trade finance or even leveraged loans and fund finance. Indicative perhaps of the growing number of players driving demand but also evidence of an established and proven track record – CRI, for example, saw a pay out of 100% of claims to regulated financial institutions by insurers in 2023.

Solving the Challenges

As with all things in life, nothing is without its challenges and as both CRI and SRT become more sophisticated and innovative (a natural evolution in any financial ecosystem over time) inhibitors to growth will of course present themselves. Interestingly, whilst CRI and SRT are very different products, the challenges are remarkably similar – lack of reliable data (not easy to come by in a private market), ongoing regulatory scrutiny, and liquidity bottlenecks created by restrictive provisions in (often leveraged) loan documentation, impacting both information disclosure and asset transferability. These latter issues are caused, however, at a much earlier stage in the loan life cycle by borrowers and sponsors unable to see their relative importance as drivers of liquidity.

Finding Solutions

The answer to many of these challenges is, as is so often the case, greater industry collaboration and education, something the LMA fortunately knows a great deal about. That might be achieved in a number of ways: by facilitating discussions with regulators to ensure the merits of the products remain appropriately understood (any financial product attracts the attention of the regulator at a certain point) or by illustrating to the borrower and sponsor community why flexible risk distribution is key to their own interests (banks cannot and should not hold on to infinite amounts of risk, and if they did lending costs would be higher).

Whatever the challenge, it is only by connecting people, facilitating discussion and tackling issues head on that we can make genuine improvements for the future of our loan markets. This is ultimately to the benefit of every stakeholder: something which the LMA will strive to show over the coming months, either at events such as these, or other industry initiatives.

The LMA CRI and SRT seminar provided a great overview of both credit risk mitigation products as well as contextualising these within a bank’s CPM toolkit. I went with a colleague who has recently joined us from a bank and both of us where able to improve our knowledge base from different career experiences to date. The presenters to the sessions were engaging and articulate. In short, a great event.

The LMA’s inaugural CRI and SRT seminar was an informative, impactful event that created a space for insurers and insureds to convene and discuss developments in the product and the market. It was a great example of the work the LMA does in facilitating liquidity, and the session with Toby Mann on NDAs was a particular highlight from that perspective. The LMA is uniquely placed to encourage these kinds of conversations and make the connections that will grow the market.

The LMA’s inaugural CRI and SRT seminar was an excellent forum not just for education but also to show the importance of industry collaboration. As the banking sector becomes more complex with more constraints, connectivity across the financial ecosystem becomes vital. Events like these hosted by the LMA are a great way to plug that gap.

The CRI and SRT Seminar organized by LMA was one of the most insightful and fruitful event that I had an opportunity to attend this year. The number of participants is rather smaller compared to other massive global SRT conferences which ensures an effective venue for networking and brainstorming. I appreciated such a variety of representatives from legal advisors, banks, investors, insurance companies that touched upon various aspects in risk sharing i.e. how to draft an NDA that is globally accepted among counterparties; what is the investors' appetite for the upcoming months; what for the banks are using CRI and SRT tools mostly and how they perceive credit risk. The seminar is perfect for the ones that aim to stay up to date with market trends and feel the pulse of everyone involved in such transactions.

I thought it was a really good event, some excellent speakers and subjects. Very relevant and with a strong commercial focus. The addition of SRTs to the agenda was very useful indeed.