The rise of SRTs

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SRTs are the celebrity of loan markets —What Lies Ahead?

With great power comes great responsibility – the rise of SRT

As any up-and-coming celebrity can attest, mainstream popularity is not always a positive. Whilst a growing fan base can help you rise to the top, it also creates an element of performance pressure that didn’t seem to exist when living life under the radar. What’s more, however much people may like and value you, there are always going to be others on the sidelines loudly predicting your inevitable demise.

There is little doubt that SRT is very much the loan market celebrity of the moment. In fact, it has already reached number one – beating secondary trading, credit risk insurance and CDS to the top spot this year as the credit risk distribution tool of choice.

Why SRT?

As made clear by panelists in a recent SRT-dedicated panel which took place at the LMA’s inaugural European Conference in Paris on 23rd October, the numbers speak for themselves. As cited in a May 2024 IACPM report, the SRT market has continued to increase substantially in recent times, “with more than 500 synthetic SRT transactions issued between 2016 and 2023, protecting both expected and unexpected losses on more than €1 trillion of underlying loans”. In 2023 alone, there was more than €20bn of new issuance.

When one delves down to the nature of the product, it’s not difficult to get to grips with its popularity. It’s an effective product from a bank perspective, allowing the transfer of credit risk in respect of very large loan portfolios in a way which is efficient, investable and, crucially, beneficial from a regulatory standpoint. As one panelist summarised, SRTs give banks “the right amount of cover for the right amount of risk”. The investor-side wins, meanwhile, are equally as enticing – access to a slice of loan market liquidity with the potential for good risk-adjusted returns.

The most difficult transaction is the first

That is not to say however that setting up a SRT portfolio is “easy” to do. A bit like riding a bike, a lot of effort is required to get there, whether that be from a structuring or a due diligence perspective. In addition, banks providing the loans need to be able to provide a good data history and a transparent set of data points, since this will reassure investors of how the underlying pool of assets will behave in both the good times and the bad. In addition, for portfolios to be replenished, agreeing precise eligibility criteria is also important.

That said, once you get there, repeating the process is easier. Not only because the hard work has, to a large extent, already been done, but also because of the nature of the relationship created between the bank and its investor base. No one can deny the good feeling which accompanies a tried and tested partnership, and that is certainly how both banks and investors view these transactions. This is not a “risk shift” enabling a bank to escape if things go wrong. Rather it is a “risk share”, with investors looking to benefit from the success of a portion of a bank’s balance sheet of loans, but at the same time be willing to step up, for a price, to take the first loss impact on any element of the portfolio which fails to perform.

Growing investor base, diversified assets

No longer the preserve of investment grade and large corporate loans, SRT is growing not only in volume but also in respect of participants and underlying loan assets. Whilst still more prevalent in Europe than the US, a closer look at the data reveals that a handful of significant players, including the European Investment Fund (EIF), currently drive these numbers. As time goes on, however, more banks are appreciating the potential benefits, including smaller banks and more regional players, particularly in the US, sometimes drawing on the expertise of an experienced arranger to get them over any initial hurdles. The investor base is also expanding rapidly, as are the underlying loans including mortgages, SME loans, asset finance, trade finance and even leveraged loans and fund finance.

What could possibly go wrong?

When financial products go wrong, the reasons are often very similar. They include for example excess leverage in the system, people investing without a true appreciation of the risk, inappropriate assets muddying the asset pool or some kind of regulatory clampdown (intended or otherwise). There are some rumblings on the horizon that a perfect storm could be brewing for the SRT market, especially given rumours of some investor leverage (mostly through repos). However, it is also arguable that provided the experts who have devoted years to making the product work so effectively continue to educate their peers on how to avoid these kind of pitfalls, mistakes of the past can be avoided. Organisations like the LMA, being the authoritative voice of the loan market, can also assist in this regard.

The crucial question for everyone however is how SRTs will perform in a severe credit downturn, since it is really only when multiple transactions fail at the same time that the product can be properly tested. However, that is not a concern unique to SRTs – whilst the economic and political environment has seen much volatility in recent times, severe stress testing of financial markets is not something which many people have experienced properly since the GFC, especially without the backdrop of low interest rates and quantitative easing.

Prevention is better than cure

Whilst we won’t know the answer to many of these questions until something happens to trigger them, a good preventative measure is to ensure greater industry collaboration and education when times are good. Ultimately it is only by connecting people, facilitating discussion and tackling issues head on that we can make meaningful improvements as well as find solutions to challenges. This is ultimately to the benefit of each and every market participant: something which the LMA will strive to show as we work with our members to improve the liquidity, efficiency and transparency of SRTs in 2025 and beyond.

If you are interested in learning more about the topics discussed or the LMA, please contact Amelia Slocombe at [email protected]

Amelia Slocombe

Amelia manages the LMA’s in-house legal team and works on the Association’s documentation projects, education and training events and regulatory and lobbying matters.

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