Syndicated loans and credit: A European perspective

Enfusion is an industry-leading platform for investment managers to oversee their credit strategies and investments. We recently discussed the state of the European credit market and its operational challenges with Sairam Ananthanarayanan, VP MS Operations Manager. Read excerpts from our interview below.

What are some of the key trends you have seen in the European syndicated loan market lately?

We have seen a few notable trends in the European credit market lately. Due to the increase in interest rates worldwide, investors such as hedge funds have shown a growing interest in trading syndicated loans on the secondary market. These loans have floating rate coupons, meaning the interest payments rise as rates increase, making them quite attractive compared to equities in the current economic climate.

Moreover, syndicated loans have a higher position in the capital structure than high-yield bonds. This higher ranking makes them more secure investments since they are paid before other debts in case of insolvency.

Private loans and small club deals from non-bank lenders have also played a big part in Europe and globally. That trend remains, but we’re also seeing signs of a slowdown in the broader European private debt market, which includes direct lending funds. According to a Reuters article on 6 September 2023, European private debt deals decreased by 48% in the second quarter of 2023 compared to Q2 2022. It’s likely that tighter financial conditions, higher borrowing costs, and economic uncertainties are squeezing private credit markets.

With the challenges the private debt market faces, there is still a strong demand for syndicated loans among investors. It helps that they are a more readily tradable asset. Aside from the impact of rising interest rates, there is a significant appetite for European syndicated loans as investors seek to diversify their portfolios. With stable yield and the potential to benefit from market dislocations, hedge funds have a strong appetite for syndicated loans, often combined with other credit instruments, as part of a comprehensive approach.

How does investing in syndicated loans in Europe differ from the U.S. in terms of standards, documentation, settlement timelines, etc.?

There are some notable distinctions between the European and U.S. markets in terms of documentation standards and procedures.

It starts with terminology. In the U.S., syndicated loans are sometimes called 'bank debt,' whereas in Europe, 'syndicated loans' or 'term loans' are more common. Also, in Europe, the Loan Market Association (LMA) establishes the documentation standards for syndicated loans, whereas in the U.S., it’s Loan Syndications and Trading Association (LSTA) standards. The LMA provides specific templates and documents, like facility agreements, transfer and assignment documents or purchase letters, agent notices, and confirmations.

Settlement timelines are also different. In Europe, the settlement cycle for par trades is usually T+10 days, while distressed trades settle at T+20. In contrast, the U.S. typically operates on a T+7 settlement period. The longer settlement periods in Europe allow for the more extensive documentation requirements.

Documentation and settlement are crucial operational considerations for hedge funds to consider when engaging in European syndicated loan trading, especially when they trade in other markets as well.

Finally, the regulatory environment also varies between the two regions. European banks face stricter capital requirements under the Basel III standards compared to their U.S. counterparts, and this can impact their ability to participate in syndication deals and their desire to offload debt from their books onto the secondary market.

What are some of the operational challenges for hedge funds investing in European credit instruments aside from settlement cycles?

The answers depend on the type of credit. Non-cleared assets, such as private equity and private credit, often require intricate bespoke workflows since they often lack standardized terms and require extensive paperwork. So, hedge funds need comprehensive front-to-back support to handle tasks such as confirmation matching, cash-flow reconciliations, and monthly valuations.

Another aspect of complexity arises when handling various securitizations, including CLOs, ABS, and MBS. These transactions require robust calculations of cash flows and interest accruals to ensure accurate and real-time monitoring of profit and loss (P&L). Enfusion's platform is well-equipped to address these needs, offering features that automate cash flow projections and provide seamless accounting. Additionally, the system allows for easy reference by directly attaching related legal documents to trades.

Regarding syndicated loans specifically, platforms like ClearPar help streamline settlement processes for European loan trades. Enfusion's seamless integration with our clients’ preferred third-party solutions and data licenses minimizes the work and risk of error. For example, we can match to ClearPar, automatically calculate cost of carry against various replacement rates for LIBOR (including SONIA, EURIBOR, and SOFR [Sterling Overnight Index Average, Euro Interbank Offer Rate, and Secured Overnight Financing Rate respectively]), and determine delayed compensation on a day-over-day basis rather than in a lump sum at settlement. Using automation lets us maximize the accuracy of clients’ P&L and cash flow in cases where syndicated loan trades fail to settle on time.

How can hedge funds effectively optimize their operations and technology to invest in European credit?

Credit is really a global capability. Hedge funds need institutional-grade operations and technology tailored to credit. They also require an integrated platform that streamlines credit workflows rather than relying on disparate tools and manual processes. You have to be able to confirm deals, reconcile with administrators, and seamlessly pass data and documents across the front, middle, and back offices. The goal is to minimize manual work so investment teams can focus on credit analysis and strategy rather than operations.

Key features include automated interest accruals, robust reference data, and straight-through processing from trade capture to reconciliation. Sophisticated reporting provides portfolio transparency. Storing attachments to trades captures relevant legal documents.

For syndicated loans, having systems that integrate with agent platforms and the loan ecosystem reduces manual efforts. Straight-through processing allows timely booking and matching. Specialized teams ensure proper handling of delayed compensation and coupon step-ups. In short, automation and connectivity help firms pursue operational alpha in a complex, labor-intensive asset class.

What are Enfusion’s market strengths for credit?

Enfusion stands out with its strength in supporting credit-cleared instruments like syndicated loans across the entire capital structure. Defaulted Bond functionality is one such example. When clients trade stressed and distressed credit, Enfusion lets them tag any bond when it’s in default for a specified time. As a result, they can automatically take down interest accruals until the bond exits from default. We include it as part of the Enfusion security master structure, which supports defining distressed time periods as a custom attribute of a bond. Bondholders can define their positions as either In Default, Trading Flat, or Liquidated, so that their downstream accounting remains valid.

Additionally, our Managed Services team employs loan experts who can work as an extension of your team, taking care of everything from trade and settlement booking to ongoing asset servicing and reconciliations. For clients who don’t have in-house bank debt specialization or the interest in building it, it is often much easier and more efficient to task our team with middle- and back-office operations.