Phase II of Delayed Compensation Overhaul, Other Modifications to Take Effect November 1st
On the morning of November 1st, many children (and some adults) may wake up with an upset stomach or headache from having overindulged in one form of Halloween revelry or another. Some participants in the loan trading market may view the approach of November 1, 2016 as even more frightening than any ghost, goblin or creepy clown looking to play a trick on Halloween - as November 1, 2016 is the day that Phase II of the Loan Syndication and Trading Association’s (the “LSTA”) new delayed compensation regime takes effect.1 However, the intent of these rule changes is actually to provide a treat to loan market participants - in the form of reduced settlement times.
Delayed compensation is a component of pricing in the settlement of loan trades that is intended to put parties in the approximate economic position on the settlement date as if the parties had settled on the trade date. Delayed compensation starts to accrue if a trade does not close on or before a specific date.2 Historically, delayed compensation has been determined on a “no-fault” basis. Generally, a buyer was automatically entitled to the benefit of all interest and ordinary course fees accrued with respect to the purchase amount of the debt for the period of time from T+7 to the settlement date.
However, after a lengthy examination of the issues, the LSTA has adjusted this calculation to a “requirements based” model, meaning that if a party to a trade does not perform certain steps in furtherance of the settlement of such trade by certain dates, then (subject, of course, to certain exceptions) that party would not be eligible to receive delayed compensation. Accordingly, there are several changes to the LSTA Standard Terms and Conditions for par/near par trades which will take effect for trades entered into on or after November 1, 2016.3
The main goal of these changes is to increase settlement speed and efficiency. For years many loan market industry participants had voiced concern that inefficiencies in trade settlement were tying up capital and exposing them to unnecessary counterparty credit risk. In effectuating this new protocol, the LSTA has stated that it is attempting to promote liquidity in the loan markets and also display “self-help”, in lieu of having regulators impose unwelcome requirements on the industry. The LSTA believes this new “requirements based” model will create urgency on the part of the parties to settle trades quickly, lest they suffer the “trick” of forfeited delayed compensation.