Dennis Heuer, partner at White & Case, discusses the drivers that could facilitate a more commoditised SRT market

Q: Having historically been secretive and opaque, is the SRT market likely to transition from highly private to increasingly more syndicated deals? Are we witnessing an inflection point? 
A: I wouldn’t describe it as a clear shift but rather something I can foresee happening. Currently the market is divided between small club (often anchored by one lead investor) or bilateral deals – with one or two investors – and the syndicated deals.

More credit heavy, less granular portfolios work better with small club or bilateral deals. The syndicated trades are usually done by frequent issuers with more granular portfolios and good history of performance that are definitely getting more proficient in this exercise.

However, many issuers still opt for small club and bilateral trades. And as this market matured, more investors have emerged - notably from the private credit space - and as such, there is still no need for issuers to engage in more syndicated transactions. Additionally, I believe issuers appreciate these type of small club (preferably anchored) and bilateral relationships for reasons of transaction certainty, confidentiality and the absence of potential conflicts between many investors that you would otherwise have if you have a more broadly syndicated deal.

However, could we envision a shift in this sector moving forward? I believe that there are three factors which could lead to an increase towards more syndicated deals.

The first is that these SRT trades have been picked up quite favourably by EU regulators. What regulators do not want to see though is credit underperformance, liquidity constraints in difficult times and lack of transparency.

It has been reported that there was a functioning secondary market also in more difficult times, such as in 2020, where primary issuance had slowed down (SCI 28 April 2020). And assuming credit performance and liquidity will remain positive for the foreseeable future, I expect no specific requirement from a regulatory perspective for more syndicated deals with better tradability.

The second point is that we have a clear trend where banks, to the extent they can, are using direct issuances off their balance sheet. So, banks do the unsecured CLNs off their balance sheets, where investors are increasingly relying on their creditworthiness and their corporate rating for the CLNs to be repaid (but always subject to performance of the reference pool).

Therefore, for some banks, SRTs are becoming more of a classic DCM product - where there is, I believe, more standardisation in the areas of structure, documentation, data, but also distribution. This might incentivise banks to use more syndication to do larger deals; e.g., for consumer loans or SMEs from established platforms.

And the third point relates to SRTs in the context of the green transition. Reports are suggesting the need for a synthetic platform to assist mid-size and smaller banks that will have capital constraints under the energy transition (SCI 9 August).

It is suggested that they may build on an anchor investor or support from public institution (e.g. the EIF) and, on the back of that, there would be more private investors joining the boat. And they would also likely be okay with lower initial investments based on the idea that you can then do repeat deals of platform issuances. And that, again, shows me that it may become a bit more commoditised.

This is certainly only true for very established and more homogenous asset classes, namely consumer loans or SMEs. Consequently, we may end up with some SRTs with a different placement structure in, say, two years.

Q: Do you think the SRT market has truly been tested? How are investors likely to approach SRTs when faced with a significant downturn in the credit cycle?
A: It is hard to tell, given the opaque nature of this market. However, I do not feel that we have experienced a period of increased testing, where things were truly challenged. I believe that so far, performance has been surprisingly good on these deals, even during more difficult times as through the pandemic.

That being said, there are private investors in this market that also invest in CLOs. Generally, CLOs are much more sensitive during a crisis and need to be marked down by investors much more quickly. I heard rumours during the pandemic that certain investors considered trading their recap positions, in order to deal with the marking down of their CLO positions.

Therefore, if we were to navigate through a period where things are really difficult, or a prolonged period of stress potentially combined with negative credit performance, it may be in the industry’s interest to have a functioning secondary market for these positions.

Q: On the regulatory front, do you expect Basel 4 to be a game-changer for the SRT market?
A: I would not call it a game-changer for SRTs, but I know that the industry is expecting Basel 4 to lead to further issuance and growth of the SRT market. In my personal view, the energy transition and the global need to improve capital ratios of banks to stem the energy transition for corporates will be a much bigger market driver for SRTs.

Raising new capital is extremely expensive and also uncertain, with a volatile market [making it] difficult to achieve. From an economic perspective, the cost of capital in SRTs is reported to be below the banks’ implied cost of equity. Therefore, bringing down RWAs (which have been inflating quite a bit in the past three years) and using SRT transactions is something many institutions have realised they will need to do sooner or later.

Vincent Nadeau