As deleveraging in the loan market drags on, there are signs that market discipline is being tested to the limit. Optimism that the new year would herald a recovery has been dashed as triggers have tripped on total return swaps (TRS) and market value CLO structures and they have been forced into portfolio unwinds. Some $85 billion-worth of TRS trades were done in just two years before the credit crisis, and this means that there is an awful lot of paper to be dumped back into an already depressed secondary market.
The loan market is an essentially private one, so in stressed conditions such as these access to information is paramount. Market practices with regard to material non-public information (MNPI) that might have been sufficient in a functioning marketplace are now under strain as participants struggle to find their way through the turmoil.
The management of the TRS unwind process is hindered by the fact that unlike bond CDS, loan CDS are not covered by securities law – as loans are not securities (the treatment of derivative instruments is governed by their underlyings). In the US, a bond default can trigger some LCDS contracts but they are still not seen as securities-based swaps.
