Navigating the new landscape: Trustee challenges in a changing market
Our Ocorian and Nordic Trustee capital markets teams recently attended the 28th Annual Global ABS conference in Barcelona alongside other leading investors, issuers, and securitisation market participants. We were fortunate to be part of some interesting conversations driving the future of structured finance deals.
One session that stood out debated the issues faced by banks, service providers and investors alike when it comes to corporate trustees and their action and reaction to changing market forces. The discussion identified current issues and asked the question of how different market participants can react to these universally experienced challenges within debt and credit deals and lifecycles.
In this article, we highlight some of the issues identified during the informative debate.
What are the key issues affecting trustees in 2024?
1. AI facilitating nuisance claims and litigation
In recent years, businesses have witnessed a surge in the adoption of AI tools, with Chat GPT leading the charge. While its efficiency benefits are undeniable, particularly in drafting voluminous legal contracts and documents, this very ease of access to information raises concerns about potential misuse.
Problem: Disrupting markets with fabricated information
This has become an area of increasing concern to corporate trustees, who are being targeted by people using AI tools to disrupt financial markets. This disruption is not always for obvious financial gain, but rather a calculated attempt to gain control of the relevant Special Purpose Vehicle (SPV) in the transaction. These tactics can cause widespread and significant interference, jeopardising not only individual transactions but the stability of the market as a whole.
One tactic involves manipulating the proof-of-holdings process, a critical step for trustees to identify legitimate bondholders for a particular action or information disclosure. A worrying trend has emerged where so-called "nuisance actors" are utilising AI to mine public information. They then use this information to manipulate documentation and exploit loopholes in processes used by corporate trustees and custodians. These actors submit requests with fabricated documents in an attempt to gain unauthorised access to information or voting rights within specific transactions.
Solution: Heightened vigilance and technological solutions
Trustees must implement robust systems and processes to scrutinise information beyond its initial plausibility. As the financial sector embraces digitalisation in structured finance transactions, mitigating these AI-powered disruptions requires a delicate balance. Trustees must leverage the benefits of digitalisation while ensuring the integrity of the system.
Problem: Increased interaction with investor group
Trustees face a growing burden of information requests, often accompanied by the threat of non-compliance claims. While transparency is crucial, complying with these requests can be time-consuming and expensive. This is especially true when dealing with potentially frivolous claims, which may be fuelled by the concerning rise of AI-generated template grievance letters.
A recent industry panel discussion highlighted a surge in such claims, all suspiciously similar, suggesting a deliberate attempt to disrupt the market rather than serve a legitimate purpose. These requests divert resources away from the core beneficiaries the trustee serves, and the associated legal fees become part of the transaction costs borne by the underlying asset pool, ultimately impacting returns for legitimate investors.
Solution: Robust solutions to identify and deter nuisance claims and fraudulent activity
To safeguard the integrity of the market and protect legitimate participants, we must implement robust solutions to identify and deter fraudulent activity. This includes establishing clear processes for bondholder identification and verification, leveraging secure technology like multi-factor authentication. Additionally, exploring artificial intelligence (AI) solutions can further enhance our ability to detect and prevent suspicious patterns.
2. Investor evolution: Adapting to new demographics
A subtle but significant shift is emerging in investor demographics. We're witnessing a rise in individual bondholders, many of whom lack extensive experience in international financial markets or the crucial role of a trustee. This trend necessitates a recalibration of service delivery by banks, asset managers, and service providers.
To effectively cater to these new investors, a two-pronged approach is crucial. Firstly, increased focus on providing in-depth and dedicated information is essential. These bondholders require a deeper understanding of the market and the role of a trustee to make informed decisions. Secondly, evolving documentation with stronger investor protections may be required. This should reflect the learnings and challenges encountered by this group. Additionally, the composition of instructing groups and indemnity arrangements for trustees might be impacted, requiring careful consideration to ensure all parties are adequately protected.
As the retail bond market expands, collaboration with regulators is crucial to identify and address any emerging gaps and risks, particularly regarding investor protection. While this market opening presents an exciting opportunity, it also comes with a responsibility. Market participants and industry groups should proactively advocate for adjustments to regulations and embrace flexibility in this area. This could involve continuing traditional face-to-face bondholder meetings while also enhancing virtual accessibility measures. Striking a balance between security, reassurance, and accessibility is key to empowering these new market participants.
The potential for digital assets as collateral remains an ongoing consideration for both trustees and investors. However, regulatory hurdles and concerns surrounding digital currencies are likely to slow progress in this area.
3. Looming defaults: A delayed impact?
While low default rates persist despite rising interest rates and yields post-pandemic, the market's rosy outlook might be deceptive. The focus has shifted from immediate defaults to potential future struggles. Like a can kicked down the road, these looming defaults are inevitable, but enforcing them presents a new challenge.
The pandemic forced swift action from trustees, who successfully navigated the crisis. However, investor anxieties and the broader market context delayed defaults. Now, time and economic conditions will determine the true extent of the issue. Businesses have responded by adjusting transaction covenants and restructuring financial obligations to stave off defaults. But ultimately, if these strategies fail to secure funding, the market will be forced to take action.
How can Nordic Trustee help?
Nordic Trustee (an Ocorian company) are working with other industry leaders to tackle the evolving market landscape and mitigate risks. As a representative to the interests of note and bond holders, we handle all trustee administrative tasks and ensure compliance throughout the bond issue lifecycle to reduce administrative burdens and concerns. We can also act as a paying and security agent, giving peace of mind when it matters.
Contact our dedicated team for more information.
