Rival platforms battle to control electronic trading of CLOs

Octaura has the backing of dealers, while Kopentech is leaning into its buy-side roots

  • The US CLO market has more than doubled in size to more than $600 billion in the past decade. But trading remains stuck in the past, with deals negotiated over telephone, email and Bloomberg messages.
  • Less than 0.1% of US CLO debt outstanding trades daily. The US high-yield market, which is a little more than twice the size, sees 24 times as much daily volume.
  • Two new electronic platforms – dealer-backed Octaura and buy-side-led Kopentech – aim to bring CLO trading into the modern age.
  • Both platforms offer competitive auctions, where investors can bid on CLOs listed by dealers. Kopentech also gives investors the option to trade with each other, cutting out the banks.
  • But the market may not be big enough for both platforms. One buy-sider says investors and dealers need to pick one platform and give it their full support.

Big banks are trying to gain the upper hand in the race to electronify trading of collateralised loan obligations (CLOs), hoping to hold onto their role as key middlemen in a market that has more than doubled in size over the past decade.

Seven dealers have backed a new trading platform, called Octaura, that will combine Bank of America’s electronic trading system for loans with a CLO bidding protocol from Citi and data from Moody’s Analytics. The idea, the banks say, is to bring CLO trading out of the dinosaur age.

“In CLOs, we trade the same way we did 20 years ago, while other markets have developed electronic trading. Octaura will bring the technology in line with the size of this growing market,” says David Trepanier, head of structured products in the global credit group at Bank of America.

Octaura still has no launch date but says it has already done demos with 400 investors. When it goes live, it will compete directly with Kopentech, a buy-side led firm that launched in 2020 and offers much of the same functionality – including auctions, private trades and data. It also gives investors the option to trade with each other, cutting out the banks.

For now, the two sides are playing nice – at least publicly.

“We view Octaura and anyone who promotes electronification as an ally,” says Kopentech’s founder, Olga Chernova, who also runs the hedge fund Sancus Capital Management. “If we compete by providing better tools and trading protocols, then investors benefit.”

Kopentech has already signed up around 180 investors and more than 30 banks, including Bank of America. “We want Kopentech to be an open access platform with everyone on it,” says Chernova.

It may not be that simple. Laila Kollmorgen, portfolio manager for CLO tranches at PineBridge Investments, doesn’t think electronic trading will gain critical mass unless all dealers and investors pick one platform and give it support. It’s too heavy a lift, she says, to onboard with several competing ones that each need a series of internal approvals from compliance, legal and tech departments.

“This isn't simply a matter of downloading an app and beginning to use it,” she says.

 

 

The one thing everyone agrees on is the need for new ways to trade CLOs. There were $635.7 billion of CLOs outstanding in the US at the end of 2021, making it by far the largest securitised credit product in the country. But only around $550 million of that – less than 0.1% of the total – traded on an average day in 2021, according to data from Sifma. The US high yield bond market, which is a little over twice the size and has been trading electronically for more than a decade, saw $13 billion – or 24 times as much – volume traded daily.

The moment for market structure reform in CLOs appears ripe and the banks are making a play for this nascent field.

‘Stuck in the 90s’

Loans today trade like boiler-room bonds of yesteryear. “Trading has been stuck in the 1990s. People use Excel spreadsheets and decide things over telephone, text, Bloomberg message,” says David Little, head of structured solutions at Moody’s Analytics.

CLO trading remains a manual process, involving multiple parties. An investor might have to call a dozen different banks for quotes, and another dozen banks to price any of the loans within the structure. A typical auction sees investors submit bids to a bank salesperson, who sends them to another bank tasked with collecting all the bids. The highest is then sent to yet another bank that represents the seller.

“Some of the most expensive employees in the bank – traders and salespeople – spend 60% of their time on voice-broked BWIC [bids wanted in competition],” says Octaura’s chief executive, Brian Bejile, describing the auction side of CLO trading. “This contributes less than 5% to overall revenues. It’s not a sustainable business model from a bank perspective.”

The big US bond trading venues have failed to crack this market. MarketAxess launched an electronic platform for leveraged loans in 2016, but the service has seen little traction.

MarketAxess declined to comment for this article. Bloomberg and Tradeweb also declined to comment or confirm if they had any electronic trading platforms in development for loans or CLOs.

Octaura’s garden

Octaura is the brainchild of BofA’s Trepanier and Bejile, the former head of CLO issuer management at Citi. Trepanier remains at his job at BofA, while Bejile left his post at Citi to become Octaura’s CEO. Once it launches, the platform will trade both loans and CLOs electronically in separate marketplaces.

Octaura has the biggest dealers with deepest liquidity. In addition to BofA and Citi, it has the backing of JP Morgan, Wells Fargo, Credit Suisse, Goldman Sachs and Morgan Stanley. Moody’s Analytics, which feeds loan data to Citi’s Velocity CLO platform, will add data and risk modelling tools to Octaura. All of the banks, except for Credit Suisse, confirmed they are keeping their voice broking businesses. Credit Suisse declined to comment.

One of Octaura’s main features will be BWIC auctions where sellers can put loans or CLO tranches up for sale through their dealers. During an auction, buyers submit bids and receive real-time feedback on their bid position, from the highest bid to the lowest. If they want to improve their chances of winning the trade, they can improve their bids. And if a seller in an auction does not receive favourable bids, they can pull the trade.

Dealers can also list an axe, indicating they have a client with a loan or CLO tranche for sale, and prospective buyers can send a request for quote directly to the dealer.

One perk for the dealers: trades on Octaura process directly through each dealer’s trade capture systems, meaning once the trade is done, it is booked automatically without any additional admin.

BofA’s Trepenier hopes electronic trading will bring more transparency to the CLO and loan markets and encourage more people to trade. “With the addition of the Moody’s analytics platform, traders will have the data and the analysis they need in real-time to feel like they are making informed decisions and to confidently pull the trigger,” he says.

Can Kopentech compete?

Kopentech was founded by hedge fund investor and former Goldman Sachs banker Olga Chernova. She got the platform up and running in 2018 before handing off day-to-day management to Jill Scalisi, an ex-Lehman banker who helped set up Nomura’s US securities operations.

Kopentech’s larger dealers include Bank of America, BNP Paribas, Deutsche Bank, Jefferies, Mizuho, MUFG and Nomura. It also has the Philippine conglomerate Alliance Global, brokers Brean Capital and Brownstone Investment Group, as well as two smaller investment banks, Greensledge and Janney Montgomery Scott.

The firm is banking on its technology and re-financing capabilities to see off Octaura. Its BWIC auctions went live in 2020. Sellers can enter the details of a CLO and choose any broker-dealers they want to participate. A notification goes out to the 180 or so clients on the platform inviting them to submit anonymous bids. Sellers can see the top three bids along with all the other bids coming on a side panel. Middle office and compliance can also log in to see the auction in a viewer mode.

Clients will use anything with perceived liquidity
CLO investor

If a buy-side seller wants to cut out the dealers, Kopentech’s own registered broker-dealer will act as the settlement agent. The first buy-side to buy-side trades on the platform were executed this month.

Separately, the platform can refinance CLOs. When the underlying loans of a CLO begin to repay, it causes a mismatch in value between the loans and the CLO tranches. When this happens, a CLO is usually refinanced with lower-cost debt in the primary markets. This requires the loans to be repackaged, with new ratings set by the ratings agencies and new prospectuses written by legal. The entire process can take between 30 to 60 days.

Kopentech’s electronic refinancing process – applicable margin reset – keeps the CLO intact but with new spreads for each tranche decided via an auction. Broker-dealers bid on different parts of the capital structure, and the lowest spread acceptable to all bidders across 100% of the tranche becomes the new coupon. There is a ceiling for these spreads, so if they stray wider than a certain level, the refi will not proceed on the tranche. This process including initiation, auction and settlement takes 10 days.

The emergence of Octaura would seem to pose an existential threat to Kopentech’s ambitions. But Chernova seems unfazed by the prospect of competing with Wall Street’s biggest names. “Client flows represent 97% of trading [in CLOs]. In this case, it might be more efficient for the buy side to have a venue to negotiate and trade directly,” she says. “Banks provide an important source of liquidity, especially in times of stress, so having a protocol where you can access both is key for investors.”

Buy-siders are watching developments closely. One CLO investor that spoke to Risk.net says any effort to electronify CLO trading is fraught with technical challenges: “It’ll be difficult to automate a product with multiple tranches, with many underlying loans.” But, he adds, if the platforms draw sufficient liquidity, investors will follow. “Clients will use anything with perceived liquidity.”

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