The U.S. leveraged loan market has grown more than 100% in the past 10 years with $1.67 trillion outstanding as of 2023‡. More than half the loans are held in collateralized loan obligations (CLOs), while other loan portfolios are widely held among different structures, including business development companies (BDCs), mutual funds, hedge funds and separately managed accounts.

Across all these vehicles, investment managers typically appoint third-party trustee and/or collateral administration providers. The following are key areas for investment managers to explore during the selection process, drawn from our team’s experience working across all vehicle types.

CLOs: Diversification of trustees

The diversification of trustees is essential for investment managers in the CLO space. Here’s how it breaks down:

  • Risk mitigation: In the aftermath of the global financial crisis and COVID-19 pandemic, diversification has continued to emerge as a critical strategy to distribute counterparty credit and operational risks. This approach is fundamental to sustaining business operations and ensuring compliance amidst unpredictable market conditions.
  • Service continuity: As investment managers move away from single-trustee reliance, most managers now prioritize engaging with multiple trustees. This shift is driven by a focus on consistent service levels and a desire to avoid dependency on any one trustee’s fluctuating service standards—especially in a market that has seen significant shifts due to acquisitions and divestitures.
  • Complex deal management: Service levels are particularly crucial for complex CLOs that feature intricate loan types. Investment managers often seek trustees with a proven track record in handling such complexity, developing trust in those who can demonstrate expertise and agility in managing sophisticated structures.

In essence, diversification is more than just a safety net; it’s a strategic choice that underscores operational risk, wisdom and a commitment to maintaining high service quality across the board for CLO management.

Private credit: Specific experience with asset-based loan types

Investment managers who manage private credit often also finance their assets with structures known as asset-based loans. These arrangements, while not technically CLOs nor securitizations in the traditional sense, demand a comparable degree of diligence and oversight due to their complex nature.

These private deals require similar rigor and strategic insight as traditional CLOs. This includes adept handling of borrowing base facilities, such as for alternative investment managers who extend direct lending to sectors that might not have direct access to large banking institutions. Collateral administrators and custodians must demonstrate an in-depth understanding of these loans and the ability to administer and custody the collateral effectively.

Credit funds: Availability of complementary services

The administration of credit funds encompasses a suite of activities that mirror the complexity and regulatory rigor found in the management of CLOs.

  • Navigating regulation: Investment managers overseeing loan portfolios in registered funds must navigate a landscape that is not only complex, but also laden with additional regulatory requirements. A prime example is the custody rule, which mandates specific duties for fund managers, including the safekeeping of assets and adherence to strict operational protocols. Collateral administrators who can offer custody services—whether book entries or physical documents in a vault—can move quickly in response to investment managers’ inquiries.
  • Integrated fund administration: Fund managers frequently rely on third-party specialists for fund administration and accounting to streamline operations. Collateral administrators who can offer fund administration can simplify the fund manager’s operational landscape across cash management, NAV calculations, investor reporting, and compliance monitoring. The availability of such comprehensive services under one roof can be a decisive factor for fund managers when selecting a collateral administrator.

For credit managers, not only the products but the operational environment is complex. Integrated services can simplify processes substantially.

Conclusion

The CLO market—along with other portfolios of loans—will continue to evolve as it grows. For managers selecting trustee and collateral administration partners, some points, such as diversification among providers, are foundational. Others, such as specific technical expertise and complementary services, are more subtle. In our experience, investment managers benefit by asking questions that probe each of these areas.

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