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Strategizing for Success: Formulating an Outsourcing Strategy in Private Debt Markets

Broadridge's Collin Kitchell's Interview with FTF News.

Video Transcript

Eugene: Hello everyone, and thank you for tuning in to an FTF news video interview with Collin Kitchell. Collin is a vice president and head of shared services at Broadridge Financial Solutions. For this video we're going to focus on the top operations and I.T. Management concerns around private debt markets. So before we dive into the questions Collin, you describe yourself on your LinkedIn page as a change agent and a firm believer that moderation is for cowards? So talk to me a little bit about that philosophy and how that relates to the private debt markets.

Collin: Yeah, absolutely. And first off, you know, thank you, Eugene and the FTF team for having me. Looking forward to a wonderful conversation around private debt. Yeah. You know, I have to admit. Right. A firm believer that moderation is for cowards is a line I stole from Shane Patton. And some folks may know him as the Navy SEAL killed in action in Afghanistan in 2005. The book about his work, Lone Survivor, turned into a movie. Right? And the concept around moderation is for cowards is really stemming at everything in life worth doing is worth overdoing. Right. And I think when we come into a firm like Broadridge and in a position like mine within shared services where working alongside my teams were at the forefront of helping clients achieve within private debt markets, helping clients achieve within the securities markets, we firmly believe that everything worth doing in the client lens is worth overdoing. So I think it's a really nice segway into our conversation here today, Eugene.

Eugene: For those who may not know what are private debt markets and what are the major chapters of a private debt lifecycle?

Collin: Yeah, it's a great question, Eugene. So it's a loaded question. We could probably spend the next 45 minutes talking solely about private debt markets. Right? But in the most elementary form, private debt market is a bilateral provisioning of debt financing to borrowers, which in this market tend to be small to mid-sized companies directly from lenders, which tend to be asset managers, specifically alternative investment asset managers. Right. And these borrowers are typically using these underlying loan vehicles to finance business growth, provide working capital or fund infrastructure or real estate projects. Now, private debt has grown in emergence over the last 10 to 15 years, specifically in the last 3 to 4. But it's pretty routed over the last 30 or 40 years. It's just traditionally been lumped into private equity, right. And there was a turning point in the market, which was the global financial crisis of 2008. So pre-crisis, banks, which were traditionally the major lenders of these loans, started to shy away from this riskier appetite due to trying to deleverage tightened regulatory awareness and risk involved with these types of loan.

So it created a supply gap in the industry and income these private lenders, these asset managers I just referred to fill that gap, which now creates the roughly $1.5 trillion dollar private debt market we have today. And you asked about the major chapters of the debt lifecycle. Right? There's varying investment tools within private debt. Right. And in each can kind of have their own unique milestones and toll gates throughout. But you know, what we've seen heavily over the last couple of years is truly the emergence of CLOs or collateralized loan obligations driving and fueling a lot of the private debt market. So when you think about a CLO, you're talking roughly a 6 to 10 year loan that goes through five concrete stages, right?

Simply put, the first stage, what we would consider a warehousing stage is the purchase of the initial collateral on that loan. Then you would roll into a ramp up stage where the borrower and lender are going to be purchasing the remaining collateral to complete the portfolio underneath that loan. You then move into an a reinvestment stage, right, which has a handful of things that occur in terms of tranches, etc.. But it's really that reinvestment period of the loans to improve the portfolio's credit quality. And then ultimately you'll finalize yourself with a repayment period, right. Which where the underlying loans are paid off by the loan manager. And those kind of borrowers within those various loan tranches receive the equity back in the order of seniority that they've bought here. So pretty structured bilateral market, really interesting time for private debt.

Eugene: How have interest rates impacted the appeal of private debt markets?

Collin: Yeah, loaded question. Right. But a very timely question. Given the cyclical nature that we live in today, with interest rates, rising inflation, rising geopolitical risk, etc.. Right. So generally, when you look at a market's response to rising interest rates, private debt becomes a highly attractive vehicle for a multitude of reasons. But I think three really stand out to me. The first is that private debt is less volatile and holds a lower correlation to market swings. And the reason for that is because these instruments are not traded in the public market. The second is that many of the underlying loans within these vehicles are floating rate loans, right?

And a floating rate loan is highly attractive in a cycle of interest rate hikes and interest rates rising because attached to a floating rate loan becomes the opportunity to actually increase your revenue as rates rise. And the third and I think last piece is private debt, unlike public debt, unlike equities, is highly negotiated through that bilateral stage between borrower and lender. Right. And these negotiations have significant due diligence periods. They have protection through covenants that are going to assist with some of that downside protection, which is really going to reduce a lot of that risk within the investment vehicle. So what's volatile because it's not traded publicly floating rate loans can increase income and the bilateral nature and the structure of the due diligence help protect the downside. So ultimately, it's a pretty attractive investment vehicle during a period of interest rate spikes.

Eugene: Are firms using manual systems or partially automated systems to manage their private debt portfolios?

Collin: And the short answer Eugene, is absolutely. So I think with any emerging market and industry within a market, there's always going to be a breaking point in terms of how we got here is not going to get us to the next stage. And, you know, I was speaking with a prospective client just a few weeks ago. We're doing some operational and technology assessments on their infrastructure and their processes all around their private debt vehicles and sizable clients, sizable wallet that share in this market. And many of their processes today are still built on legacy infrastructure from a technology stack perspective, and the operations behind it is quite manual. In fact, I would say their most cutting edge tool they're using to manage these portfolio of loans is Microsoft Excel, right?

So obviously spreadsheets are not a sustainable way to manage a business or grow a business. And in fact, it creates operational risk and it lacks resiliency. Right. And there's a ton of unstructured data in this market as well. So the ability to create straight through processing and to use emerging technology to manage your portfolio is key. Right. And I think the good news, going back to the industry being at that point of reflection and now progress, we're seeing a lot of firms within the private debt market focusing on shifting their target operating model towards digital transformation, towards enhanced data transparency and towards enhanced operational resiliency. Right. And I think that's where Broadridge and we like to kind of come in and help partner with the industry to enable that transformation from a tech and ops perspective.

Eugene: And then just very quickly, what are some emerging technologies that are proving very helpful?

Collin: Well, you set me up nicely, right, If I could take. I think there are a handful of technologies out there across service providers in this space right now, and it gives me an opportunity to speak a little bit about Broadridge. Right. And which obviously I'm passionate about. Within Broadridge, I think we would consider our technology, which is called Sentry, to be a best in class solution for asset managers to manage their private debt. Right. It's and it creates that automation from loan entry. Right. So first stage recording a loan or amending a loan on your on your system of record, it provides automation through quarterly financial tracking and provides automation around one computation. So it's truly a what I would consider best in class technology in the market for private debt at this stage.

Eugene: And so how different are operations for private debt markets compared to operations for securities transactions? Can firms simply transfer their securities operational skills to private debt markets?

Collin: Yeah, it's a great question. Eugene Right. And I think if you ask that question to the folks sitting within an asset management shop focused on private debt or a shop that solely works around security operations, their immediate instinct would be, no, I think that I'd probably provide a unique view on that, right, because I happen to have the privilege of working with inside an organization that provides services to both private debt markets and securities operations. So my view on it is, you know, there are differences, but at the core, there's always going to be those transferable components within a process that are truly asset class and market agnostic right now. You know, some of that some of the differences, right, in a oversimplified way is like when we think about securities transactions. Eugene, the primary focus from an operations perspective is going to be the reconciliation of transactional and economic data to ensure timely and accurate settlement. Right. And as we know, we're currently in T2 environment moving to T1 by May 24.

And when you flip the script and look at this from a private debt perspective, that focus from an operations perspective shifts away from timely and accurate settlement to data integrity in terms of scheduling lifecycle events, managing pay downs and coupons and accruals, and accurate financial tracking on underlying loans within the portfolio. So there are obvious differences, but when you really dig granularly, there are core components that are truly agnostic and transferable. And that really leads me into the second part of your question, Eugene, in terms of the skill set from an ops perspective, is that transferable? Right. And. Going back to being a firm believer that moderation is for cowards. I think I work amongst some of the best operations associates in the world. And I have seen firsthand folks who are spent ten, 15, 20 years managing securities operations, move into the world of private debt seamlessly. Right. There's always going to be that that transition period in terms of maybe learning a new system, learning a new attribute in terms of an operational process. But the skill set for an ops professional, I think, is truly transferable across markets.

Eugene: What are the advantages of letting a third party provider manage the operations for private debt markets?

Collin: Yeah, I think there's a tremendous amount of advantages, right? And you take you take private debt out of it and just think agnostically, and I'm going to come back to private debt in a second. I think as firms think about outsourcing providers. They should be looking at what are some of the core competencies of my business and what is really going to permit my business to grow and generate that next level of revenue we're looking for. And in most instances Eugene, operations usually doesn't find its way into one of those core competencies or components of an organization that is truly advantageous compared to their peers. Right. And when you step into the private debt markets, it's the same, right?

So we believe there are significant amount of advantages for firms within private debt and leveraging a third party provider to manage the operations. The first two that come to mind and what clients will always immediately think of is economies of scale. Right. So providing a firm with cost optimization upfront and then accompanied by some type of capacity multiplier that your operating your outsourcing operating provider is going to grow with you as your business grows. The second piece that always comes to top of mind that clients will ask or prospective clients will ask about is, you know, we're in a period of a talent crisis. This great resignation that we've all been reading or reading about for the last 18 months. Right? Traditionally, third party service providers are going to provide a client with access to global talent that's ultimately going to combat that attrition or talent crisis issues that you may be facing now.

Eugene: And there may be more talent available.

Collin: Absolutely right. As a as a share service and a utility within the space, you know, some of these asset management firms, they may have very small operations one, two, three, four or five people. But when you look at a third party provider such as a Broadridge, that becomes a 1000, 1500 to 2000 people, right? So the scaling pool from which that expertise lies is it's magnificent compared to internally. And I think as we drill down further in conversations with clients to other points, usually hit home. The first is around continuous improvement. Right? So back to our points on digital transformation. Sometimes working through that journey alone is very challenging. When partnering with a third party service provider, specifically one that does both technology and operations, you find opportunities for continuous improvement, which is ultimately going to generate a greater ROI on your business case.

And the last, I think, is a concept, a concept at Broadridge that we consider network value. And it goes back to that point. You were just you were coming to Eugene, which is, firms like Broadridge and other third party providers in this space are managing technology and operations for many players within private that market and within the industry. So joining that network right is going to provide an amount of value that you wouldn't receive if you are solely doing the operations on your own. Right? Industry best practices. Having a third party provider be a voice in the industry to ensure that your business is involved with everything going on and up to speed with the way the industry is moving. That is tough to quantify, but it's a very significant value that third party providers provide to firms within private debt.

Eugene: So should firms formulate an outsourcing strategy for the world of private markets? And if that's the case, what are the first steps?

Collin: Yeah, I think based on the last question, of course, my answer is going to be absolutely. I think there are an immense amount of value ads, right, that a that a third party provider would give. And so I would always stress to a firm to think about outsourcing as part of your target operating model. However, before contemplating that, I think there are some questions that a firm needs to sit back and think about internally and address before making that decision to move to that next stage.

Right. And I think some of those questions are, you know, what is our what truly is our firm's current strategy and our growth objectives? And does our target operating model today align with that strategy and those growth objectives? Or are we going to need to make a monumental shift in order to get to where we want to be? Right from a technology perspective, very similar. So is our current tech stack enabling our growth plans or is it just keeping us static or really hindering our ability to grow? Right. So if the answers to these questions are, you know, we've got some work to do in order to get where we want to be, I think it opens up the door of taking that leap and having a conversation with service providers who have very deep roots within these markets.

Eugene: So lastly, how does integrating the front, middle and back office functions of private debt operations meet the transparency requirements of regulators?

Collin: Yeah, it's a great question, Eugene. Right. And I think it's a question that a lot of firms, when we talk to them, will focus on as well. First and foremost, front to back integration is always key. To the extent you can do it, it is it is vital to growing a business. Right. And when I say front to back integration, I'm talking obviously the best ability from a technology perspective. But also when you think about the front to back flows or front to finance flows from an operating model perspective, it is truly key to have those parts linked where they can be. May not be applicable in all cases, Eugene. But certainly to strive for that front to back integration is key. Now when we think about it in terms of providing that level of transparency to the regulators, right, I mean, a couple of things come to mind, right? Data transparency and data integrity.

Absolutely key for firms in terms of meeting their regulatory reporting requirements and other requirements set out by the regulators within private debt. The second is using a service provider is actually going to aid in your in a firm's control framework and performance reporting, which ultimately is going to provide firms with the evidence they need to support not only regulatory requirements but audit requirements. Right. And I think that's something that firms think quite a bit about as well. So front and back integration is going to promote data integrity, it's going to promote data transparency, and it's going to enhance your control framework all of which are going to better position firms in meeting regulatory requirements.

Eugene: Okay, Well, great. I'm really glad we got a chance to talk today and do a deep dive into private debt and all its implications.

Collin: I was happy to do it. It's wonderful conversation. And I appreciate your time as always.

Eugene: Thank you.

Collin: Thank you.

In this FTF interview, Collin Kitchell, Vice President and Head of Shared Services, discusses the evolving landscape of private debt markets and the critical concerns surrounding operations and IT management. The conversation shed light on the challenges industry professionals face and potential solutions to enhance efficiency and streamline processes.

There is a need for digital transformation in private debt market operations. Manual processes are identified as a bottleneck, hindering productivity and increasing the risk of errors. Market participants can optimize operations and improve decision-making by leveraging emerging technologies, such as automation and data analytics.

It is essential to address IT management concerns in the industry, with an increased reliance on technology, cybersecurity, and data privacy. There is a need for robust systems and proactive measures to safeguard sensitive information and mitigate cyber threats.

The role of third-party providers in private debt market operations is vastly significant. Outsourcing certain functions can offer significant advantages, including access to specialized expertise and cost efficiencies.

Overall, there is a transformative potential for embracing digital technologies, rethinking operational strategies, and addressing IT management challenges in private debt markets. By doing so, industry professionals can unlock efficiency, enhance risk management, and position themselves for success in an increasingly competitive landscape.

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