Educational Alpha: Episode S2 - In-Depth Conversation with Scott McMunn, CEO of Loan Market Association

Podcast Information:

• Title: Educational Alpha
• Host/Author: CAIA Association
• Description: Engage in insightful conversations with host Bill Kelly and a diverse array of guests from the finance world. Discover their professional journeys, career and life advice, and unique perspectives on the industry. Dive deeper into the stories behind the headlines.
• Episode: S2: Conversation with Scott McMunn, CEO, Loan Market Association (LMA)
• Release Date: October 30, 2024

Introduction to the Episode

Bill Kelly, CEO of the CAIA Association, welcomes Scott McMunn, CEO of the Loan Market Association (LMA), to discuss the evolving landscape of private credit and the pivotal role of trade associations in today's financial environment. The conversation delves into Scott's extensive career in asset management, his transition to leading the LMA, and insightful perspectives on the growth and transformation of loan markets.

Scott McMunn's Professional Journey

Background and Early Career: Scott McMunn shares his beginnings in the finance industry, starting his career at a small UK bank, Abby National, attracted by the competitive salary typical of finance roles. He reflects on his naivety upon entering the industry and highlights his involvement in pioneering asset-backed securitizations and private credit during the early stages of his career.

• Notable Quote:
  “I was involved in some really exciting, groundbreaking types of transactions...the early structured synthetic CDO markets.” [02:43]

Transition to Leadership: Scott's career trajectory took him from managing proprietary businesses at Deutsche Bank to setting up asset management operations within RBS. His entrepreneurial ventures, including attempts to establish a private equity firm and a US mortgage fintech, provided valuable learning experiences before being approached to lead the LMA.

• Notable Quote:
  “I put my best foot forward and said if you want me to run it, this is what I would like to do...” [05:00]

Evolution of Loan Markets and LMA's Role

Shift from Banks to Non-Bank Financial Intermediaries (NBFIs): Scott emphasizes the significant shift in global financing sources—from traditional banks to non-bank financial intermediaries (NBFIs). He highlights that approximately 80% of global financing now originates from non-bank sources, a stark contrast to the 90% reliance on banks two decades ago.

• Notable Quote:
  “20 years ago it was maybe 90% of financing came from the banks. Now I think we're probably 80% of global financing is coming from the non banks.” [12:58]

Private Credit Growth and Innovation: The conversation explores the expansion of private credit, including various fund structures like macro funds, single strategy funds, and private credit funds. Scott underscores the importance of technological advancements—such as tokenization and AI—in enhancing liquidity, efficiency, and transparency within loan markets.

• Notable Quote:
  “We have nearly 900 members across the whole of EMEA...It's really powerful.” [06:00]

LMA's Annual General Meeting (AGM) Highlights

Successful AGM Execution: Scott recounts the recent AGM, noting increased member engagement and a competitive election process with multiple candidates vying for board positions. This year saw a 25% increase in voting turnout, reflecting heightened member involvement and commitment.

• Notable Quote:
  “We actually had an election with candidates who were all viable and credible...a 25% increase in voting turnout.” [20:57]

Key Discussion Topics at the AGM:

• Inefficiencies in Loan Markets: Focus on improving settlement operations to match the efficiency seen in equity, bond, and derivative markets.

• Regulatory Developments: Addressing potential regulatory reviews and the impact on NBFIs.

• Technological Integration: Exploring the role of AI, web3, and other technologies in transforming financial services.

• Fund Finance Innovations: Growth in subscription finance lines, NAV lending, and credit risk insurance products.

• Notable Quote:
  “We're seeing the growth of either provision of finance from my bank members and non-bank members...optional capital to do more.” [29:14]

Breaking Down Private Credit Returns

Understanding the Risk-Return Matrix: Scott breaks down the components of private credit returns, emphasizing the importance of understanding the underlying risks. He explains that a typical 10% return comprises a risk-free rate, credit risk, liquidity risk, and other premiums for the additional risks taken.

• Notable Quote:
  “You really have to understand the risk factors you're taking on and how you're being compensated for them.” [19:51]

Permanent Capital and Long-Term Investments: He discusses the shift towards longer-term capital structures, such as GPLP (Global Prime Limited Partnership) structures, which offer more stability compared to the volatile, mark-to-market oriented bank portfolios.

• Notable Quote:
  “The provision of capital now is in locked up 9 year, 10 year, 12 year money through a GPLP structure.” [16:46]

Fund Finance Market: Opportunities and Challenges

Growth Opportunities: Scott highlights the burgeoning opportunities within the fund finance market, including:

• Subscription Finance Lines: Increased investment from institutional members in subscription and NAV lending.

• Credit Risk Insurance Integration: Incorporating fund finance lanes into credit risk insurance products to enhance capacity and recycle capital.

• Notable Quote:
  “There are some really developing growth opportunities I think in the space...” [33:24]

Regulatory Scrutiny: The LMA actively engages in lobbying and represents member interests amidst evolving regulatory landscapes, ensuring that NBFIs are adequately supported and represented.

• Notable Quote:
  “We did see something of that nature in the UK over the course of this year...a big book of work for us going into 2025.” [33:24]

Secondary Market Evolution

Benefits of the Secondary Market: Scott discusses the secondary market's role in providing liquidity and opportunities for investors to engage with established vintages and managers, rather than relying solely on startup investments.

• Notable Quote:
  “The beauty of the secondaries is it gives investors the opportunity to pay up for particular vintages and particular managers...” [29:14]

Market Resilience: Despite initial skepticism during its inception, the secondary market has grown into a vital component of the ecosystem, demonstrating resilience and adaptability even during market downturns.

• Notable Quote:
  “I think that's probably one of the starting points I'd make...the growth of the secondary market.” [29:14]

ETFs and Wrappers in Private Credit

Pros and Cons of ETFs: The discussion turns to the emergence of ETFs and other wrappers in the private credit space. Scott acknowledges the benefits of increased exposure but also cautions against the challenges related to liquidity, valuation, and investor understanding.

• Notable Quote:
  “It’s about understanding the risk appetite and the risk continuum of the underlying investor.” [35:11]

Liquidity and Valuation Challenges: Scott addresses concerns about daily liquidity for traditionally illiquid private credit assets and the complexities in accurately valuing these instruments in a retail environment.

• Notable Quote:
  “They wouldn't be unlimited. It will be finite in capacity because these things don't trade daily in that kind of size and scale.” [35:11]

Collaboration Among Trade Associations

Global Connectivity: Scott underscores the importance of collaboration between various global trade associations. He highlights fruitful relationships with peers in the US (LSTA) and Asia (APLME), fostering a unified approach to addressing common challenges and promoting best practices.

• Notable Quote:
  “There needs to be collaboration and interconnectivity between the various trade bodies.” [40:44]

Shared Goals and Synergies: By working together, these associations aim to enhance liquidity, efficiency, and transparency in loan markets worldwide, ensuring consistent capital flow and robust market frameworks.

• Notable Quote:
  “We have the same goals and desires, which is liquidity, efficiency and transparency in these loan markets.” [40:44]

Future of the Finance Industry: Talent and Innovation

Attracting Future Talent: Recognizing the industry's need for fresh talent, Scott discusses initiatives like Future Lend, which aims to promote careers in loan markets and operations. These efforts are crucial for sustaining industry growth and innovation.

• Notable Quote:
  “We help develop and grow economies and help manufacturing and employment and social growth.” [44:22]

Embracing Technological Advances: The LMA is committed to integrating cutting-edge technologies to streamline operations and enhance market efficiency. Future initiatives will focus on harnessing AI, blockchain, and other innovations to stay ahead in the competitive landscape.

• Notable Quote:
  “How can we look at new forms of distribution, web3 tokenization and other channels of fractionalization to increase the ability to diversify risk?” [26:51]

Conclusion and Key Takeaways

The conversation between Bill Kelly and Scott McMunn provides a comprehensive overview of the dynamic changes in the loan and private credit markets. Key takeaways include:

• Shift to Non-Bank Financing: A significant move from traditional banks to NBFIs has reshaped global financing landscapes.
• Importance of Trade Associations: Organizations like the LMA play a critical role in advocating for members, fostering collaboration, and driving market innovation.
• Growth and Risks in Private Credit: Understanding the intricate risk-return profiles is essential for investors engaging in private credit markets.
• Technological Integration: Embracing new technologies is pivotal for enhancing market efficiency and transparency.
• Future-Proofing the Industry: Attracting and nurturing new talent through initiatives like Future Lend ensures sustained growth and adaptability.

Final Notable Quote:
“Funding, transparency, efficiency—those are the pillars that will support the future of our loan markets.” [46:13]

Thank you for reading this detailed summary of Educational Alpha's conversation with Scott McMunn. To explore more insightful discussions, subscribe to Educational Alpha through the CAIA Association at caia.org.