Thinking against the current: Collateral thinking

<div class="grid grid--33-66-col"><div class="col"><img loading="lazy" src="/getContentAsset/6f31815b-059e-4f86-9965-83418930642d/cb87803a-320c-480f-ab75-7b9029eaaf79/GEMCORP_10_11_2020_Parvoleta_0086_V2.jpg?language=en" alt="Parvoleta Shtereva" title="Parvoleta Shtereva" style="width: 180px" class="fr-fic fr-dii"></div><span style="font-size: 12px"><div class="col"><strong>PARVOLETA SHTEREVA<br></strong>CO-FOUNDER, CIO &amp; BOARD MEMBER<br><br><p>Parvoleta Shtereva is a Co-founder and the Chief Investment Officer at Gemcorp Capital, where she oversees the firm’s investment portfolio, and leads the execution and management of investments.<br><br>Prior to co-founding Gemcorp in 2014, Parvoleta spent most of her career managing credit portfolios at Goldman Sachs and Black River Asset Management as an Executive Director and Portfolio Manager. Earlier in her career, Parvoleta worked as an Economist at Renaissance Capital and as a Sovereign Analyst at ING Investment Banking. She brings more than two decades of experience across Eastern Europe, the Middle East and Africa.<br><br>Parvoleta holds a degree in European Business Administration from Regent’s University London and serves as a Board Director of Empower - The Emerging Markets Foundation, enabling young people to transform their lives and communities.</p></div></span></div><hr><p><em>Secured lending promises protection through collateral but can prove illusory if investors fail to assess its quality, liquidity and enforceability. Experience in emerging markets offers timely lessons for investors looking to limit the risks, as Parvoleta Shtereva explains.&nbsp;</em></p><h2 style="font-size: 2rem">Collateral</h2><p>Collateral is supposed to be a comfort blanket for credit investors. Yet as recent high-profile corporate failures in developed markets remind us, security interests do not automatically lead to secure outcomes. From New York to Nairobi, lenders can discover that what they considered strong protection quickly evaporates when a business goes bad.</p><p>We have spent over a decade financing companies across emerging markets, where volatility, political uncertainty and legal complexity are facts of life. This experience has taught us to view collateral not as a box-ticking exercise but as a living, breathing part of the investment process, which can strengthen or weaken a loan depending on how it is structured, monitored and enforced.</p><p>There are good reasons why secured, or asset-backed, debt is desirable for lenders and investors. Properly structured, it provides them with enhanced capital protection, a lower probability of loss and senior claims over cashflows and assets.&nbsp;</p><p>For borrowers, pledging collateral can unlock access to finance that might otherwise be unavailable or unaffordable, particularly in higher-risk jurisdictions. It can also lengthen maturities and preserve company ownership, an important consideration for family-owned or growth-stage businesses unwilling to dilute equity.</p><h2 style="font-size: 2rem">When protection fails</h2><p>Yet theory and practice can diverge. Collateral can lose value, prove illiquid or be far harder to realise than expected. In some cases, it may not even exist. History tells us that secured lending can go wrong for several reasons:</p><p><strong>1. Overreliance on cyclical or correlated assets</strong></p><p>When collateral values move in lockstep with the borrower’s fortunes, the supposed safety net disappears when it is most needed. The most obvious example of this is in commodity-linked sectors where falling prices erode revenues and the liquidation value of equipment or inventories. The same principle applies to a wide range of other cyclical assets, including property or equipment during downturns: a mine, landbank, warehouse or a vessel may be worth much less – or nothing at all – if the potential buyers or operators have disappeared from the market or are unable to raise funding.</p><p><strong>2. Illiquidity and carrying costs</strong></p><p>Collateral that cannot be sold quickly, or which requires expensive maintenance and storage, can hurt recovery values. The patience needed to ride out a cycle and avoid disposing of collateral into oversaturated markets is often underestimated, as are the ongoing costs of safeguarding and valuing the assets.</p><p><strong>3. Structural and legal weaknesses</strong></p><p>A lender’s claim is only as strong as its documentation. Ambiguous security packages, poor registration of claims or gaps in inter-creditor agreements can all damage recoveries. In multi-jurisdictional deals, different insolvency laws and enforcement timelines can add more complexity.</p><p><strong>4. Information asymmetry and fraud</strong></p><p>A sobering lesson from both developed and emerging markets is that collateral is not always what it seems. Duplicate pledges, inflated valuations and falsified receivables are not confined to any one geography. Robust verification, independent inspections and cross-lender cooperation are essential defences for all transactions.</p><p><strong>5. Readiness to enforce</strong></p><p>Taking possession of an asset is only the beginning. If enforcement leads to ownership, lenders may find themselves running businesses in sectors far removed from their areas of expertise. Without operational capability, or partners who can provide it, the recovery process can go awry. Participating in enforcement processes which involve a multitude of lenders is extremely complicated as not all credit investors can hold equity or equity-like instruments or may be subject to punitive capital charges if they do. This inevitably complicates the enforcement process and very often leads to dissipation of value and suboptimal choices.</p><h2 style="font-size: 2rem">Lessons from emerging markets</h2><p>Operating in countries where legal recourse can be slow and collateral enforcement politically sensitive has forced us to build a disciplined approach to secured lending.&nbsp;</p><p>We have learned three enduring lessons:</p><ol><li><strong>Understand cycles and correlations.&nbsp;</strong>In markets where macro shocks can materialise suddenly, it is essential to run stress tests and scenarios of how collateral values could behave under stress. We look closely at the liquidity of secondary markets and practical means to monetise assets if needed. In cyclical industries, we model recovery scenarios that assume fire-sale pricing and extended holding periods or ask for uncorrelated collateral. It is important to point out that not all potential collateral issues have a solution – sometimes we just have to walk away from a potential transaction.</li><li><strong>Relentless verification.</strong> We utilise independent inspectors, alternative data sources and intelligence from suppliers, customers and competitors to confirm whether pledged assets exist and are properly segregated. When concerns arise over multiple pledges or blurred ownership chains, we work collaboratively with other lenders and counterparties. Transparency benefits everyone.</li><li><strong>Be ready to act, not just litigate.</strong> In rare cases where we must enforce security, we assume responsibility for stabilising and running the business until an orderly exit can be achieved. That requires operational expertise, governance oversight and capital. It is a process that is invariable harder than originally expected - if a company’s finances have been mismanaged to the point of default, deeper operational and cultural weaknesses will almost certainly be uncovered beneath financial ones.</li></ol><h2 style="font-size: 2rem">Local lessons, global relevance</h2><p>These lessons are not just applicable to emerging markets. The recent wave of defaults in developed-market asset-backed structures, from consumer finance to logistics and commercial real estate, have highlighted the same vulnerabilities: collateral that proved hard to liquidate, valuations that were overly optimistic and documentation that did not deliver priority for lenders under stress. Perhaps the key difference is that, in emerging markets, investors often assume, rightly or wrongly, that imperfections are part of the baseline.</p><p>Secured lending works best when it is treated as an integrated part of the credit process rather than an afterthought. Collateral analysis should begin at origination and continue throughout the life of a loan. It is not enough to know an asset exists; lenders must also understand its economic function, liquidity and legal enforceability.</p><p>Equally, strong relationships on the ground with borrowers, regulators and local counterparties can make the difference between a swift resolution and years of deadlock. Our experience of navigating these complexities across Africa, Latin America, the Middle East and emerging markets in Europe has shown us that collaboration and local insight are often more beneficial to the recovery process than time in the courtroom.</p><p>Investors would do well to remember that “secured” does not automatically mean “safe”. Collateral may back a loan, but only discipline, diligence and experience can truly secure it.</p>