Regulators are stepping up their scrutiny of private credit as the sector has grown rapidly and defaults are looming. We speak with IFM’s Co-Heads of Australian Diversified Credit about whether the sector is in trouble
In February, the Australian Securities and Investments Commission (ASIC) published a discussion paper on the dynamics between public and private markets, which contained the following warning:
“There will be more failures in private credit investments, and Australian investors will lose money.”
Although it didn’t consider the private credit sector in Australia a systemic risk, the corporate regulator announced it was increasing its focus on private credit to “test whether investment offers comply with existing laws”.
ASIC is not the only one concerned about the rapid growth of private credit and the potential effects on financial stability. The regulator joins an increasingly louder chorus of oversight organisations ringing the alarm bells, including the Reserve Bank of Australia, International Monetary Fund (IMF) and United States Securities and Exchange Commission.
But it is not so much the private credit investments themselves that worry regulators, but more so the increasing number of publicly listed vehicles and the channels through which they are marketed to relatively unsophisticated investors, including high net worth and even retail investors.
A key concern centres on the presumed liquidity of these products. The listed nature of these newer vehicles, which include exchange-traded funds, means on the surface they promise daily liquidity. Yet, the underlying assets are very much illiquid.
Product providers can manage some of this illiquidity by funding exits through cash reserves or even through cash inflows, but if too many investors exit all at once, the fund might lock up or investors will be left holding illiquid assets.
I don't think there's anything wrong with [ASIC] questioning the sector – Lillian Nunez
Not all investors that access such listed vehicles are aware of the limitations of these investments.
Regulators also question whether investors are sufficiently informed of the leverage risk profile of assets and fee structures in these vehicles.
The International Monetary Fund was especially outspoken about certain types of listed private credit funds and slammed the lack of transparency and poor governance of these vehicles in a report last year, when it observed “a growing share of semi-liquid investment vehicles, multiple layers of leverage, stale valuations and unclear interconnections between participants”.
Regulators, including ASIC, are now calling for increased transparency on the underlying risks, related-party interests, portfolio holdings, valuation practices and fee structures.
IFM Investors Co-Heads of Australian Diversified Credit, Lillian Nunez and Hiran Wanigasekera agree the sector could benefit from better governance, accurate valuation of assets and increased investor protections.
“I don’t think there’s anything wrong with [ASIC] questioning the sector,” Nunez says in an interview with [i3] Insights.
“It really goes to: who are they acting on behalf of? Because from an institutional perspective, you would expect that investors’ relationship with their managers and their consultants gives them significant transparency on what they’re investing in.
“It’s for those investors that don’t get that information that ASIC is really acting on behalf of and I think that that’s appropriate.”
Wanigasekera adds: “I think some level of standardisation around disclosure is not a bad thing.”
Preparing for the Storm That’s Brewing
The private credit sector in Australia has grown rapidly in recent years. At the end of 2023, assets under management reached $188 billion, according to figures from EY. At the end of 2020, this figure was $109 billion, meaning the sector grew 72 per cent in only three years.
Nunez and Wanigasekera see the increased regulatory scrutiny as a sign of a maturing sector, but do not believe it points to wider troubles in the private credit sector. It is simply part of the normal cycle of growth and the greater attention this growth attracts, they say.
Asked whether the much-discussed decision by Metrics Credit Partners to take an equity stake in Pacific Hunter, a hospitality company that includes high-profile restaurants, including Rockpool Bar & Grill, points to deeper issues in the private capital sector, the Co-Heads say that concern is somewhat overblown.
In October 2024, Quadrant Private Equity divested from the hospitality group, which grew out of celebrity chef Neil Perry’s high-profile Sydney steak restaurant, to Metrics Credit Partners. As a private credit investor, Metrics doesn’t necessarily intend to take equity stakes in companies, but it saw no other option to protect its credit investors.
Although taking an equity stake is a last resort type of action, Wanigasekera says it is not unprecedented in the sector.
“It has happened forever in lending. Even for banks, their last resort position is actually taking ownership of these assets,” he says.
“You walk through your approach of put more equity money in, refinancing, find other ways of deleveraging, all of that. And then [taking an equity stake is] the last resort situation.
“It’s not the preferred process lenders would like to undertake, but these things do happen from time to time.”
Nunez adds that this is exactly what private credit investors should be aware of, especially considering the current level of uncertainty and volatility presently observed in global markets.
“Credit [investors] are always looking at the downside: what’s going to go wrong? That’s our natural bent, to always be cautious. We’re not like equity where the sky is always blue. There’s a storm brewing and we prepare for that,” she says.
It is often exactly because businesses find themselves faced with some headwinds that private credit investors can step in and help weather the storm.
“We can find opportunities where you’ve got a fantastic company with a sustainable business that’s got a long track record, [but which experiences short-term difficulties]. So I think let’s not be afraid of the uncertainty and the volatility. I think we like to take advantage of that,” Nunez says.
Diversification Across Private Credit Spectrum Key to Success
Yet, with rising geopolitical tensions in the world and a tariff war still on the cards, the current outlook for the global economy is somewhat uncertain, and, in extension, IFM sees the level of risk in private credit rising too.
“We’ve gone through this period where demand for credit has been relatively low because of uncertainty in the economic outlook, first because of interest rate rises and then the resultant expectations of recession,” Wanigasekera says.
“And now we had a slight improvement of outlook for deal activity late last year and it was meant to get better this year, but then we’ve got another spanner that’s been thrown in the works out of the US with tariffs.
“So its pricing is a function of demand versus supply and right now demand remains somewhat stagnant at the moment because of that uncertainty that’s driving that.”
Nunez acknowledges risks are rising and says managers need to ensure they keep communicating this to investors.
Pricing is a function of demand versus supply and right now demand remains somewhat stagnant at the moment because of that uncertainty that's driving that – Hiran Wanigasekera
“There could be a situation where people have to keep deploying even though the risk keeps rising, then it is really important to talk and explain this to your client base,” she says.
“Perhaps you need to shift a little bit and go up the credit curve, even though that means returns might just be tweaked a little.”
But investors can address these rising risks by ensuring they invest across the private credit spectrum, whether it is direct lending, asset-backed lending or securitised loans.
“For us, it is about being so diversified that you can go to another sector and that’s what we tend to do. We can move sectors if one is particularly under pressure,” Nunez says.
Wanigasekera points out IFM has built up a diversified business over the years it has been active in the sector and this has helped in not being exposed to any one sector of private credit.
“Our business is a little bit different to most others. We actually do offer private credit in forms of asset-backed securities and structured finance, as well as traditional direct lending,” he says.
“We also even have options of doing private credit in the investment-grade space, rather than necessarily looking at sub-investment grade. Again, it depends on the type of investor. The private credit label traditionally has tended to imply one thing, but in reality there’s lots of different flavours of it.
“We tend to have that flexibility to operate across each of these different segments. And that allows us to more consistently be able to deploy capital and find valuable investment opportunities that continue to remain attractive.”
Opportunities in Volatile Times, Eyeing Logistics and Care
The current market environment still offers plenty of good investments, the Co-Heads say. The fund manager sees future opportunities in areas such as logistics and property for the care sector.
“Care is always in demand. If you think about our population and where that’s headed, then there is a natural growth in that sector,” Nunez says.
IFM also has looked at food and beverages, energy, recycling and waste assets and even domestic manufacturing investments.
“Obviously, there’s not a lot of manufacturing in this country, but we’re hopeful of opportunities to go into that space. We’re not necessarily looking at things like AI, or technology at the moment,” Nunez says.
“We’ve also got the structured credit and private placement warehouses that we’re looking at to support some of those non-bank lenders who are under pressure, which adds more of a consumer-type angle as well.
“But we’ll be mindful there of the consumer credit appetite and the economic outlook with sentiment being a little bit softer. So we’ll be mindful there, but that adds diversity to our portfolios.”
Environmental, social and governance (ESG) considerations have become an increasingly more important part of the team’s discussions on whether to invest or not, and recently even caused the fund manager to walk away from an investment opportunity.
“There were a couple of things in front of us that we didn’t particularly like for ESG reasons. Some of it has to do with regulatory risks and environmental risks that we considered,” Wanigasekera says.
“We have another opportunity at the moment where the team has been debating quite extensively on the environmental risk issues attached to it, which attracted quite a robust debate across the team about whether or not it’s something that we should be considering.”
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