(Bloomberg) -- An Australian corporate watchdog’s probe into the private credit market faces challenges including the absence of a secondary loan market and non-standardized fees, underscoring the risks particularly for retail investors in the growing market.
The Australian Securities & Investments Commission is conducting a two-year private-markets review amid persistent concerns over loan valuations. With trading in the after-issuance market thin — as most investors buy and then hold the loan — the regulator faces headwinds in a sector estimated by advisory firm Alvarez & Marsal as accounting over 10% of the country’s A$1.4 trillion ($892 billion) corporate debt in 2023.
The scrutiny from ASIC is timely as more wealthy Australians and retail investors are piling into private credit. Opportunities were previously limited mainly to pension funds due to the high barriers to entry, but they are now becoming increasingly accessible to individuals.
“There are clear risks for investors if valuations are not handled appropriately, including impacts on investor entry and exit prices and fee calculations,” said an ASIC spokesperson in response to questions.
To determine the market’s valuation, the global standard is fair value and is determined by the marketplace, according to David Larsen, managing director specializing in alternative asset advisory at Kroll LLC. Fair value is “the amount that you would receive if you sold the investment in an orderly transaction using market participant assumptions as of the measurement date or valuation date,” he said.
In the US, often sighted as the market leader, many direct lenders are set up as publicly-listed “business development companies,” a type of private lender. They are required to update their investors every quarter, giving investors better visibility on their loan prices.
Credit managers are also regulated and the reporting under US Securities and Exchange Commission rules in relation to business development companies is “much further along than we are,” said Hiran Wanigasekera, executive director and co-head of Australian diversified credit at IFM Investors Pty Ltd. “It’s part of that evolution process that we also need to get to that level and style of disclosure and transparency.”
The lack of mandatory disclosure around these valuations in Australia adds to the problems faced by ASIC and is similar to that in the UK and Europe, where regulators have also raised concerns.
Manager Fees
Another industry concern is disclosure around the fees some managers pay themselves when they originate loans - a potential conflict of interest, according to Bob Sahota, chief investment officer at Revolution Asset Management Pty Ltd. The current disclosure rules around fees do not make it mandatory to reveal these type of upfront fees.
“If I’m negotiating with you on a loan and I’m taking some or all of the upfront fees, guess which way I’m going to skew the conversation?” said Sahota. “It’s going to be a lower margin and high upfront fee because I get that day one with no risk and with somebody else’s money.”
ASIC Chair Joe Longo said in July that the regulator had made private markets a “top five priority” and is engaging with market participants to examine where improvements could be made.
ASIC is “really trying to cater for the lack of transparency that might be there for the smaller and less sophisticated investors,” added Wanigasekera. “It’s not the large institutional investors or the pension funds or the insurance companies as they can look after themselves.”
--With assistance from Silas Brown.
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