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P
rivate credit – as the name implies – comprises finan-
cial instruments such as loans, bonds, notes or private
securitisation issuances that are not publicly traded, and
which are often deployed by strategies operating under alterna-
tive credit, private debt or direct lending banners. The growth
of such strategies is well-documented, with private debt now
accounting for around $638 billion (as of June 2017) in AuM,
and it is rapidly encroaching on the $811 billion controlled by
real estate, and the $2.8 trillion managed by private equity.
Explaining the growth: Regulation
The growth of private credit strategies globally has been driven
primarily by regulatory dynamics. Capital adequacy rules
introduced under Basel III have forced banks to deleverage, a
consequence of which has been a significant shrinkage in their
lending activities resulting in a number of small- to medi-
um-sized enterprises (SMEs) losing access to financing. The
rules have also prompted banks to sell their loan portfolios to
buy-side firms.
Hedge funds and private equity have spotted a gap in the mar-
ket, and managers are now increasingly offering loans to SMEs.
“Direct lending funds are filling the gaps left by the banks in the
mid-market SME space,” says Bhagesh Malde, global head of
real assets at SS&C Technologies. Other regulations, in addition
to Basel III, have also sparked an upsurge in private credit funds,
particularly in Europe.
In the EU, the much-vaunted Capital Markets Union (CMU) is
likely to deepen the private credit industry further as regulators
have said they want SMEs to become less dependent on bank
lending, in favour of non-bank providers. CMU eases restrictions
on managers launching and marketing EUVECAs (European
Venture Capital Funds) and EUSEFs (European Social Entrepre-
neurship Funds), in what should prompt an increase in non-
“Banks have largely been the dominant providers of
financing in Europe, whereas in the US they represent
about 30% of the lending market.”
DIRK HOLZ, RBC INVESTOR & TREASURY SERVICES (RBC I&TS)
bank lending.
“Banks have largely been the dominant
providers of financing in Europe, whereas
in the US they represent about 30% of the
lending market. This unevenness is start-
ing to change with the growth of private
debt and private capital funds increasing-
ly providing and issuing loans in Europe,”
says Dirk Holz, head of origination and
development in the private capital busi-
ness at RBC Investor & Treasury Services
(RBC I&TS).
Local regulators in Ireland and Germany
have introduced reforms making it easier
for credit funds to operate. BAFIN, for
example, no longer obliges fund managers
to hold a credit license if they issue or
underwrite loans. Such reforms are noble
but better market-wide standardisation
is required, with some experts calling for
loan funds to be given pan-EU passport-
ing rights under the Alternative Invest-
ment Fund Managers Directive (AIFMD).
There is, however, a lot of scepticism
about CMU’s objectives, mainly because
EUSEFs and EUVECAs – while good ide-
as in principle – have struggled to attract
capital as they are not endowed with the
brand recognition that comes with UCITS
or AIFMs. In addition, CMU’s momentum
has been temporarily disrupted by Brexit,
leading to doubts in certain market circles
about how many of the reforms will actu-
ally be implemented.
Meanwhile, US courts have made it
easier for Collateralised Loan Obligation
(CLO) funds by exempting them from
Dodd-Frank era requirements that forced
them to hold risk retention or “skin in the
game” on deals. While overall issuance
volumes were broadly unaffected by the
risk retention rules, the Loan Syndica-
tions and Trading Association success-
fully sued the SEC and Federal Reserve
describing the provisions as arbitrary and
capricious.
Investors want exposure
Investor demand for private debt and
credit strategies is high. “More institu-
tional money is flowing into private capi-
tal driven by pensions, insurers, sovereign
wealth funds, family offices and HNWIs
(high new worth individuals). I would ar-
gue the asset class is now becoming fairly
mainstream as a result of these capital
allocations,” adds Holz. This migration by
investors to private credit has been driven
by their thirst for new returns.
Starved of yield due to the persistently
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Global Custodian
Private Equity Issue 2018