Blackstone’s homage to Taylor Swift last December made two things abundantly clear. One, acting is best left to the professionals. And two, it is indeed “the alternatives era”. In particular, private credit is attracting a lot of attention. Lending by non-banks has grown rapidly in recent years, exceeding US$2.1 trillion at the end of 2023. This expansion of private credit, participation in it by Australian superannuation funds, and questions about cross-industry financial contagion have seen an unusual number of headlines generated this year.
Growth in Private Credit Markets ($US trn)
What is private credit?
Private credit (aka private debt) describes lending by non-bank institutions that happens outside public markets. The current boom in this type of lending traces its origins back to the 2007-2008 financial crisis and the tightening of lending requirements for banks in its aftermath, led in large part by private equity firms.
Common types of private credit include:
- Senior direct lending.
- Mezzanine financing.
- Distressed debt.
- Special situations.
- Venture debt.
Private Credit End Investors and Borrowers
Superannuation funds and insurers are investing in private credit
In August, AustralianSuper was forced to write off US$757 million due to its private credit and equity stakes in Pluralsight, a US-based education technology start-up. This high-profile failure drew attention to the growing stake that many superannuation funds have in private credit. According to Morningstar, AustralianSuper currently allocates 4.5% of its total assets under management to private credit, while fellow industry funds Cbus and Hostplus each allocate around 7%. Holdings within this range are fairly typical across the superannuation sector.
Insurers too are investing more in private credit. Bonds make up the majority of insurers’ balance sheets, with industry estimates hovering around 70%. Of that, an increasing share is made up of private credit. At the end of 2022, private credit, in the form of structured securities, constituted 11% of total bond holdings for US insurers. Interestingly, where insurers were owned by private equity firms — as was the case for 132 insurers — private credit made up 29% of total bond holdings. In both situations, private credit was the fastest growing bond type.
Regulatory scrutiny
APRA flagged in its Corporate Plan 2024-25 that it would be developing its “first system stress test to better understand interconnections across the financial system, and provide a platform to quantify, assess and respond to identified risks.” Speaking about private credit investment by superannuation funds, APRA deputy chair, Margaret Cole, flagged it as an area that would be closely scrutinised in stress testing beginning in 2025. “The interactions between all these participants, including banks, non-banks, and super funds, however, is opaque. This is a central driver for APRA moving towards cross-industry stress testing,” Cole said. ASIC has also indicated that it is expanding “supervision of private equity and private credit funds, by establishing a dedicated private markets unit.”
Risks
Exposure to private credit at superannuation funds and most insurers is, for now, relatively small. Nonetheless, regulators both in Australia and globally share concerns about a number of possible risks posed by private credit, especially as its popularity as an asset class continues to grow.
Last quarter we discussed how data management platforms (DMPs) and look through data can help solve investment managers’ data problems. We think that’s true in this case too.
Consider the following risks posed by private credit:
- Leverage
Private credit arrangements often involve issuers layering leverage in a range of different forms, including subscription line financing and borrowing against portfolio assets. Current reporting requirements are often insufficient to provide a comprehensive view of the leverage employed. End investors (like superannuation funds and life insurers) would benefit from being able to capture and interrogate data on leverage in private credit arrangements, and where this might have interactions with other assets they hold. Leverage accumulated by a private equity fund could be secured against other assets in that fund’s portfolio. An end investor might find that they have exposure to those assets too. Understanding this would allow for a more clear-eyed assessment of risk. - Interconnectedness
Private credit is creating new links between private equity firms, superannuation funds, life insurance companies, and banks (who provide leverage for private credit). These links are often opaque, but they may have the potential to amplify shocks to the financial system.It seems likely that superannuation funds and life insurance providers will be subject to expanded reporting requirements to enable APRA and ASIC to understand the risk associated with this interconnectedness. Complying with this reporting in an efficient and timely manner will depend on their being able to access related data quickly and easily. - Asset valuation
Like other kinds of private market assets, private credit is infrequently valued. Furthermore, there is generally little regulatory guidance on how private credit should be valued, as the assumption is that the institutions buying these assets are sophisticated.Integration of third-party data feeds could enable more regular valuations of private market assets, including private credit. Again, end investors will need to ensure that they can store this data, associate it with an appropriate robust data hierarchy, and incorporate it into analysis accordingly — all of which is, to us, a DMP problem.
Private credit is becoming an increasingly important asset class for superannuation funds and insurers, but it comes with its own set of risks. As regulatory bodies like APRA and ASIC increase scrutiny, firms will need robust data management platforms to capture and assess risks such as leverage, interconnectedness and asset valuation. The growing complexity of private credit investments calls for greater transparency and more frequent valuation, which can be addressed through better data access and integration. Ultimately, managing these risks effectively is key to navigating the future of private credit.
This article was produced as part of The Quarterly – Q1 FY25
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Key Contributors:
Kevin Fernandez is General Manager, Market Strategy and Propositions at Novigi, and is based in the Melbourne office.
Sophie Bowen-James is an analyst in the Market Strategy and Propositions team at Novigi, and is based in the Sydney office.