ASIC sounds alarm as private credit funds fail investors

Australia's private credit market has grown rapidly, but ASIC says many funds are still failing to clearly explain risks, fees and conflicts of interest, leaving investors in the dark about what they're buying.

Private credit has emerged as one of the fastest-growing areas of investing, attracting everyone from wealthy investors to super funds and, increasingly, everyday Australians.

But a new review from ASIC suggests many investors still aren't getting the information they need to properly assess the risks.

The regulator found that private credit funds continue to fall short on disclosure, distribution and conflict-management practices, despite a major ASIC review highlighting the same concerns a year ago.

ASIC examined 24 private credit funds managing a combined $18 billion and found many products were complex, difficult to understand and lacked clear disclosure around risks, underlying assets, fees and conflicts of interest.

Given the rapid growth of the sector, ASIC warned the consequences extend beyond individual investors.

The regulator says harm to retail investors and superannuation funds has the potential to "damage general market confidence and cause harm to sectors of firms and consumers".

What is private credit?

Private credit generally involves lending money directly to businesses, property developers or other borrowers outside the traditional banking system.

The sector has grown quickly in recent years as investors search for higher income and diversification, particularly at a time when many traditional fixed-income investments have offered lower returns.

However, private credit investments can be complex, less liquid than traditional investments and harder to value, making transparency especially important for investors.

ASIC finds widespread disclosure problems

According to ASIC's report, too many providers failed to adequately explain key information investors need to make informed decisions.

Problems included poor disclosure of fees, economic incentives and conflicts of interest, as well as insufficient information about the underlying investments and risks.

ASIC says there were "prevalent" and "material shortcomings" in marketing materials, disclosure documents and target market determinations (TMDs).

"We observed there was often an inadequate explanation of product features, liquidity constraints, underlying assets, fund structures, fees and conflicts," the report says.

"Investors are distributed products without the benefit of disclosures to help them clearly understand what they are investing in and what risk they are taking."

Retail investors increasingly in the spotlight

A key concern for ASIC is that private credit is no longer limited to institutions and high-net-worth investors.

Among the retail funds reviewed, ASIC found nine of 12 failed to clearly explain information critical to investment decisions, including exposure to non-performing or distressed assets.

The regulator also found 10 of 12 retail funds had target market determinations that were poorly designed, citing broad or unclear risk ratings and inappropriate allocation recommendations.

Retail funds reviewed included the Bentham Syndicated Loan Fund, Trilogy Monthly Income Trust and Skyring Fixed Income Fund.

Wholesale funds reviewed included the Apollo Asset Backed Credit Trust, GCI Real Estate Credit Fund and iPartners Property Credit Fund.

Advisers generally met best-interest obligations

ASIC says financial advisers generally demonstrated they were acting in their clients' best interests when recommending private credit investments.

In most cases, exposure to private credit represented a modest portion of a diversified portfolio and formed part of a broader fixed-income allocation.

However, ASIC identified some advisers who recommended large allocations to a single private credit fund despite having financial incentive arrangements with fund operators, raising concerns about conflicts of interest.

More scrutiny ahead for the sector

ASIC commissioner Simone Constant says some improvements had been made since the regulator's first major review, but significant concerns remain.

"While we have observed pockets of improvement, complexity and opacity persist, in some cases leaving investors unable to properly assess the risks and benefits of their investments," Constant says.

"ASIC has made clear what good practice looks like by providing industry with significant guidance, including our ten principles of private credit done well. Our focus now will be on holding the sector accountable for persistent poor practices."

The regulator says it will increase scrutiny of the sector and release updated guidance for managed funds that use private credit strategies.

ASIC will also work with industry bodies to strengthen standards across both retail and wholesale private credit funds.

"It is past time for the sector to embrace its role as good stewards of other people's money, which means being clear and transparent about risks, fees and conflicts," Constant says.

"It is time now for urgent action from all involved in the private credit system."

A version of this article first appeared on Financial Standard

Get stories like this in our newsletters.