Concentration of private credit sector a concern: ASIC
ASIC has released the interim report from its review into the nation's $200 billion private credit market, which it says could pose a systemic risk to many investors if a downturn were to occur.
The review has so far found that while most investors are "appropriately rewarded for taking sub-investment grade credit risk and maturity/liquidity risk", these risks are not always adequately outlined in offer documents and performance reports.
It said, unlike the global private credit market, much of the local industry is concentrated in real estate construction and development finance "which has represented the majority of credit losses in past economic downturns in Australia and overseas".
"This segment of the market may present as a systemic risk for small and self-managed superannuation funds and 'sophisticated' investors in a downturn," the interim report reads.
"The concentration of Australia's private credit market in higher-risk real estate construction and development is where we see the greatest area for improvement for investor protection and market integrity.
"This market segment has a higher concentration of investors using the wholesale sophisticated investor exemption, and with less transparency on conflicts of interest, manager remuneration disclosure, and valuations and portfolio reporting."
In all, the interim report identifies four key areas of the sector requiring improvement. These are conflicts of interest, fees and remuneration, portfolio transparency and valuations, and terminology.
The report said conflicts of interest are prevalent across fee structures, valuations, related party transactions and loan structuring. It also said fee and remuneration structures vary widely and are often opaque and not quantified, adding that there is inconsistency in fees charged and they're not often disclosed, meaning some investors don't know the true cost of the fund.
"Thinking about private credit business models, there is a question about the stability, during a downturn, of remuneration structures that derive a majority of their income from borrower and other non-investor-paid fees. Unsustainable business models may ultimately have an impact on fund management and investor outcomes in a decline," the report reads.
On valuations, it has found many funds don't perform these quarterly and that often they're done by internal staff with no independent oversight; a lack of independence can create a conflict of interest where fees are attached to asset values. It also said there is a lack of consistency when it comes to methodologies, and that marketing materials often don't adequately reflect risks and illiquidity of private credit investments.
The review also raises concerns around the use of terminology such as 'investment grade' by many private credit managers, often being used without formal rating agency involvement and based on internal models. Other methodology that it has identified as being inconsistently defined include 'security', 'loan-to-value ratio', and 'senior debt'.
There are several other areas that also warrant further investigation by ASIC, the interim report suggests, like liquidity facilitation, investment report information, and distributions paid out of capital without confirmation of this nature.
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