Regulators and the asset class need to talk more

The spotlight is intensifying as private debt’s role in the stability of the financial system is questioned – and misunderstandings needs to be addressed.

Even to have financial stability on the agenda was a brave move by the Alternative Credit Council at its annual summit last week. It prompts the thought that maybe there is something about private debt that could pose systemic risk. And this is presumably the very reason why regulators are paying closer attention to the asset class.

In fact, the ACC did a good job of defending private debt against any such charges. While acknowledging “signs of excess” in certain areas, its claim that the market was on the whole diligent when it came to fundamental risk analysis and assessing creditworthiness seemed credible.

It also rightly highlighted the advantages of private debt funds versus the banks. These include the “cradle to grave” process by which the originator or buyer of a loan is responsible for the performance of an asset until maturity, thereby helping to ensure alignment of interest with the end investor; and the lack of a taxpayer guarantee, which means funds bear the risks of their investment decisions and are less connected than the banks to the broader financial system.

But despite this solid defence, regulatory oversight is far more likely to strengthen than weaken. The regulators hear too many stories about poor underwriting standards, weak loan documentation and overuse of leverage for it to be otherwise. And while there may be some substance to the claim that banks worried by the competition are keen to spread scare stories, concerns about private debt can’t all be put down to a whispering campaign on the part of others.

One of the biggest problems is that the asset class and regulators don’t always appear to be talking the same language. Calls from the UK’s Financial Conduct Authority for more data and greater transparency, for example, are often met with a puzzled response from industry players who say they are more than willing to provide this information and just haven’t been asked for it. They query whether the regulators really know how to ask the right questions.

But wherever the blame lies, it seems there is something of a disconnect and that the two sides don’t really understand each other. Events such as the one staged by the ACC, which included representatives from the FCA, will hopefully help to bring them closer together – and allow for a fair assessment of the risks relating to private debt.

Write to the author at andy.t@peimedia.com.