In its latest update on Australia’s public and private markets, ASIC has called on industry bodies to lift their standards across Australia’s private credit sector following expert observations on the sector’s practices.
The report identified positive private credit practices and called out concerning ones that require addressing, including opaque remuneration and fee structures, related party transactions and governance arrangements, valuation practices and inconsistent use of terms for effective disclosure.
According to the report, half of the $200 billion private credit market is real estate-focussed finance and segments of the market targeting wholesale investors have practices that “do not compare favourably against international practice”.
“Lenders in these segments are more likely to have conflicts of interest, opaque fee and interest margin arrangements, inconsistent and non-independent valuation methodologies, and ambiguous terminology. These practices are more prevalent in real estate-based funds,” it read.
The report added that while it has not assessed the systemic risk to the Australian financial system from private credit, it notes the concentration 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 a systemic risk for small and self-managed superannuation funds and ‘sophisticated’ investors in a downturn,” it read.
The report continued that with the concentration of Australia’s private credit market in higher-risk real estate construction and development, there is an opportunity to make greater improvements 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.”
“The private credit investor base now spans large institutions such as top-tier superannuation funds and insurance companies, wholesale investors using the sophisticated investor exemption, and self-managed super funds and retail investors.”
Furthermore, the report said that the growth in the market raises questions about the quality of credit, especially whether investors fully understand the investment exposure they are taking on for the returns being promoted.
“In particular, there are legitimate questions about whether, in some cases, retail investors could fully understand and appreciate the nature of their private credit investment exposure, based on readily available information,” it added.
“Those funds targeting wholesale ‘sophisticated’ and retail investors should provide more transparency on risks, loan valuations and loan characteristics. Their fee structures also have potential to create conflicts of interest for managers.”
The report said funds targeting higher-risk real estate construction and development finance likely represent the greatest priority for addressing potential conflicts of interest and improving transparency.
“In this report, we have predominantly considered superannuation funds as being the largest and most sophisticated funds. However, it is important to consider the governance of all superannuation funds in relation to private credit, regardless of size and sophistication,” it read.
“Regardless of third-party advice and recommendations, fund trustees need to ensure that they are sufficiently aware and educated about the nature and risks of their private credit investing.
“In what can be a complex asset class, it is possible and even probable that many superannuation fund trustees do not yet have a proper understanding of private credit. This is a potential problem for the sector.”
The Financial Services Council welcomed the findings of the report and acknowledged the issues ASIC identified.
Blake Briggs, chief executive of the FSC, said: “ASIC’s private credit report is a timely call for greater transparency in the sector, which the FSC and mature operators in the industry support.
“The FSC acknowledges ASIC’s consultative and constructive approach throughout this consultation process, and we welcome ASIC’s recognition of the role that industry-led standards can play.
“The FSC will work with the experienced and industry leading operators in our membership, in consultation with ASIC, to develop consistent standards that enhance governance and disclosure practices in private credit and private markets more broadly.”
Briggs added that the FSC’s approach aims to build consumer trust and support the long-term growth and stability of Australia’s capital markets, ensuring private markets can continue to deliver strong outcomes for investors and the economy.
“Private capital fills a funding gap for innovative Australian start-ups, growing businesses and property and infrastructure projects. It also provides diversification, return and income opportunities for Australians through superannuation and retail investments.”
