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The new norm of private debts in Asia

24 Jun 2024

By Neil Synnott, Chief Commercial Officer, APAC and Clare Chang, Managing Director, Greater China

Across the globe, private debt is experiencing a surge in popularity. This alternative asset class, offering attractive returns and diversification benefits, is rapidly becoming the “hottest” option for alternative investments. According to the International Monetary Fund (IMF), the private credit market, in which specialised non-bank financial institutions such as investment funds lend to corporate borrowers, topped $2.1 trillion globally last year in assets and committed capital. This resilient private asset class also boasts a 10% compound annual growth rate over the past decade, and the global private debt market is expected to reach a staggering $3.5 trillion by 2028. In this global landscape, Asia is experiencing its fair share of similar growth dynamics. According to IMF and Preqin Pro, data from 2023 indicated that Asia’s allocation to private credit remains under-represented. While Asia contributed 36 percent to global GDP, the region comprises only 7% of global private credit assets under management. This implies that Asia’s private credit market has significant growth potential.

Beyond tradition: allure of the private debt market in Asia

The Asia private credit industry has the potential to grow as an appealing market for investors seeking high returns. According to a recent survey conducted by alternative asset manager Coller Capital among more than 100 private markets investors, 72% of respondents wanted to increase their private credit holdings in Asia. The report also states that India and Southeast Asia are seen as the most attractive markets for buyout opportunities in Asia.

Private debt is generally accepted to refer to debt (i) provided by non-banks, (ii) not offered publicly and (iii) that is unlisted. Its strength is its diversity of strategies and transactions. Its longevity is due to its flexibility and how it can be reinvented for new financing opportunities. The recent growth of private debt arises from an undersupply in bank lending coupled with the evolution of nonbank financial intermediaries.

Here’s a breakdown of the key factors:

1. Filling the gap left by traditional financing

  • Regulatory complexities: New regulations have made it tougher for businesses to access traditional bank loans and public markets. This has created an opening for non-bank lenders in the private debt space
  • Bank limitations: Real estate publication, Private Equity Real Estate (PERE) reported that banks are becoming increasingly reluctant to lend to real estate. This creates an opportunity for private debt to step in. Recently UBS also noted that reduced lending by regional banks presents opportunities for private debt providers to enter the commercial real estate sector, albeit with challenges such as debt defaults due to rising operational and financing costs

2. Demand for financing

  • Strong economic growth: Asia’s economic prospects remain positive, attracting investors seeking higher returns on their capital. This fuels demand for private debt options
  • SME financing needs: Harneys reported that small and medium-sized enterprises (SMEs) are the backbone of many Asian economies. Private debt offers them financing solutions that might be more flexible than traditional bank loans

3. Tailored solutions for businesses

  • Flexibility: Private debt providers can offer more customised loan structures compared to banks, catering to specific business needs with its different strategies for lending like direct lending, mezzanine debt, distressed debt and special situations
  • Growth sectors: Private debt is well-positioned to finance businesses in booming sectors like technology, real estate, education, supply chain development and renewable energy, which often lack traditional collateral

4. Support from structural reforms

  • Key Asian markets are ushering in long awaited structural reforms which are unlocking significant potential for Private Debt. For instance, India promulgated the Insolvency and Bankruptcy Code legislation in 2016. The consequent re-alignment of the debt environment in favour of banks as debt providers rather than founder-owners with respect to distressed assets has given a significant boost for private participation, risk control and realisation of assured returns

With growth comes challenges – navigate regulatory crossroads

The private credit market in Asia is experiencing a surge in growth, driven by the region’s robust economic activities. However, alongside these exciting opportunities lie significant challenges that the IMF urges authorities to consider a more intrusive supervisory and regulatory approach to private credit funds, their institutional investors, and leverage providers, to ensure sustainable growth.

1. Transparency and standardisation

A key regulatory concern is the varying legal and regulatory frameworks across Asia which creates a fragmented private debt market, hindering lenders and investors from effectively comparing and assessing risks.

To address this, regulatory measures can play an important role in fostering transparency and standardisation. This could involve:

  • Harmonising disclosure requirements: Regulatory bodies across the region can strengthen cross-sectoral and cross-border regulatory cooperation and make asset risk assessments more consistent across financial sectors. This standardised framework will minimise risk and capitalise on opportunities in the Asia private credit market when it comes to disclosure of private credit transactions
  • Encouraging rigorous due diligence: To ensure transparency and thorough scrutiny, private credit investors must prioritise rigorous due diligence in order to comply with regulatory requirements

2. Strengthening credit reporting systems

Another challenge is the limited credit history which creates significant data gaps. Many Asian businesses, especially SMEs, lack a long track record. This can make it challenging for lenders to accurately assess creditworthiness. Limited access to credit history can lead to overborrowing. Strengthening credit reporting systems is essential to address this challenge. Regulators can:

  • Expand credit bureau coverage: Encouraging wider participation of businesses in credit reporting systems would provide lenders with a more comprehensive view of a borrower’s credit history
  • Enhance data collection: Enhancing data collection to better monitor private credit’s growth and its implications for financial stability

3. Mitigating risks from uneven growth and economic slowdown

Rapid private debt growth can lead to situations where companies become overleveraged, increasing the risk of defaults during economic downturns. CNBC recently reported that the world is looking at a debt crisis that will span the next 10 years. Moreover, an uneven growth can lead to economic slowdowns. This concern is amplified in developing economies, which have a higher reliance on bank loans, making them more vulnerable to economic slowdowns compared to developed economies with mature financial systems and a diverse range of lenders. Solutions include:

  • Increasing taxes or growing the economy faster than debt accumulation could address the vulnerability, according to the recent CNBC report
  • Requiring lenders to develop a strong understanding of the Asian business environment and employ rigorous underwriting practices to mitigate risk

4. Regulatory compliance as a cornerstone

All the aforementioned points correlate to adhering to local regulations which are essential for any rigorous strategy for operating in Asia. While increased access to credit can be positive, careful monitoring and proactive regulatory measures can help ensure investor confidence, market stability and sustainable growth.

Outlook for 2024 and beyond

Despite challenges, the outlook for the private debt market remains positive. Over the years, private credit has matured as an asset class in Asia and become a permanent part of the financing environment. The lack of alternative financing mechanisms, as stated in a 2024 report of Private Debt Investor (PDI), makes private credit a critical driver of growth in the region. Low loss ratios are opening up the door for investors and Limited Partners to gain access to an asset class that has excellent risk-return dynamics.

The growth of non-financial sector in the current financial environment, where interest rates are high, will also help the private credit to flourish. According to 2024 PDI report, higher interest rates suggest a positive outlook for the global economy, which will  benefit Asia’s position as a hub for global manufacturing. Such an environment should be favourable for private credit to perform.

The IMF’s 2024 Report on Global Financial Stability states that an increasing number of mature companies are seeking funding in Asia for acquisitions and diversification of their creditor base, while long-term investors, such as pension funds and wealth managers, are drawn to potentially attractive yields. In recent years, several international alternative asset managers have launched Asia-focused funds.

Regional regulators and tax authorities have also become aware of the potential of this asset class. It is possible that there will be targeted regulations or tax exemptions in the near future. The Singapore government acknowledges the private debt market’s potential as a growth driver, particularly with a cautious banking sector. It is committed to supporting private credit managers in their Asian expansion and building an ecosystem to promote responsible investment practices and mitigate risks. On the other hand, the Hong Kong government is considering new tax rules that would treat the private credit business more favourably.

Looking ahead, we expect continued growth and evolution within the private debt market in 2024 and beyond. With careful navigation and strategic partnerships, investors can harness its full potential in emerging opportunities.

How IQ-EQ can help

IQ-EQ provides a comprehensive range of solutions for alternative investment businesses including due diligence, risk assessment, regulatory compliance, etc. to help manage all challenges associated with private credit. If you’d like to find out more about the support available from IQ-EQ’s expert team, please get in touch.

Working with IQ-EQ has been seamless – you and your team understand our business, advise us appropriately, and handle your side of our collective partnership so that we can focus on making good investment decisions. Evan Gibson SVP, Merchants Capital

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