A sense of tension is sweeping through one of the fastest growing corners of the global investment space – and for good reason.
The private credit market is swelling so fast its size and growth rate has become something of a debate among experts, with the IMF and JPMorgan at odds over whether it’s worth a mere two or three trillion dollars. Given the market grew 50% over the past four years and is expected to grow another 90% in as many more, the debate seems somewhat academic–but it certainly won’t stop watchdogs’ tails from wagging.
Since the Global Financial Crisis when banks pared down their capital markets balance sheets, private credit issuance has excited the imagination of countless private capital firms, and market regulators are understandably growing wary of the trend.
It’s easy to see why many financial institutions are compelled by private credit, with demand forecast to surge considerably over the coming decades to fuel structural global themes like the net zero transition and the development of artificial intelligence.
Explosive growth trajectory aside, the pressing concern from a systemic perspective is that a great deal of credit risk is being taken on by private investment partnerships, which do not carry the same transparency regulations as banks and mutual fund companies do.
Moreover, new players are entering the space at an unprecedented rate. Household names including State Street have even launched private credit exchange traded funds (ETFs). This will place private credit within arm’s reach of retail investors – yet more cause for concern from a regulatory and systemic perspective, due to the potential for substantial inflows should this growing investor base develop a healthy appetite for private credit.
Against this backdrop, firms operating in the sector can almost certainly expect regulators to come knocking. The question is, will they be operationally equipped to co-operate with authorities?
The effectiveness of compliance processes and regulatory reporting relies heavily on the quality of underlying data – much of which will be novel, complex and largely unfamiliar for the firms only just dipping their toes in private credit.
One only needs to scan the IMF’s most recent analysis on the subject for an idea of the amount of data firms may be required to supply watchdogs, with the report stating there must be greater ‘reporting standards and data collection to better monitor private credit’s growth and its implications for financial stability’. This may pose lofty challenges for firms without sophisticated data management capabilities in place geared specifically towards private credit.
The asset class encompasses a diverse range of data types, including loan terms and structures, cash flow projections, detailed information on underlying assets, and covenants, to name a few. To manage these effectively, firms new to the space will need to standardize much of the data, a crucial step not only in fulfilling regulatory requirements in a timely fashion, but also to enhance decision making and empower firms to leverage new and exciting data analytics tools. The problem is that a huge amount of legwork is required to extract and unite data housed in the various spreadsheets, email attachments and SharePoint drives in which it typically arrives.
The strain on resources and the associated costs with this labour intensive process threaten to prove too great a burden for many firms, especially as competition in the space heats up. It seems essential those looking to dive into the sea of opportunity posed by private credit first think carefully about their data strategy. Those that do not may find themselves drowning in regulatory penalties when watchdogs tire of circling the issue.
By Jeremy Katzeff CFA, Head of Buy Side Solutions at New York-based data management company GoldenSource
