The International Monetary Fund (IMF) has urged regulators to keep a watching brief on private debt as the once obscure asset class enters the investment mainstream.
Included in its 2024 Global Financial Stability Report released this month, the IMF says budding risks in the now US$2.1 trillion plus market require closer scrutiny from regulators.
“Authorities should consider a more active supervisory and regulatory approach to private credit, focusing on monitoring and risk management, leverage, interconnectedness, and concentration of exposures,” the report says.
The IMF namechecks five “fragilities” of private credit compared to traditional debt markets, including:
- companies in the sector tend to be smaller and more indebted proportionally;
- infrequent trading leaves loan valuations subject to potentially misleading risk models rather than mark-to-market bonds;
- possible ‘hidden’ leverage is hard to gauge given the lack or reliable data;
- concentration exposures and “interconnectedness” of investors; and,
- rising liquidity risks as products targeting retail investors come on to the market.
“Private credit funds use long-term capital lockups and impose constraints on investor redemptions to align the investment horizon with the underlying illiquid assets,” the IMF says. “But new funds targeted at individual investors may have higher redemption risks. Although these risks are mitigated by liquidity management tools (such as gates and fixed redemption periods), they have not been tested in a severe runoff scenario.”
The private debt chapter of the yet-to-be fully released Global Financial Stability report was authored by IMF executives Charles Cohen, Caio Ferreira, Fabio Natalucci and Nobuyasu Sugimoto.
“Overall, although these vulnerabilities currently do not pose a systemic risk to the broader financial sector, they may continue to build, with implications for the economy,” the authors conclude.
Despite noting that private credit has “created significant economic benefits”, the IMF says regulators need to improve data collection, monitoring, cross-border cooperation and reporting standards of the market.
“Securities regulators should pay close attention to liquidity and conduct risk in private credit funds, especially retail, that may face higher redemption risks,” the report says.
Over the last couple of years several private debt funds have launched in NZ targeting retail and wholesale investors with offerings from the likes of Metrics, Merx, iPartners and Revolution.