Darrell Clark, Deputy Director of Research and Manager, Alternatives, Lonsec Research and Ratings
Private credit has become one of the fastest growing segments of Australia’s capital markets, now estimated at around A$200bn. Its rise reflects a pullback in bank lending and strong investor appetite for yield. ASIC’s new Report 814: Private Credit in Australia (REP 814) shines a spotlight on both the sector’s strengths and shortcomings, calling for the industry to promote higher standards in governance, disclosure, and investor protection.
The release of REP 814 follows published reports or working papers from several international bodies including the International Monetary Fund (IMF), Bank for International Settlements (BIS) and central banks such as the Federal Reserve and the RBA.
While the report identifies significant risks, it also recognises that “private credit, done well, has a valuable role to play in the Australian economy”. For advisers and investors, the challenge is to balance the opportunity presented with the various risks associated with the asset class.
Key Areas Requiring Improvement
Transparency and fees
ASIC found that some funds have multiple layers of remuneration in addition to RG97 fees quoted in the PDS. These can include upfront borrower fees and default interest and are often undisclosed to investors. In some cases, hidden fees can be several times the stated management fees.
Governance and conflicts of interest
Weak governance was highlighted as a recurring issue. Concerns included lending to related parties, funds holding both debt and equity in the same corporate borrower or project and transferring assets between related funds. Without external oversight or the presence of mitigants, such practices can compromise investor interests and muddy decision-making.
Valuations and liquidity
Many funds rely on infrequent or in-house valuations when determining the carrying value of the loans. This can overstate asset values and delay recognition of impairments. Liquidity mismatches were also flagged, where funds offer frequent redemptions despite holding illiquid loans.
Disclosure and terminology
ASIC noted inconsistent use of terms used in investor disclosure, for instance “senior debt,” “investment grade,” and “loan-to-value ratio (LVR).” Some LVRs were quoted on optimistic completion values rather than cost.
Priority Issues Identified by ASIC
REP 814 outlined several priority issues:
- Opaque fee structures – highlighting the potential for misalignment between manager and investors, hidden fees, and weak disclosure.
- Related-party exposures and governance – loans to related parties, holding debt and equity in the same entity via the same fund or related funds, or transferring investments between funds managed by the same manager, potentially creating valuation and governance issues.
- Weak valuation practices – infrequent, conflicted, or unclear methodologies.
Overview of Good Practices
Importantly, section 5 of REP 814 also highlighted examples of strong practices, many of which align with global standards. Funds backed by global institutions or large super funds typically demonstrate these standards, showing that higher-quality practices are both feasible and beneficial in the Australian context.
Good practices include:
- Regular, independent valuations conducted at least quarterly or at least audited or signed off quarterly by an independent third party.
- Fund composition reporting at least quarterly including metrics such as number of loans, material borrowers (over 5% of NAV), impairments or loans on a watch list, income sources, and credit rating bands (and whether these are internally derived or externally sourced).
- Full disclosure of all manager remuneration, including upfront, establishment, arrangement, origination, base and performance and workout fees, and default interest and net interest margin. Best practice would be that all fees received from the fund or borrowers are disclosed as a proportion of funds invested.
- Liquidity including the prospect of and the mechanics behind it should be fully disclosed in marketing and product information.
- Leverage should be disclosed including any guardrails.
- Robust governance structures, with independent oversight of conflicts and related-party dealings.
- Consistent terminology and reporting, enabling fair comparisons across funds.
- Special consideration and disclosure for real estate lending funds.
Lonsec’s Leadership in Research
At Lonsec Research and Ratings, our 7-factor model is supported by a range of house views that support many of the issues highlighted by ASIC. Importantly, private market funds have a greater assessment weight towards what is known as the Product factor, the factor that deals with the nuances of the structure being assessed.
| ASIC Concern | Lonsec Scoring Model Inclusion |
|---|---|
| Opaque fees | Assessment included in the Fees factor including the overall quantum of fees and fairness. |
| Related party exposures and/or conflicts | Assessment included in the Business factor within Business Governance and/or Portfolio Construction within the Process factor. |
| Valuation practices | Valuation governance sub-factor included in the Product factor. |
| Liquidity | Liquidity assessment including a comment on mismatches, disclosure, and redemption mechanisms included in the Product factor. |
| Investor disclosure | Assessed in the Transparency sub-factor included within the Product factor. |
Funds that fall short in these areas receive lower scores in our scoring model, while those demonstrating strong governance and disclosure are recognised. Our overall opinion supporting the rating and commentary throughout the report will reflect a product’s relative strengths and weaknesses versus its peer group. This approach ensures advisers and investors can identify which managers are adopting global best practice, and which may expose them to heightened governance or transparency risks.
REP 814 highlights the sector’s growing importance and the need to lift standards around governance and transparency. Lonsec’s research process already aligns closely with these principles, supporting advisers in identifying well-structured, high-quality products.
Further to our paper earlier in the year, Private Credit: Balancing Opportunity and Risk in a Growth Market, Lonsec Research and Ratings confirms it has a vetting process for new products seeking a rating. This paper contained a table of minimum gates for managers to move forward in our rating process. Where minimum standards are not met, Lonsec will not proceed to cover these managers.
Conclusion
The private credit sector has genuine merit, but regulatory scrutiny has underscored the need for managers to strengthen areas such as conflict management, transparency, and governance practices. It is important to recognise that Australia’s private credit sector is still developing and strengthening these core areas will benefit investors and bridge the gaps to products offered offshore.
As a research house, Lonsec Research and Ratings will continue to provide leadership via our ratings methodology which captures these risks, while holding managers to account and supporting advisers to aid their clients in making informed investment decisions. We will remain adaptable to evolving market dynamics and ASIC’s ongoing review to ensure our research approach remains aligned to best practice.
Important Information: This article has been produced by Lonsec Research Pty Ltd ABN 11 151 658 561, AFSL No. 421445 (Lonsec). Generation Development Group Limited ABN 90 087 334 370 is the parent company of Lonsec Research.
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