Following a legal rebuke to the U.S. Securities and Exchange Commission’s (SEC) efforts to enhance oversight of private funds, the private credit sector will remain opaque at a time when it’s rapidly growing and evolving, says Moody’s Investors Service.
In early June, the U.S. Fifth Circuit Court of Appeals struck down proposed new rules from the SEC that aimed to improve regulatory oversight and market transparency in the private fund sector.
“The court held that the SEC rule, which would have required hedge funds and private equity firms to provide details of fees and expenses to investors, were beyond the SEC’s authority,” the rating agency said in a new report.
Moody’s noted that, while regulators remained concerned about the evolving risks in private credit, there’s little prospect of enhanced regulatory oversight of the private fund industry in the short term.
“That means private credit participants will continue to self-monitor risks at a time when the market is rapidly expanding in new directions,” it said.
Private lenders are increasingly venturing into the kinds of transactions that have been the territory of the syndicated loan market, such as financing leveraged buyouts by private equity, the report noted.
“Private credit is entering a new era of growth, well beyond the scope of its more traditional direct lending business to corporate middle market companies,” it said.
And alternative asset managers are venturing into new business lines, such as asset-based finance, in an effort to meet the high demand from investors for fixed-income opportunities, Moody’s said.
The report projects that traditional private credit lending will grow from a US$1.7-trillion market today to US$2.7 trillion by 2027, and that alt managers will play an increasingly bigger role in the US$40-trillion asset-based finance market.
“This rapid and more diverse growth is happening at a time when regulatory calls to shine a brighter light on areas of private credit have been growing from a range of international organizations and regulators, including the International Monetary Fund, the Bank of England and the Federal Reserve,” it said. It also noted that, while private credit isn’t yet a systemic threat, “the depth and extent of risk interlinkages are still unknowns.”
Alongside regulators’ concerns, the report noted that the sector’s growth will increase the concentration of non-bank lending at the largest asset managers, and it said, “Opacity can also make it challenging for investors to know what kind of risks may be present in private credit portfolios.”
“While performance has so far been fairly healthy, if uneven, increased stresses could have ripple effects,” it said, with deteriorating asset quality and valuations potentially spilling over to other parts of the financial markets.
At the same time, the report said, “Private credit’s ability to answer growing calls for capital expansion across major markets raises the bar for those arguing to contain it.”