Inside ASIC’s private credit manager survey

The corporate cop’s probe into the opaque private credit sector is demanding operators come clean on conflicts of interest and secret fee-earning arrangements.

ASIC chair Joe Longo. Picture: Colin Murty

The corporate regulator’s private credit probe is demanding operators come clean on conflicts of interest and secret fee-earning arrangements, according to information orders sent to market participants as part of the Australian Securities and Investments Commission’s industry survey.

Its questions to lenders underline the regulator’s priorities as it ratchets up pressure on the opaque private credit sector, which it has warned will be a source of future failures.

A copy of the survey seen by The Australian shows the regulator is focused on the “governance, valuation practices, conflicts of interest, insider trading, the protection of confidential information, and the fair treatment of investors”.

Although ASIC is targeting retail private credit funds, its scrutiny is likely to be extended to the operations of wholesale lenders too, based on the recipients.

In particular, the regulator singled out disclosures around credit risk and liquidity management in retail funds, expecting they “will have a direct impact for any managers with retail feeder structures” in a nod to wholesale providers.

Attempts to obtain the survey via ASIC were denied after the regulator’s Freedom of Information lawyers warned making it public “would reveal details of the confidential considerations used by ASIC to investigate and determine potential harms and risks that may influence market development”.

The version sighted by The Australian notes the regulator’s fixation on fees charged to investors, and concerns “managers may otherwise be ‘extracting value’ from their role in a way that is difficult for investors to monitor”.

The regulator warns private credit managers it will focus on “undisclosed asset-level fees to related parties” such as placement or origination fees, related party brokerage arrangements, and interest and margin sharing deals.

“Under the current regulatory framework, we would not consider these charges to necessarily be problematic for wholesale managers, provided that there are appropriate conflicts of interest and consent arrangements in place.”

ASIC, which went public in February over its concerns regarding the growth of private markets and private lenders, also asked managers to cough up information relating to the appointment of fund managers, authorised representatives, or special purpose vehicles and how assets, fees, and expenses flow between these entities and the parent.

From left: ASIC commissioner Simone Constant, executive director of Markets Calissa Aldridge and chair Joe Longo. Picture: John Appleyard / Snappleyard

Chair Joe Longo said in his flagship discussion paper published on February 26 that private credit was not yet systemically important in Australia, but “failures are on the horizon, and at current volumes it is untested by prior crises”. While Australia’s private capital market is valued at $148.6bn, only $2.8bn of that is ascribed to private credit funds. Replies to ASIC’s paper are due by April 28.

The survey also requests private lenders provide copies of disclosures made to investors with respect to their interest rate risk and side letter arrangements entered into.

The Australian reported previously that ASIC investigated private lender the Pallas Group over concerns regarding its disclosures to investors. It reported how Pallas Group told investors it had pre-sold 60 per cent of lots at its Mona project when internal company documents showed only 30 per cent had been sold. 

ASIC is also demanding funds provide a register of their fees and expenses and copies of disclosures made to investors about those fees. This will need to detail any incentives offered to portfolio companies to use an associated service.

This includes marketing materials “particularly that refer to prior performance”.

Finally the regulator is seeking documented investor special arrangements and co-investment information, based on its demand that companies provide copies of their “processes for identifying and managing the conflicts that arise from managing debt and equity investments positions for the same assets”.

Several lending and banking sector sources told The Australian it was time to shine a light on the private credit sector’s growth.

Jonathan Ng, partner and co-founder, Reach Alternative Investments.

Reach Alternative Investments partner Jonathan Ng said ASIC’s survey “seems to stem from a lack of visibility into how private capital managers actually operate” given Australia’s private credit sector was “still in its relative infancy”.

“Many of the operational practices, governance structures, and compliance frameworks are not yet fully developed,” he said.

Mr Ng, who is also head of investments at Reach, said the information gap in private credit was compounded by the reality that many investors were new to the asset class.

“ASIC may also be acting out of concern that not all wholesale investors are as sophisticated as the label suggests, and is looking to introduce safeguards accordingly,” he said.

Mr Ng noted a large portion of ASIC’s requests were aimed at unmasking conflicts of interest and preferential investor treatment.

“For global asset managers, particularly those already working with institutional investors, many of these practices are already well documented and governed,” he said.

“These managers often have been pushed to avoid conflicts or have transparent policies to deal with the conflicts.

“For example, many would proactively avoid managing both debt and equity in the same company via different vehicles, as it inevitably raises questions about whether one set of investors is being prioritised over another.”

But Mr Ng speculated whether asking for side letters may be an “overreach”, pointing out these were often used in commercial negotiations.

“They could perhaps simply say certain things are not best practice.”

Mr Ng was struck by the regulator’s apparent limited emphasis on headline management or performance fees, instead “zeroing in on related-party arrangements and less visible revenue streams that may influence manager behaviour in ways investors can’t easily monitor”.

“These arrangements aren’t inherently inappropriate. But without transparency, they can lead to misalignment between managers and investors,” he said.

One practice this may expose is the banking of consulting or servicing fees from borrowers or affiliates, acting as a shadow fee that doesn’t show up in fund-level expense disclosures and masks the true cost to investors.