Poor disclosures, conflicts of interest, and a failure to prepare: ASIC has private credit figured out
Lenders to the construction and development sectors have been named as the worst offenders in Australia's $200b private credit market.
The corporate regulator has sounded the alarm on the dark side of the private credit market where retail investors are vulnerable to being ripped off by inadequate documentation and conflicts of interest.
The Australian Securities & Investments Commission identified concerning conduct, including several funds in breach of the law and financial controls, according to the report prepared by former CBA banker Nigel Williams and financial analyst Richard Timbs. They singled out organisations lending to the construction and development sector as the worst offenders.
ASIC has been increasingly worried about poor behaviour in the private credit market, thought to represent more than $200bn of investor capital in Australia.
On Thursday, it swooped on La Trobe Financial by putting a temporary freeze on its ability to accept new money across funds worth $13.8bn amid concern about the quality of its regulatory disclosures to investors.
ASIC said its review, done in the wake of surveys and industry surveillance, showed the need to improve disclosure standards and how investors are treated.
Chairman Joe Longo, who will leave ASIC in May next year, said it was up to the sector to deliver “enhanced standards”.
“They will help promote confidence, improve market integrity and empower investors to make informed decisions,” he said.
“When an industry agrees on clear standards, it shows a strong commitment to doing things right and we welcome the industry’s commitment to leading this work. They need to act decisively.”
The regulator has good reason to act. Investors piled almost $1.2bn into the First Guardian and Shield Master Fund schemes through their superannuation savings, only for those to be frozen amid allegations of fraud and mismanagement. Liquidators are trying to recover money for investors but some of the funds were lent out to other parties and will be difficult to repatriate.
Mr Longo said ASIC’s review found “encouraging practices” among some lenders.
But it is focused on several examples where conduct “fell short of market expectations” or was “inconsistent with existing financial services law”.
ASIC is looking to make an example of some private credit lenders who act illegally.
Among the poor behaviour ASIC identified are its concerns around valuations, liquidity, and disclosure.
The regulator notes many market participants are already bound by requirements to engage honestly and fairly and avoid misleading or deceptive statements. But this was not always the case.
Mr Longo said the pace of growth in private credit made reform of the rules governing it “all the more important”. “Promoting confident and informed market participation is a shared responsibility, including those already demonstrating and upholding high standards,” he said.
“ASIC expects meaningful action in response to these findings and will not hesitate to intervene where progress falls short.”
The report finds the wholesale space that invests on behalf of the largest clients was reasonably well behaved. Retail and sophisticated investor options were more problematic and many funds were beset by conflicts of interest or poor disclosures.
In some cases, lending managers were accepting significant upfront fees which could “conflict with maximising the interest margin to the benefit of the fund investors”. And lending margins were being skimmed by managers, resulting in them acting both on behalf of investors and on their own as intermediaries.
“The true interest return for the risk being taken is not being passed on to investors, or is not completely transparent to investors, impacting their potential understanding and assessment of credit risk,” the report said.
The review identified lenders holding multiple competing capital stack exposures to projects, which could see them prefer one class of investors over another.
Funds in high-risk real estate construction or development “represent the greatest priority for addressing potential conflicts of interest and improving transparency”.
Further, the regulator’s review notes given the market is yet to experience a downturn, the funds had not considered how to manage their way through a crunch.
Many managers do not have adequate provisions for expected losses set aside.
The $1.2bn private lender Merricks, picked up by Regal in a $225m deal last year, has suffered several problematic exposures in its loan book including the Milligan Group’s Halo Tower project in Sydney.
Last week, the Federal Court of Australia made orders in a $38m dispute between Merricks and Yass-based farmers John Waldren and Tom Waldren, who had borrowed money to develop land to sell.
ASIC’s private credit review canvasses several international models for regulating the private credit space, pointing to the American Business Development Company reporting model as an exemplar.
The authors note while the BDC disclosure regime cannot be exactly replicated for the Australian credit market, “it does provide a good reference point for testing what disclosure might be appropriate for unlisted private credit”.
Disclosure of individual borrower names “is not appropriate” given the size of the Australian market.
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