In Conversation – Private Credit Financial Stability and Economic Resilience

very happy to be here. We're here to talk about private credit, financial stability, and economic resilience. Uh just to dive right in, Apollo's definition of private credit is a $40 trillion market, a more majority of which is investment grade. This includes non-traded and private corporate and consumer credit found on bank balance sheets as well as insurers, asset managers, pensions, and many others in the investor marketplace. Other market participants focus on a narrower definition of corporate lending, direct lending, broadly syndicated loans.

Estimates range in that category from about a trillion to to three trillion. Since the passage of DoddFrank and other regulations around the world, some credit provision undeniable that some credit provision has left the banking system and has now moved to the investment marketplace in particular in in regard to longduration investment grade and direct lending. So I want to start the start the panel with these types of questions terms of the scope of of the private markets you know the health of private credit today how supervisors are thinking about the migration and the growth and regulation in private markets and brie why don't we start with you.

Thank you. Um, so one Safari Jackson from the UK FCA. So one seen as a really niche area. We're seeing the the growth in private markets. The AUM has tripled over the last um decade.

It's a really important source of funding following the financial crisis. We've seen banks step away from providing um um loans to corporates and we've seen that the fund managers kind of stepping in to fill that gap. Within the UK, we we think our exposure to private credits via fund structures is around 1.2 trillion and it's really important in terms of its involvement with the economic development of the UK and economic growth and supporting the real economy. So, it actually accounts for 10% of the private sector employment and up to 15% of corporate debt is deemed to be private um private credit.

It really allows for a a tailored solution. I think there's a number of risks that we'll come on to when we're discussing that are maybe more prevalent within private uh market and private credit compared to the public sector or p um private markets, public markets I should say. But I think it's fair to say that we we very much see this as a growing area and we're keen to support that trend.

George, what are your thoughts on this? Um f first let me thank the the organizers for the their invitation to participate in this very interesting panel. So uh let me start by saying that um private private markets in general which includes private credit it includes venture capital in includes private equity. I think it's a very important market. Uh I think there is a need basically for um uh certain projects certain entities of high risk to get financing and this financing cannot come from the banking sector because of the various requirement and restrictions as it regards to uh lending out money to high-risk uh projects.

uh and it doesn't come from the public markets as well because we know the difficulties of the public markets and the fact that a number of entities have a difficulty in actually going through an IPO and and and and listing in a in a in a public market. So there is a need for the the the the the uh private credit and it's growing uh as I understand majority of that is in the US but Europe is also behind there is a 30% of the of the total market it's it's in Europe um and there is uh and talking also of being part of the ESMA board which is the European authority for securities and and and capital markets there is a renewed interest in understanding more about these markets and understanding more about what it entails as it regards to risks for the investors, what it entails as it regards to to risks for the uh um for for the system and and maybe I just very briefly point out a few of the of the risks that you know we would like to learn more about them basically as regulators which obviously the the one it's about a systemic uh systemic wide risk because of interconnections between banks, asset managers, insurance and pension funds which are obviously participants in these markets. The high complexity of the of the products, any liquidity mismatches that might exist, uh exposures in terms of leverage, conflicts of interest, uh complexity of the underlying products, uh and um valuation difficulties. I think it's another one that we have to mention. So all of these things I'm not saying that they they do exist but we have to learn more as regulators and in order to learn more we need to collect more data.

So um there is a need for collection of more data of more disclosures or more transparency so that we are able to assess whether these risks are significant or not. Uh and it's a it's a job of the regulators to do that and I think I'll stop here.

Thank you George. Well, well said. That was kind of covered the waterfront of some of the issues that we hear uh quite quite extensively from regulators around the world. Emanuel, what's what's your perspective on on this question?

Well, firstly, um I think I said this earlier today at a regulator summit that we hosted, we had 20 regulators uh discussing private credit today because we identified it 12 months ago as a as a topic that needed discussion amongst regulators. um it's been on the agenda of regulators for some time now with the FSB really leading the way and ICO coming into play but private credit has been around for many many decades it's not new but after the GFC it's become more and more prevalent mainly because because of regulations globally whether it's Basel or DoddFrank etc what we've seen here is a real interest in not only private credit but private markets as private uh as public markets are shrinking, private markets are growing and part of those private markets is private credit. So we came out with a private uh credit regime uh just in the last couple of years. Uh we believe that it's an area that has real opportunity but also risks. So we've tried to manage those risks.

Um, look, there are there's a number of challenges around private credit, but I think if it's done responsibly and we understand the risks, the underlying risks, whether it's the um the underlying assets that are involved, the credit quality, because people need to think about credit quality and the rating agencies utilize to determine that credit quality. So I think there's a lot of opportunity there though because the markets are constantly developing. The the challenge for us as regulators from what I'm seeing is the appetite by retail investors to want to get into this space. Traditionally it's been more the institutional side, the professional investor side, but we're getting more and more retail appetite and demand to enter those markets. So how do we as regulators make sure that retail investors are protected because ultimately that's one of our mandates is investor protection since

since you mentioned retail that is the the topic is your I'm going to put put one back to you here for a second. How do you think about the risk versus the opportunity for retail and what advice would you give market participants like Apollo in regard to its ventures to retail and then I'm going to come to the FCA right after that because there's a huge amount of emphasis there. Well, retail investors like high returns, low risk to

really equate very well with the with markets. Um so retail investors want access where they believe that they can have that that higher return but ultimately they need to understand and sometimes disclosure may not be enough but they need to understand that that higher risk involved in that higher return may need less liquidity for them. So we don't want retail investors jumping into a private credit space where the assets and the and and the instruments are illquid in in real est. So if you have an expectation that you're going to invest in a private credit product and you're going to be able to liquidate your position very quickly, then there's a disconnect because those types of investments are not liquid generally speaking. So how do you create the liquidity?

If you can create some liquidity in that space, then we'll consider it. But if you can't and you're in essence uh misleading investors into thinking that you can, then we have a problem.

Yeah. I uh gave a presentation to the ECB recently and and um they first question was what if you put 100% of a very small net worth investor's money into a illquid private account? I'm like that should not be happening. you know, that is the that is the debate that we're having as as a sector because these are the types of fears that are out there that are founded and and so buried, how how do you think about this question and given all the all the emphasis from the FCA?

I think it's a really good question. I mean, we've seen um private markets outperform public markets for some time now, we do think that retail investors deserve a choice. They should be able to gain that exposure to the private markets but through the right vehicle. So we've we've launched um what we call the long-term asset fund within the UK. So it's an authorized open-ended fund.

It has quite strict requirements in terms of its liquidity profile. So it has to have a notice period. It can't deal more frequently than monthly. Um and we also believe that that the retail investor in this dynamic needs to take some ownership themselves. So again to the point about diversification.

So, we've we've written into the rules that the UK retail investor should only be able to access um up to 10% or invest up to 10% of their investable assets into um long-term illquid um funds. We've also got really clear risk disclosures um making sure that um they understand that their money could be and should be locked in for quite a period of time. But let's be clear, there's there's a huge range of retail investors right through from your pension schemes that have that long-term investment horizon right through to to direct retail. So when we were developing that fund structure, we were also engaging with with the institutional investors who were investing on behalf of those retail investors and found that they didn't invest in the long-term liquid private market through pension schemes um despite having a really long investment horizon. So we we've kind of developed that fund structure fund structure to kind of support that.

Overall we think it's going to really change or there needs to be a cultural shift for retail investors to get comfortable with investing in private markets. So far we see 3% of the markets um having exposure but we we just see that growing going forward.

I agree with all of that. George, do you want to add anything perspectives?

Yes. Um so coming from the the European Union uh uh you probably are aware that there was a actually last week there was a proposal coming out of the commission uh regarding the SIU. It's called the savings and investment union. So it's the idea of of of putting more of the savings of European citizens into uh the capital markets basically. Uh so there's there's actually 10 trillion of of of of savings of EU citizens sitting at banks basically and the idea is if it's a portion of that can actually go into the capital markets and and um and within the SIU agenda there is also the need to grow the private markets as well which includes venture capital, private equity and and private credit as well.

um and and and also encourage investors to invest in long-term um so however when it comes to uh um investments which can be risky uh I can understand if there is a if it's part of a diversified portfolio right so if even if a retail investor wants to diversify their portfolio investing some risky uh products Basically it makes sense basically because it provides an element of the diversification. But we have to be we have to be careful though right because Emanuel mentioned about you know the difficulties basically as it regards to liquidity the difficulties as regards to disclosures you know uh do they understand basically what are what risks uh are included in these types of of of of products. So I am I am on the conservative side. I want the retail investors to invest more in securities and capital markets. But we need to be careful with the guard rails.

Yeah. The the disclosure and the fiduciary advice that that is needed for for many investors including myself when I'm accessing things that are you know I don't know. I mean we're all we're all we we can't all know everything. So all of these are I think very very thoughtful uh discussions that we're having and and um lots of proposals out there around the world. Um coming back to George something you had said earlier um with regard to uh interlinkages of the of the system.

Um you know the word interconnections has a special meaning to all the four of us on stage and many many business people that come to the table uh thinking about risk and so forth don't even really understand what interconnections are. So today we're having I think a more of a systemic risk oriented vernacular and jargon if you will that I think it's commonly understood by the financial sector more broadly. So even business people are thinking now about well how do we think about interconnected risk and so forth and and um you the UK has done a lot of good work in in putting out thought pieces around well if if we if we have more systemic risk analysis and disclosure then you can incorporate that back to the business managers and then they'll think about systemic risk and that feedback loop and I think that's kind of the world we're headed in but that with all of that said um there still is a lot of worry about the interconnection interconnections and interlinkages um both banks to non-banks but also within the NBFI ecosystem. So, so George, what's your what's your worry or and and and observations about those types of questions?

Uh yes indeed. I mean, you know, we have certainly we have to think about the intercon interconnectness. Um and obviously, you know, we had a we have a a good example of what happened during the global financial crisis of because of these interconnections between real estate markets and capital markets. you know we we have seen how the crisis propagated uh from one market to another. So uh there is a and if we look at the private credit market there certainly there are interconnections there are interconnections between the banks on the on the one side the asset managers and then from the perspective of the investors you have pension funds insurance companies which are basically investing citizens money you know for the for the for the future for their retirement.

Um so we need to think about you know whether there is an element of systemic risk in these markets and how we we go about it and I think the the the FSB the financial stability board is doing a lot of work in un in looking at these markets and IOS as well not not only FSB FSB and IOS so some international organizations are are are are looking at that and and there's also the conflicts of interest uh right so it could be the case that private uh funds private fund firms own insurance companies where the insurance companies are participating from the perspective of the the investors where the others are the one who are setting up the fund. So these conflicts of interest that exist like any market we need to deal with them basically and find ways to mitigate them right um so uh yeah it's something that and that's why I said earlier that more transparency uh enhanced reporting actually there was a report by the IMF uh last year discussing about um uh more intense supervisory approach to funds and investors closing the data gaps, enhancing the reporting requirements, monitoring, addressing liquidity and the contact of risk and strengthening international corporations are key to understanding these risks.

Okay, that's great. Emanuel, do you want to add anything to that? Well, I think um as regulators, we're always conscious of whether a risk becomes a systemic risk and and this contagion effect. At the moment, from what we're seeing and what we're hearing from industry bodies like AMA, for example, is that those types of risks are not eventuating. And I think if you look at the the recent collapse um in the United States with where there was significant amounts of private credit involved, everyone was holding their breath um to see whether there was contagion risk from first brands and there were a couple of others post first brand.

So it it felt like what's what domino is going to fall next and and how fast are the dominoes cuz I still remember the I still remember Bear Sterns and it was sort of the first domino really significant one to fall and so as a regulator you're always conscious of that. Um the interconnectedness of finances is something that you don't always have a full grasp of because it it's so global these days and there's so many counterparties involved and if one falls how many others fall because of that one. So um as a regulator we want to make sure that uh the systemic risk possibility if it if it is arising we need to be able to control it and and if if there is an incident we need to be able to contain it.

Yeah. Um I think I think I saw some statistics today which were not troubling but you know in the media and and a lot of the the data that comes out suggests there's around 3 and a half trillion um direct lending debt in the private capital in private credit market. Then I saw another number of 40 trillion and that 40 trillion number was in relation to um indirect lending through the private credit markets. So is there something in that that could potentially lead to a contagion systemic problem? We don't absolutely know because we don't have all the data.

So that's something that as a regulator unnerves me a little bit because I like to know what's going on. So these are the things that keep us up at night.

Yeah, understandable. I think um I think we will have our uh our our day in and with with supervisors and and they up all the way through the FSB just given the number of uh processes and inquiries that we have as a firm. I'm sure others as well. uh there is a huge amount of data that we have that the market has that it's just not in this common format across the across the globe across firms and so forth. So the the question that we have is what is the best use of our time and most effective way to have risk metrics out there and and and to provide the comfort and you know we won't represent everyone.

So we also worry about what if somebody does something really bad and that you know bad facts make really bad policy sometimes. So that's a real concern of ours. I'm I'm gonna ask one last question to each of you. Um, if you could have one improvement in the regulatory system or ask the market to do one thing that would help your life as a as a supervisor in the private credit area, what would what would that be?

So, I I would say that um one of the really important things is data. So, we're we need to know we need to have that visibility across the market. But we're working really closely in the the global fora to make sure we have the taxonomy getting the right data to do that testing. What we haven't tested is the the the downside. So what we're working with um closely with the Bank of England and what we call the systemwide scenario test to do a a systemwide stress test.

So we'll effectively say right okay the the rating's gone down by X amount. How do all of the market participants react to that? then we're going to say actually hold on do it again run it again you were down you weren't actually their preferred client you didn't get your liquidity line do it again this person acted that way that way so I think that would be my one ask is to see actually how everything is interconnected and for the regulators to learn from the industry to understand where the pockets of the risk actually lie going forward

thank you governor I think governor Bailey will will deliver some on on results next year um George

so I mean I I would agree that it's it's a provision of reliable data right I mean we need data that is reliable that can we can assess and uh and and and and come with the analysis in order to be able to guide the market uh in a better way.

Thank you Manuel.

I concur with my regulatory colleagues here. I think um the only other thing I would ask industry is to be open and transparent with us about the data that they do have and allow us to be able to supervise their activities in an open transparent way. Uh especially when it comes to private credit because we're learning and I think the industry is learning as it goes as well.

Very very very thoughtful. Trans all all roads lead back to transparency it seems. Um, and as a as an industry participant, I can I can say that's a consistent answer across the planet. So, thank all of our our panelists here. Very very much appreciate it.