An ASIC-commissioned report, Private credit in Australia, prepared by former banker Nigel Williams and infrastructure investor Richard Timbs, found that private credit funds with large superannuation and institutional investment generally demonstrate sound governance and transparent valuation and fee practices.
In contrast, segments of the market targeting wholesale investors using the “sophisticated investor” exemption and retail-based offerings, including platforms, “have practices that do not compare favourably against international practice”.
“Lenders in these segments are more likely to have conflicts of interest, opaque fee and interest margin arrangements, inconsistent and non-independent valuation methodologies, and ambiguous terminology,” the authors wrote.
The warnings come after months of sector surveillance, prompted by ASIC earlier this year flagging the vulnerabilities that super funds’ growing exposure to private credit could pose to financial stability.
In consultations over possible regulatory action, several super funds, including industry body ASFA, have urged ASIC to tread carefully, cautioning that heavy-handed regulation could undermine a sector that plays a key role in delivering superannuation returns.
But in Monday’s report, Williams and Timbs argued that ASIC should consider regulatory intervention, citing, among other issues, the heightened risks faced by smaller super funds – particularly self-managed accounts – compared with larger institutional investors.
“A number of the real estate funds targeting self-managed superannuation funds offer monthly distributions of approximately 0.70–1.00 per cent, despite these loans not generating regular interest payments. The question needs to be asked as to whether distributions are being paid from capital – from loan capital drawdown or new investor funds,” the pair said.
Elaborating on discrepancies between larger and smaller funds, the authors also highlighted stark differences in fees, noting that international managers and those backed by large superannuation funds typically retain little or no borrower origination fees, while managers of real estate and smaller super funds often keep a higher share.
The authors cautioned that while presented as an “alignment of interest” between managers and investors, these fees are often excluded from official disclosures, their size is rarely revealed, and they can exceed the fund’s regular management fees by several times.
But while the report mostly praised the institutional end of the private credit market – including very large superannuation funds – for demonstrating “good operating practice”, it warned that pre-investment information, documentation, and ongoing performance reporting still require significant improvement.
At the other end, it advised funds targeting wholesale “sophisticated” and retail investors to provide “more transparency on risks, loan valuations and loan characteristics”.
The report also highlighted that fund trustees must be fully aware of and educated about the nature and risks of private credit investing, even when relying on third-party advice.
“In what can be a complex asset class, it is possible and even probable, that many superannuation fund trustees do not yet have a proper understanding of private credit. This is a potential problem for the sector,” the authors said.
On potential structural shocks, the report warned: “While we have not assessed the systemic risk to the Australian financial system from private credit, we note the concentration in real estate construction and development finance, which has represented the majority of credit losses in past economic downturns in Australia and overseas,” the report said.
“This segment of the market may present as a systemic risk for small and self-managed superannuation funds and ‘sophisticated’ investors in a downturn.”
To improve transparency and investor protection, the authors recommended regular reporting on fund composition and independent loan valuations, clear disclosure of whether credit ratings are internal or third party, disclosure of mezzanine debt and equity holdings, and full transparency of all manager fees and earnings, including interest.
They also recommended enhanced transparency over liquidity risk management and leverage, independent review of related-party or inter-fund transactions, and consistent use of investment and real estate terminology across the sector.
Ultimately, they conclude: “Private credit, done well, has a valuable role to play in the Australian economy.”
The focus on super is a part of a much broader, in-depth look at the private credit market, which called out how private credit is packaged, priced and disclosed.
At the heart of the critique are four recurring themes: conflicts of interest – “prevalent across fee structures, valuations, related party transactions and loan structuring”, opaque remuneration, inconsistent valuations, and terminology.
