Breaking down the barriers to investing

A large portion of the world’s assets are tied up in private debt assets, yet these assets are difficult to trade. Christoph Gugelmann of Tradeteq explores the challenges around securitising private debt assets and how emerging technology can widen the pool of investors

Christoph Gugelmann

Private debt has emerged over the years as a key market for investors – it boasts excellent performance and has accumulated approximately $93 billion through 2022 in returns, while offering portfolio diversification during volatile times.

Yet, despite their attractive qualities, private debt assets are not easy to trade, mostly due to high-cost barriers and a lack of investor access.

There is an estimated $3.5 trillion of private debt and real assets under management globally. Traditional asset managers securitise these assets into funds but charge high management fees and interest for manual workflows, deterring investors from entry.

This also causes difficulties for asset sellers such as banks and non-bank originators who face increasing capital restrictions and need to free up their balance sheets. This lack of investment means that asset sellers must also be prepared to hold the debt to maturity, leaving them in a vulnerable position.

However, new technology can convert private debt assets into various forms of tradable instruments with real-time processing, more advanced reporting and reduced friction costs. This has the potential to break down the barriers to investing in private debt and, crucially, widen the pool of investors.

Enabling access to secondary trading markets

The key to overcoming barriers in the private debt market is improving access.

There is widespread acknowledgement of the attractiveness of private debt as an asset class, but investors struggle to access the market due to high costs and operationally intense reporting requirements.

By opening up private debt to capital markets, banks and non-bank originators will be able to more easily sell their assets and free up their balance sheets, while institutional investors will have more opportunities to invest and create alpha.

Secondary markets also grant the ability to review and choose different investment options. Institutional investors such as pension funds can compare the advantages of potentially higher-yielding instruments against the risk of defaults in a tougher environment before making any portfolio decisions.

This increased level of transparency enables private debt to be invested in the same way as other asset classes and is generating interest in new forms of capital.

Investors can also utilise cloud-based platforms to manage the end-to-end trading lifecycle, receive notifications of deals, and gain the ability to match specific deal criteria and negotiate terms.

In effect, a primary marketplace would form a bridge connecting asset sellers and institutional investors, enabling collaboration and creating new opportunities for both.

Securitising assets that are difficult to transfer

Securitisation transforms assets that are difficult to sell into tradable liquid instruments, enabling asset sellers to refinance their debt and reduce the amount of liability they hold. The process also allows for smaller debts, such as consumer debt, to be grouped together with other assets and repackaged into readily available products.

Meanwhile, investors can gain exposure to a wider range of investible assets and the opportunity to diversify their portfolios. While investors would traditionally struggle to access real estate, trade finance, aviation and other such asset classes, securitisation is now unlocking the barriers to entry.

Traditionally, assets are securitised off-chain and made available via capital markets notes. Banks pool together the necessary assets and sell to financial institutions. These firms then issue the pooled assets to capital markets investors in a tradable format.

However, in recent years a new method of on-chain securitisation has emerged – tokenisation. Through the use of distributed ledger technology, a wider pool of investors is now able to access private debt instruments.

Assets are being securitised into regulated security tokens using blockchain technology. The potential is huge – the total size of tokenised illiquid assets could reach $16.1 billion by 2030, according to a report by Boston Consulting Group and ADDX.

The introduction of digital assets unlocks access to much lower minimum investments for a fraction of the cost, creating the opportunity for portfolio diversification and democratising access to opportunities previously reserved for investments managers and larger players only.

Security tokens also provide much needed stability and substance as they effectively provide an on-ramp for the real economy into the private debt market. Their collateralised, regulated nature can neutralise the impact of recent market turbulence, geopolitical tension and price slumps.

Automating workflow to reduce friction costs and boost yield

Currently, institutional investors struggle to gain efficient entry to private debt and real asset investments due to high operational costs and intense manual processes. Trade finance is an example of an operationally intense, low-risk asset class within private debt. Manual distribution processes are error-prone and regularly cost more than the yield a bank-originated trade finance pool can provide. This explains why bank balance sheets are still by and large the sole host of trade finance and why capital market investors have not found access yet.

For an investment bank to execute on behalf of an asset manager, the transaction costs would exceed the asset spread of short-term bank exposure, limiting access to a small portion of riskier assets.

Workflow automation is a tool that can be used to free up resources, increase capacity and lower operational costs. The technology has made significant advancements over the past decade and is continuously evolving to offer both asset sellers and institutional investors the potential to identify and monitor risks, resulting in higher investment yields.

The adoption of workflow automation is already on the rise, with the technology projected to reach $12.61 billion by 2023. It’s likely that the increasing amount of transaction data required will also make automation a necessity for the securitisation and distribution of private debt assets over the next few years.

Market factors and strict regulation have forced asset sellers to reduce their lending activities, an issue that is likely to continue. It has, however, led to the emergence of asset distribution as a lifeline for the private debt and real assets space, creating an essential need for investors to gain access to the market. By utilising available technology such as cloud-based marketplaces, tokenisation and workflow automation, distribution can be widened to break down barriers, create additional opportunities and welcome a wider pool of investors.

Christoph Gugelmann is co-founder and chief executive officer of Tradeteq, a London-based marketplace for private debt and real assets