Political risk: New threats to European private credit

As private credit grew rapidly around the world, many commentators tried to find cracks in what is an extremely successful asset class, writes Jiri Krol.

There was too much competition; spreads were worsening, as was credit quality; and loan terms were too loose. As soon as we entered the next cyclical downturn, these commentators predicted private credit would crash and burn.

Jiri Krol

When covid-19 happened, the asset class confounded those critics and proved itself a dependable provider of capital. Q4 2020 saw record dealflow and 2021 performance to date suggests the industry continues to expand at an amazing pace. But while the market has proved resilient, there are clouds on the horizon: new regulatory interventions from Brussels. Amendments to the Alternative Investment Fund Managers Directive – under which most private credit managers operate – will see new rules for loan funds in Europe.

The EU wants to support the growth of the European private credit market by addressing some of the challenges faced today when lending on a cross-border basis. For example, French-domiciled funds can lend in France, but Luxembourg funds cannot. Although some jurisdictions, such as Germany, accept cross-border lending in certain circumstances, the overall picture is that of a complex patchwork of rules creating costly legal and compliance issues.

A common EU approach could enable a loan origination passport which would cut through these rules. So far so good, but this privilege is likely to come at a high price.

Loan funds are on the radar of macro-prudential regulators as a source of potential systemic risk. This means the EU is also likely to introduce additional regulation around fund leverage, liquidity risk management as well as interconnectedness with the wider financial services sector.

Knowledge ‘underdeveloped’

The precise shape of this is not clear but some of it will take inspiration from existing loan origination fund regimes in Ireland and France. Both include fixed leverage limits, mandatory fund structures (closed-end), various ‘skin in the game’ risk retention provisions on dealings between funds and the banking sector, as well as rules around eligible assets – all of this based on a narrow definition of what a loan origination fund is. Introducing these Europe-wide is likely to limit the flexibility of credit fund managers to develop innovative strategies or expand existing business.

The European Commission is set to present its proposals this month. Once published, these will be subject to amendments by the European Parliament and Council. Both have taken a circumspect approach to the non-bank lending sector in the past decade. Knowledge of our sector among many politicians remains extremely underdeveloped, as witnessed in the negotiations on the legislation regulating credit servicers.

The Alternative Credit Council has been able to rebalance perceptions of our market through years of intensive research and public advocacy, but negative opinions of our sector still have traction among many politicians. Non-bank lenders are often incorrectly described as unregulated, lacking expertise and posing significant risks for borrowers and investors alike.

Our industry risks being tied by onerous rules and boxed into a constrained operating model if we cannot convince legislators to take a proportionate approach to regulating our sector. The ACC has been working with our members to define what those policies should look like. We also meet regularly with policymakers to raise awareness about the value members provide in supporting the real economy.

To support this, we have published a position paper that will educate policymakers and assist them in achieving the stated objectives of the EC proposal – the sustainable development of the asset class. We will also continue to demonstrate the value of our industry to politicians and why they should cultivate rather than constrain.

We hope all private credit providers will join us in this endeavour.

Jiri Krol is global head of the Alternative Credit Council, a trade body that represents the interests of private credit and non-bank finance participants in asset management

To request a copy of the ACC’s position paper please contact info@lendingforgrowth.org