SQM Research has responded to concerns regulatory bodies the Australian Securities and Investments Commission and the Australian Prudential Regulation Authority have expressed with regard to the private credit sector by putting the asset class on watch status.
Changing the private credit sector’s treatment means the research house will be increasing its active monitoring of the asset class, with SQM confirming it has adjusted its rating scoresheet to reflect a greater focus on governance.
“We are taking this precautionary measure in response to increased issues observed in the sector and in response to recent announcements by our financial sector regulators. This action doesn’t necessarily mean that a fund rated by SQM will be automatically downgraded or placed on hold,” SQM Research managing director Louis Christopher explained.
“However, it is viewed as a necessary step to ensure appropriate oversight of an asset class that has been growing in relevance and size over recent years.”
The concerning issues that have been identified with the sector include a lack of transparency as to who the borrowers are, questionable categorisation of the assets regarding liquidity characteristics, lack of transparency in sub-fund holdings and group financials, and inadequate disclosure within information memorandums.
Further, SQM is concerned about the asset class’s elevated loan-to-value ratios, vertical and horizontal related-party structures, a rise in loan arrears and refinancing of existing borrowing arrangements when they were set to be exited, significant interest rate margins not being passed on to investors and a jump in instances of misaligned stated liquidity compared to the actual liquidity of the underlying loan assets.
“As our financial regulators have stated in recent months, there is a clear link between weak governance and poor outcomes for investors. And so, while we have throughout our ratings research history placed an emphasis on fund governance, we are determined more than ever to reduce the risks for investors by taking an increasing cautious approach to potential governance issues,” Christopher confirmed.
“It must be stated there is no imminent event that SQM Research is aware of that may trigger a series of fund failures and that overall SQM Research expects the sector to weather current challenges. The private markets sector has a positive future in front of it as there are genuine opportunities for investors.
“What we are observing to date is nothing like what was experienced back in 2008 when a large number of mortgage trusts were forced into redemption suspensions. However, I think the risks within the sector have increased in recent times and so increased diligence is required.”
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