Author/Interviewee: Christoph Gugelmann, Co-Founder and CEO of Tradeteq
There comes a point in the history of every new market, commodity, or asset class where the traditional players start to take notice. For private debt, that moment has finally arrived – coming after more than a decade of steady, though largely unsung, growth.
Towards the end of last year, a host of traditional banks announced plans to enter the private debt market, or to greatly scale up their existing offering. First to jump was JPMorgan Chase; soon followed by Barclays, Rabobank, Wells Fargo, Société Générale, Deutsche Bank, and – most recently – Citigroup.
Doubtless, the entry of these big players will do much to spur the private debt market on. The financial resources that traditional banks can bring to bear will certainly increase liquidity, which has been a perennial problem for the private debt market for over a decade. There are already signs of this: Deutsche Bank is set to raise €2 billion from investors to begin furnishing private debt loans.[1] It’s developments like these that have caused Preqin, a market data provider, to predict that the private debt sector will be worth US $2.3 trillion by 2027.[2]
But the private debt market is still in many ways opaque. If the sector is to keep up its impressive levels of growth, then it will need to become more open and transparent to involved parties; and this is something that can be accomplished by harnessing digital technology.
What is attracting banks to private debt in 2024?
The entry of these flagship institutions is a milestone for a market long considered a slightly recherche alternative to more conventional funding options like bank loans or corporate bonds.
Private debt is now considered a credible alternative to these traditional sources. We can trace this all the way back to the immediate aftermath of the Global Financial Crisis, where new financial regulations such as Dodd-Frank made public credit harder to access, driving firms to private debt as another way to fund projects, mergers, and acquisitions.
Other market and regulatory forces are also causing banks to take notice of this asset class. Private debt has greatly benefitted from the global IPO drought – that is to say, the increasing reluctance of growing companies to list on the public market at all. Growing companies are more and more likely to seek funding on the private market, and this has of course been a boon to private debt. The asset class is also becoming the favoured financing option for leveraged buyouts (LBOs), as this capital is subject to fewer regulations and can be raised more quickly for this purpose than from banks.[3] According to PitchBook, 108 of 120 tracked LBOs were carried out with private debt.[4] Further, the Basel IV regulations, which are to be rolled out in 2025, are expected to cause banks to cut down on lending by tightening up capital requirements and regulating internal risk modelling.[5] This will, in turn, cause them to look further afield for new sources of revenue.
There is, in other words, every incentive for big banks to now enter the private debt market. As methods of financing change, these traditional players are looking to keep up.
The growing pains of private debt
The arrival of these traditional institutions is a testament to the growing maturity of the private debt sector. However, it is still a sector that is far less developed than, say, traditional banking or the public market. This has led to three problems for the sector.
For one, there is a problem with information flow in the market. Private debt is of course not cleared on any kind of central exchange, and instead takes the form of a direct relationship between borrower and lender. This can make the market less transparent than others, and these traditional banks will have to carry out more due diligence than they are perhaps accustomed to in order to lend with confidence.
Second, there is the matter of private debt liquidity. This problem also has its origins in the opacity of the sector, which limits market discovery.[6] Would-be borrowers and lenders find it difficult to find one other, and often rely on specialist brokers. This of course raises costs for all involved – and it puts a bottleneck on the flow of transactions. The result has been a perennial problem with liquidity over the last decade and a half, where there has not been enough liquid private debt in the marketplace to service growing demand.[7]
Third, there have been concerns about the risks involved in private debt to financial institutions. The ability of financial institutions to value the loans themselves poses a fiduciary risk. These valuations – the methodology of which are often opaque – means that the loans could be abruptly reappraised; with the potential for major losses if a financial institution is heavily exposed to these instruments. This problem, again, ties back to the general difficulties with information flow and transparency – in this case, with the ability to make credible valuations of assets in the marketplace.
Next steps for a maturing asset class
To solve these three interlocking problems, and to achieve a greater level of maturity as traditional players enter the sector, the private debt will have to become much more rationalised and transparent.
Platforms like Tradeteq are accomplishing this through technical innovations. Such platforms greatly simplify the private debt market by providing what it currently needs most: transparency, clarity, and open lines of communication. Tradeteq, for example, allows users to broadcast their offers to the marketplace, track negotiations with buyers and sellers, analyse their portfolios, and to automate legal documentation and asset selection.
These innovations are helping the private debt sector to mature, and to begin to solve the problems that have dogged it. An open and centralised marketplace allows leading global banks and alternative lenders to connect, interact, and transact with institutional investors. This helps improve liquidity in the private debt marketplace by allowing for easier and cheaper market discovery. Further, such a marketplace would allow for much greater clarity and accountability in valuations, reducing risk to the balance sheets of financial institutions. In addition, the platform’s automated legal documentation function helps create a more developed regulatory structure for the market; allowing banks and other institutions to lend with much greater confidence. It also opens up the market to smaller institutions that cannot afford large legal departments.
The arrival of big traditional financial institutions is a testament to the private debt sector’s success – but it is also a call to action. If this asset class is to truly enter the financial mainstream, then it must build up the appropriate regulatory and commercial architecture to match. Given the often-slow pace of regulatory change, technology can and must lead the way on this front.
[1] https://www.bloomberg.com/news/articles/2022-06-02/deutsche-bank-plans-multi-strategy-push-into-private-credit
[2] https://www.alliancebernstein.com/corporate/en/insights/investment-insights/private-credit-outlook-evolution-and-opportunity.html#:~:text=According%20to%20Preqin%2C%20a%20data,to%20%242.3%20trillion%20by%202027.
[3] https://www.blackstone.com/insights/article/private-credit-meet-higher-for-longer/
[4] https://pitchbook.com/news/articles/banks-private-credit-debt-2024#:~:text=So%2C%20why%20are%20banks%20now,2023%20Global%20Private%20Debt%20Report.
[5] https://www.nordea.com/en/news/basel-iv-is-coming-what-you-need-to-know
[6] https://www.federalreserve.gov/econres/notes/feds-notes/private-credit-characteristics-and-risks-20240223.html
[7] Private debt secondaries flooding the market overwhelm limited capital – PitchBook
