The lack of reporting requirements for private assets gives private managers an advantage compared to investors who face stricter regulation. This benefit could disappear over time leading to lower returns on alternative credit funds, NN Investment Partners’ former head of alternative credit Gabriella Kindert told the IPE Summer Congress 2021 virtual audience today.
Kindert, an expert in alternative lending and a board member at Mizuho Europe, used the case of banks and asset managers investing in leveraged loans as an example to illustrate the opaque environment many alternative credit managers operate in.
“From my time working at a bank [in the early 2000s at Dutch bank MeesPierson], I remember that banks have to report line by line on everything they do in leverage loans. Private debt funds don’t have that level of scrutiny,” she said.
Thanks to this relative regulatory freedom, private debt funds can make high returns on their assets, she added.
“Investors need to be cognisant of the fact that a 7% return, which is not abnormal for alternative credit funds, is very high. When I was in banking, I never had a loan returning more than 6% unless it was distressed debt or mezzanine.”
Investors should be aware of the risk this “regulatory arbitrage”, which also exists between public and private markets, could at some point disappear, she warned.
“Because of the lack of reporting requirements in private markets, there also tends to be a big information asymmetry in terms of knowledge between general partners and limited partners [i.e. end investors such as pension funds] with regards to the risks of the underlying assets of the investment, the potential recovery rate of a credit and the collateral being used,” said Kindert.
Because of the lack of regulatory oversight, risks in alternative credit can easily be overlooked, she continued.
This notion is especially urgent considering the growing importance of ESG criteria, she noted, saying: “I’m fundamentally convinced enterprise values will look very different in 2030 than today because of this. The world is not on track to meet the Paris goals, and therefore we need a reset to define enterprise value. Considering financial profit is not enough.”
Because of the lack of ESG reporting standards in private markets, there is an urgent need to improve transparency on this front and to develop standard on how to measure ESG risk, Daniel Booth, CIO of UK pension investor Border to Coast, told IPE in April.
Cyril Demaria, a private markets consultant and professor at EDHEC Business School who attended the same panel on private markets, resisted the introduction of stricter reporting requirements on ESG, claiming this would be too expensive and difficult to implement.
“Requiring private firms to do more reporting will lead to higher costs [and lower returns]. And besides, there’s no definition of ESG so there is no consensus on what to report on. It would be like opening a Pandora’s box.”