The following article, from an offshore law firm, looks at the rise of private credit, how it works, its place in wealth management, and more.
The following article comes from Michelle Frett-Mathavious,
partner in the BVI office of offshore law firm Harneys. She talks about the
world of private credit, which has expanded rapidly in recent
years, fuelled to some degree – until two years ago – by
more than a decade of ultra-low interest rates and tighter
capital regulations on traditional banks after the 2008 market
crash.
The rise in interest rates since the pandemic has shifted the
equation. The International
Monetary Fund recently
raised a red flag about potential systemic risks in the
growth of such “shadow banking.” Even so, the editorial team
continues to be regularly regaled about the benefits of private
credit and why wealth managers should use it for clients. We
will cover this market with a balanced view, mindful of how the
long-standing financial trends can be repackaged in new
guises.
The editors are pleased to share this content; the usual
editorial disclaimers apply. Email tom.burroughes@wealthbriefing.com
if you wish to respond.
The rise of private credit
Global events of the past decade in particular have done nothing
if not reinforce the notion of change as the one constant. One
area in which the adage certainly resonates is within the global
finance system which has itself borne witness to a changing
landscape, characterised in many ways by what appears to be a
supplanting of the dominance of traditional bank lending with
various alternative lending strategies deployed by private credit
lenders.
The vacuum created by the largely retrenched position of banks
has opened wide the door for alternative sources of financing for
borrowers. As private credit (or private debt as it is also
known) continues to amass more and more of the market share
previously enjoyed by traditional bank lending, it seems certain
that the somewhat subtle shift in the lending market is here to
stay.
What could well have been little more than lightning in a bottle,
has planted roots and some may say, grown wings since its
emergence. The gradual but steady rise in alternative credit
originated more than a decade ago as a direct result of what is
now commonly known to most as the global financial crisis.
Resulting from the meltdown across the global financial system
which occurred in 2007/2008 was the creation of certain market
conditions and investor demand for alternative sources of credit
to plug a gap left by the traditional banking system. Tough
conditions often act as catalysts for change and the prevailing
conditions at the time ultimately gave life to the alternative
lending sources that we see at play within the finance system
today.
The market has grown to a position where at the beginning of
2023, it was valued at approximately $1.4 trillion, with an
estimated growth trajectory of $2.8 trillion by 2027. By any
measure, this signifies the importance of private credit to
global finance and lenders operating within the space, who span
the gamut from private equity to varying types of funds and
institutional investors such as hedge funds. Alternative
investment funds have significant sums of money at their disposal
for lending.
This makes the market an undeniably important source of financing
for corporates seeking capital and as a counterpoint to the
borrower perspective is that of the lenders within the space. The
market operates to serve dual interests and as an investment
strategy, engaging in private lending has proven very lucrative
for the investment portfolios of many private lenders. As long as
this continues to be the case, the greater the likelihood that
the alternative sources of funding associated with private credit
will continue to command the market share it has carved out for
itself.
The impact of private credit
The impact of the more recent global events relating to the
Covid-19 pandemic, elevated inflation and ongoing regulatory
pressures for banks (particularly regarding issues such as
regulatory capital requirements for banks) has stifled bank
lending over recent years. While the worst of the pandemic now
appears to be in the rearview mirror and some indicators point to
an ease in interest rates on the horizon in the not too distant
future, the regulatory pressures seem less likely to abate. On a
macro level this means that we are likely to see
a favourable environment continuing for private credit
transactions which has developed over the past several years.
It is difficult to deny the appeal of the flexibility associated
with private lending. The availability of tailored lending
solutions means that, unlike traditional bank lending (which in
many ways remains locked into operational practices which can be
viewed as cumbersome), private credit lenders have the
flexibility to offer borrowers customised solutions for facility
size, the form of financing and even timing for completing
transactions, all taking into account the specific needs of
borrowers. Many private credit transactions also feature floating
rates which adjust as interest rates change. The innate
flexibility of this approach is one which many borrowers find
appealing (particularly when compared with alternate
fundraising sources such as fixed-rate bonds).
While in more recent times it has become clear that private
credit transactions involving larger corporates are also on the
increase, primarily small and medium-sized businesses (arguably
the backbone of most economies) in need of capital for both
operational and expansion purposes have benefited most, having
found a ready market in private credit.
Over the last few years, during a period of fiscal stress
for many SMEs in particular, the optionality available to them
has been a welcome boon.
Whether the solution for the particular borrower comes in the
form of direct lending (which is often made available to private,
non-investment-grade companies offering a source of steady
income), mezzanine financing or preferred equity (which typically
takes the form of junior capital, providing a source of junior
debt for borrowers while providing an equity incentive for
private lenders) or distressed debt (helping financially
distressed companies navigate their way through balance sheet
restructuring and operational stabilisation), there is undeniable
appeal for borrowers in dealing with lenders with (in stark
contrast to traditional bank lending) flexible and innovative
approaches to lending.
Navigating the nexus: Private credit and the offshore
world
Having established its value to the global credit system, private
credit now plays a role in facilitating global capital flows in
ways which are both similar and dissimilar to that played by
traditional bank lending.
Increased market share across Europe, the US, Asia and beyond,
fuelled by the demand for credit by borrowers and an enhanced
investor risk appetite has positioned it to function on a level
akin to banks within the context of cross-border financings which
typically involve both onshore and offshore elements.
The same features (such as tax neutrality, efficient regulation
and well-established legal jurisprudence) which make the use of
offshore vehicles domiciled in jurisdictions such as the British
Virgin Islands and Cayman Islands attractive for use in bank
financed lending transactions hold true for non-bank
financing.
The flexibility associated with private credit transactions
marries well with the flexible nature of offshore corporate
vehicles which feature in many cross-border finance transactions.
As the market continues to grow and evolve and parties continue
to explore ever more innovative financing options, we would
expect the commonalities between the world of private credit and
that of offshore to continue generating synergies between
the two.
