The New Norm of Private Debts in Asia

Asia's private credit industry has the potential to become an appealing market for investors seeking high returns.

Across the globe, private debt is experiencing a surge in popularity. This alternative asset class, offering attractive returns and diversification benefits, is rapidly becoming the "hottest" option for alternative investments. According to the International Monetary Fund (IMF), the private credit market, in which specialised non-bank financial institutions such as investment funds lend to corporate borrowers, topped $2.1 trillion globally last year in assets and committed capital. This resilient private asset class also boasts a 10% compound annual growth rate over the past decade, and the global private debt market is expected to reach a staggering $3.5 trillion by 2028.

In this global landscape, Asia is experiencing its fair share of similar growth dynamics. According to IMF and Preqin Pro, data from 2023 indicated that Asia’s allocation to private credit remains under-represented. While Asia contributed 36 percent to global GDP, the region comprises only 7% of global private credit assets under management. This implies that Asia’s private credit market has significant growth potential.

The recent growth of private debt arises from an undersupply in bank lending coupled with the evolution of nonbank financial intermediaries. New regulations have also made it tougher for businesses to access traditional bank loans and public markets, which has created an opening for non-bank lenders in the private debt space.

At the same time, banks are becoming increasingly reluctant to lend to real estate, which creates an opportunity for private debt to step in. Recently UBS noted that reduced lending by regional banks presents opportunities for private debt providers to enter the commercial real estate sector, albeit with challenges such as debt defaults due to rising operational and financing costs. 

Beyond tradition: allure of the private debt market in Asia
The Asia private credit industry has the potential to grow as an appealing market for investors seeking high returns. According to a recent survey conducted by alternative asset manager Coller Capital, 72% of respondents wanted to increase their private credit holdings in Asia. 

This is largely due to strong economic growth in Asia which is attracting investors seeking higher returns on their capital, fuelling demand for private debt options. As reported by Harneys, small and medium-sized enterprises (SMEs) are also the backbone of many Asian economies. Private debt offers them financing solutions that might be more flexible than traditional bank loans. For example, customised loan structures that cater to specific business needs with different strategies for lending like direct lending, mezzanine debt, distressed debt and special situations.

Key Asian markets are ushering in long awaited structural and regulatory changes which are unlocking significant potential for Private Debt. India announced the Insolvency and Bankruptcy Code legislation in 2016, which has given a significant boost for private participation, risk control and realisation of assured returns. The Singapore government acknowledges the private debt market’s potential as a growth driver, particularly with a cautious banking sector and the Hong Kong government is considering new tax rules that would treat the private credit business more favourably.
With growth comes challenges – navigate regulatory crossroads 

Alongside these exciting opportunities for the private credit market in Asia, lie significant challenges that the IMF urges authorities to consider a more intrusive supervisory and regulatory approach to private credit funds, their institutional investors, and leverage providers, to ensure sustainable growth.

1. Transparency and standardisation
A key regulatory concern is the varying legal and regulatory frameworks across Asia which creates a fragmented private debt market, hindering lenders and investors from effectively comparing and assessing risks. To address this, regulatory measures can play an important role in fostering transparency and standardisation. This could involve: 

• Harmonising disclosure requirements: Regulatory bodies across the region can strengthen cross-sectoral and cross-border regulatory cooperation and make asset risk assessments more consistent across financial sectors. This standardised framework will minimise risk and capitalise on opportunities in the Asia private credit market when it comes to disclosure of private credit transactions
• Encouraging rigorous due diligence: To ensure transparency and thorough scrutiny, private credit investors must prioritise rigorous due diligence in order to comply with regulatory requirements

2. Strengthening credit reporting systems  
Another challenge is the limited credit history which creates significant data gaps. Many Asian businesses, especially SMEs, lack a long track record. This can make it challenging for lenders to accurately assess creditworthiness. Limited access to credit history can lead to overborrowing. Strengthening credit reporting systems is essential to address this challenge. Regulators can:

• Expand credit bureau coverage: Encouraging wider participation of businesses in credit reporting systems would provide lenders with a more comprehensive view of a borrower's credit history.
• Enhance data collection: Enhancing data collection to better monitor private credit's growth and its implications for financial stability  

3. Mitigating risks from uneven growth and economic slowdown
Rapid private debt growth can lead to situations where companies become overleveraged, increasing the risk of defaults during economic downturns. CNBC recently reported that the world is looking at a debt crisis that will span the next 10 years. Moreover, an uneven growth can lead to economic slowdowns. This concern is amplified in developing economies, which have a higher reliance on bank loans, making them more vulnerable to economic slowdowns compared to developed economies with mature financial systems and a diverse range of lenders. Solutions include:

• Increasing taxes or growing the economy faster than debt accumulation could address the vulnerability, according to the recent CNBC report  
• Requiring lenders to develop a strong understanding of the Asian business environment and employ rigorous underwriting practices to mitigate risk

Outlook for 2024 and beyond 
Despite challenges, the outlook for the private debt market remains positive.
Low loss ratios are opening up the door for investors and Limited Partners to gain access to an asset class that has excellent risk-return dynamics. 
Looking ahead, we expect continued growth and evolution within the private debt market in 2024 and beyond. With careful navigation and strategic partnerships, investors can harness its full potential in emerging opportunities.