Private credit in the Asia-Pacific (APAC) region has grown remarkably in recent years, becoming a key alternative financing source in the region. Though still developing in the region, private credit offers significant potential due to strong investor interest and unmet capital needs.
Success in investing in the asset class requires thorough due diligence, expertise, optimal asset allocation, operational excellence, regulatory compliance, and strategic agility. While offering compelling prospects, APAC's private credit landscape is multifaceted, and investors need to deploy sophisticated strategies to manage risks and generate returns.
APAC: The emerging landscape of private credit
Though nascent, the APAC private credit sector has potential for expansion as an attractive arena for investors in pursuit of returns. One recent survey of over 100 private markets investors by alternative asset manager Coller Capital indicates that 72% of participants are looking to escalate their private credit investments in APAC. This enthusiasm signals that investors are undeterred even as the region has witnessed reduced capital raised by private credit funds.
Private credit has risen globally as an essential alternative source of liquidity for borrowers, especially as traditional leveraged buyout (LBO) financing avenues have shown signs of strain. Private credit institutions have broadened their influence, often stepping in where syndicated loan markets have not (or cannot). In 2021, almost two-thirds of the leveraged buyouts globally were financed in the private market, according to Pitchbook. In the first half of 2023, the private market funded 90% of 120 LBOs globally.
The Asia-Pacific (APAC) region's private credit market has grown steadily over the last two decades. Industry insights reveal a staggering increase in private credit assets under management. These have expanded nearly 30-fold from USD 3.2 billion in 2000 to over USD 90 billion today, reflecting the region's economic vitality and the escalating demand for alternative lending mechanisms. The growth prospects of the APAC private credit market are inextricably linked to the region's anticipated contribution to global economic expansion. Key sectors such as financial services, infrastructure, healthcare, and technology are tapping into private credit. The diversification benefits of adding private credit in APAC to an investment portfolio, alongside allocations in North America and Europe, are considerable, offering exposure to a spectrum of economies from emerging to mature markets.
On the secondary market front, the APAC private credit secondary market remains more subdued compared to other regions. Further repricing and maturation of the APAC secondary market should boost deal flow. Globally, activity in the private credit secondary market has accelerated sharply in recent months as firms such as Apollo, Ares and JPMorgan have acquired stakes from institutional investors looking for liquidity. JPMorgan estimates that the global secondary market volume will reach USD 30 billion in 2024.
While promising, the market still faces challenges. Most central banks throughout the region have been raising interest rates to curb inflation, which has implications for borrowing costs and companies' ability to service debt. The dynamic credit landscape underscores the need for flexible and robust risk management strategies. There are also different views on whether rapid private credit growth poses systemic risks. While some see this growth triggering shadow banking crises, others argue that it reduces the leverage of the banking system and that the channels of contagion are limited. However, the influx of capital as interest rates rise raises concerns about the industry's practices and the potential impact on the wider economy. Even if it is not an immediate crisis catalyst, the rapid expansion of retail lending remains fraught with uncertainty and should be monitored. Further, the intricacies of regulatory environments across jurisdictions such as China, Japan, and Australia present investors with complex challenges that must be adeptly navigated.
Risk Management Considerations
As they consider the vibrancy and complexity of the private credit sector in APAC, discerning investors will need to employ sophisticated risk management techniques to manage the inherent market fluctuations, diverse regulatory frameworks, and distinctive economic characteristics of the region. Control Risks presents the following strategies, distilled from our wealth of expertise, as indispensable for investors aiming to mitigate risk and seize the opportunities present within the APAC private credit landscape:
- Rigorous due diligence and unwavering commitment to transparency: Private credit investors must prioritise rigorous due diligence to ensure transparency and proper scrutiny. We advocate that investors take a comprehensive review beyond traditional financial analysis, delving into the fabric of a borrower's operations. This involves an exhaustive examination of corporate documentation and legal entanglements and an in-depth analysis of financial trajectories and business models. Due diligence is a critical safeguard against opaque business practices in the private debt sphere. Investors must evaluate the creditworthiness of borrowers meticulously, including their repayment capabilities, collateral integrity, and overall fiscal robustness. Additionally,we insist on gaining a nuanced understanding of the borrower's strategic market positioning, competitive advantages, and operational vulnerabilities. This often requires the engagement of local market experts, on-the-ground site inspections, and the strategic application of forensic accounting techniques to uncover concealed risks.
- Portfolio diversification and local market acumen: In the varied economic landscape of APAC, portfolio diversification is not just a strategy, it's an imperative for diluting risk. Our philosophy at Control Risks is to embrace the full spectrum of opportunities that APAC's mix of emerging and developed economies presents. This strategy increases the potential for diversification. Yet, true diversification is not achieved through a mere scattering of investments. It requires a profound comprehension of the intricacies of local markets—knowledge of regulatory idiosyncrasies, cultural dynamics, and the economic forces at play. Such acumen is cultivated through strategic partnerships, the deliberate recruitment of local expertise, or sustained immersion and research within the region. This deep local insight empowers investors to navigate the complexities of APAC's varied markets with confidence.
- Operational infrastructure and technological advancement: A robust operational infrastructure integrated with advanced technology is crucial for effective private credit investment management. This involves utilising scalable platforms to manage different lending activities and advanced analytics to monitor investments, forecast defaults, and manage risks comprehensively. In today's technology-driven era, sophisticated systems make real-time reporting and strict compliance easier, while robust cybersecurity protocols are essential to safeguard sensitive financial data. Private credit is operationally complex and requires a solid middle- and back-office capability to precisely manage customised loan agreements and covenants. Furthermore, similar default models used in the public bond market could also be applied in private markets, first to larger borrowers and then to other smaller companies that banks have also neglected.
- Regulatory conformity and economic agility: Adherence to local regulations is the bedrock of any rigorous strategy for operating in APAC. The agility to pivot in response to regulatory evolution distinguishes the astute investor. A compliance team intimately familiar with each jurisdiction's legal landscape is indispensable, as is a keen sensitivity to macroeconomic trends—interest rate movements, currency volatility, and geopolitical developments. A dynamic and malleable investment strategy capable of adapting to APAC’s fluid economic climate, is crucial for enduring success.
Case Study
Private credit transactions require due diligence, especially when reputations are at stake with a large sum of capital is involved. In Thailand, Control Risks was commissioned to investigate a private credit borrower and his company. This required careful data analysis and discreet insights from trusted sources. Our investigation revealed a controversial industry figure with a history of lawsuits and broken promises. Despite these reservations, the sources confirmed the individual's business acumen and emphasised the importance of solid legal agreements in all business dealings. We interviewed senior bankers as well as those who had personal dealings with the individual. We also researched his business interests and public behaviour. Our client received a detailed dossier with factual and reputational intelligence to help them make lending decisions.
Challenges
The Asia-Pacific private credit market is witnessing a pivotal shift with heightened institutional focus and increasing investor engagement. Global asset managers and investors are increasingly drawn to the region, a trend underscored by the proliferation of specialised private credit strategies.
Furthermore, APAC's private credit landscape is diversifying, reaching into emerging industries and underwriting significant transactions. The sector's extension of capital to areas such as renewable energy exemplifies its versatility in response to market evolution and its commitment to supporting sectors poised for exponential growth. The advent of private debt funds has been instrumental in orchestrating sizeable deals, traditionally the purview of banks, underscoring private credit's growing capability to fulfil extensive financing demands.
However, this year has seen a notable drop in the amount of capital raised amidst the economic headwinds in the APAC region, including in China. This has led to a marked decrease in both the capital raised and the number of funds compared to the preceding two years: the fund count dropped in 2023 to just 12 funds, far below the 33 funds in 2021 and 23 funds in 2022. This trend suggests a deceleration in private credit fundraising activities within the region.
Nonetheless, private credit in Asia is demonstrating remarkable tenacity. It is likely to sustain its equilibrium in the face of traditional banking retreats and broader market volatility. The intrinsic allure of private credit is further magnified by its floating-rate characteristic, offering a strategic edge in an environment of ascending interest rates.