Private credit investments focused on real estate construction and development finance have been flagged as an area of systemic risk for SMSFs in a new report released by the Australian Securities and Investments Commission (ASIC), which noted these areas are prone to credit loss and potential conflicts of interest.
“Report 814 – Private Credit in Australia” was released by the corporate regulator as part of its ongoing oversight of the rapidly growing sector and stated there were greater concerns about products and practices at the retail end of the market, as well as those on offer to SMSFs and wholesale investors.
“The funds with large superannuation and institutional investment, and the best international private credit managers operating in Australia, generally demonstrate sound governance and transparent valuation and fee practices,’ the report stated.
“Segments of the market targeting wholesale investors using the ‘sophisticated investor’ exemption and retail-based offerings, including platforms, have practices that do not compare favourably against international practice.
“Lenders in these segments are more likely to have conflicts of interest, opaque fee and interest margin arrangements, inconsistent and non-independent valuation methodologies, and ambiguous terminology. These practices are more prevalent in real estate-based funds.
“While we have not assessed the systemic risk to the Australian financial system from private credit, we note the concentration in real estate construction and development finance, which has represented the majority of credit losses in past economic downturns in Australia and overseas.
“This segment of the market may present as a systemic risk for small and self-managed superannuation funds and ‘sophisticated’ investors in a downturn.”
The report added given the higher risks around private credit related to real estate construction and development finance, this was where the greatest improvement in investor protection and market integrity should take place.
It also noted this market segment had a high concentration of investors using the wholesale sophisticated investor exemption and there was less transparency on conflicts of interest, manager remuneration disclosure, and valuations and portfolio reporting.
“The growth in the market does raise questions about the quality of credit and especially whether investors fully understand the investment exposure they are taking on for the returns being promoted,” it said.
“Those funds targeting wholesale sophisticated and retail investors should provide more transparency on risks, loan valuations and loan characteristics. Their fee structures also have potential to create conflicts of interest for managers.”
The report, which is a high-level review of the private credit market in Australia, was based on 90 submissions to ASIC, public and non-public information, and information provided by 30 parties involved in or with knowledge of private credit who were interviewed during a consultation process.
