The institutional end of the private credit market “demonstrates good operating practice”, according to ASIC, though there are still areas that warrant improvement, including the transparency of pre-investment information and documentation, and ongoing investment performance information.

“Sophisticated investors who are prudentially regulated, such as very large superannuation funds and insurance companies, are typically investing in funds that offer transparent fees and valuations or have bespoke arrangements and are sophisticated enough to understand those arrangements,” ASIC said in its interim report into private credit in Australia, released on Monday.

But funds that raise money from less sophisticated investors appear to have less transparent portfolio composition and fee arrangements, and the explosive growth in this segment of the market “does raise questions about the quality of credit” – and whether investors understand the exposures they are taking on for the returns being promoted.

“In particular, there are legitimate questions about whether, in some cases, retail investors could fully understand and appreciate the nature of their private credit investment exposure, based on readily available information,” the report says.

The report arrives during a period of increased anxiety over private credit funds in Australia, with regulators, media and consumer bodies raising questions over their quality, liquidity and transparency. The regulator highlighted fee incentives, net interest margin capture, related-party transactions, and multiple capital stack exposures as potential conflicts of interests.

“Some managers retain 50–100 [per cent] of upfront and other fees paid by borrowers or default-related fees,” the report said.

“In borrower negotiations, this structure could be in conflict with maximising the interest margin to the benefit of the fund investors. In some cases, interest could potentially be paid from the loan capital.”

ASIC was also concerned that loans to related developers or transfers between funds managed by the same group may happen without independent valuation oversight. It also noted instances of funds that didn’t undertake regular valuations; distributions being paid from new or existing investor capital; and the arbitrary usage of labels and definitions such as “senior debt” or “investment grade”.

The interim report is sourced from an ongoing review of Australia’s private credit funds sector led by infrastructure investment executive Richard Timbs and former banker and chief risk officer Nigel Williams. In November, ASIC will release its response to the discussion paper on Australia’s evolving capital markets, alongside its retail and wholesale surveillance findings.

“Private credit is playing an important role in our capital markets and Australia should implement industry standards that align with international best practice,” ASIC chair Joe Longo said in a media release accompanying the report.

“Enhanced standards are needed to lift practices across the sector. They will help promote confidence, improve market integrity and empower investors to make informed decisions.

“When an industry agrees on clear standards, it shows a strong commitment to doing things right and we welcome the industry’s commitment to leading this work. They need to act decisively.”

Stop orders
The report comes as ASIC commences interim product stop orders against multiple private credit funds offered by alternative asset manager La Trobe Financial: the La Trobe US Private Credit Fund the 12 Month Term Account and 2 Year Account products offered under the La Trobe Australian Credit Fund and the RELI Capital Mortgage Fund.

The orders are valid for 21 days unless revoked earlier.

ASIC raised concerns about the target market determinations for the funds, particularly that they suggest investors make an “inappropriate level of portfolio allocation” to the funds, given the risks. In the case of the RELI fund, the target market potentially includes investors who intend to hold the fund as a “core component” (defined as 25 to 75 per cent) of their portfolio.

La Trobe said it intends to continue to pay maturing investments on time and is currently updating its La Trobe Direct investment platform, which was offline at the time of writing.

In an investor communication, La Trobe chief investment officer Chris Paton said investments in those products “remain safe and under our careful stewardship” and that La Trobe is working though the matters with ASIC.

“Our products are supported by granular, high-quality investments contained within highly diversified portfolios with embedded conservatism,” Paton said.

“These portfolios are carefully constructed to perform across the cycle and will continue to support the payment of consistent monthly income to investors.”

La Trobe chief executive Chris Andrews told investors the fund manager treats its legal responsibilities with the “utmost of seriousness”.

“We will, of course, comply with the interim stop order and pause the receipt of new investments while we address these issues,” Andrews said.

Separately, Metrics Credit Partners’ ASX-listed Income Opportunities Trust and Master Income Trust have been downgraded by Lonsec, with the influential ratings house identifying governance concerns including material related-party transactions, lack of separation between debt and equity committees, and lack of transparency.

More oversight
ASIC commissioner Simone Constant told the Investment Magazine Fiduciary Investors Symposium in the NSW Blue Mountains in June this year that there is greater scope for more targeted enhancement and active and ongoing monitoring and supervision in wholesale and retail private markets.

“While there’s limited desire for increased regulation of private markets, there is an openness to increased supervision, especially when it comes to things like valuation of assets, management of conflicts of interests, management of sensitive information, meaningful and effective disclosure of fees and risks, fair treatment of different investor types, as well as further information from ASIC on what good could look like,” she said.

Constant said that one of the regulator’s greatest concerns is “where folks are getting into private credit that’s actually more like equity”, and that ASIC is worried about the trend of “investments that some people in this room might think of as equity that have very little equity in them are being described as ‘private credit’.

“Disclosure is important, but disclosure is only important if it’s effective,” Constant said.