The emergence of private debt 

Private debt emerged in the wake of the subprime crisis when new regulations such as the Dodd-Frank Act and Basel III were put into place. Because banks were no longer able to loan money as before, especially to small and medium-sized companies, private debt entered the market to fill the gap. Since then, private debt has become one of the fastest-growing alternative investment asset classes, enjoying 45.4 percent growth last year in terms of assets under management. Compared to public debt, private debt offers higher and regular returns. Commonly, the strategy is either sectorial or geographic.

With private debt, the investment manager follows a loan until it reaches maturity. Financial covenants are monitored, and if for example the borrowing entity’s financial health consistently improves, they might be eligible for a decreased interest rate. Such arrangements are not just side incentives; they are at the center of private debt relationships. Unlike when you borrow from a bank, with private debt, you receive not only monitoring, but also advice from the lender, a specialist in your sector, who will assist you with the financial health of your company.

Managing complex data

Private debtors play a key role during the entire lifecycle of the loan. They monitor and control plenty of financial data, both from the debt investment and also from the borrower. To do their job well, they require high-quality, accurate data as well as portfolio and investor reporting. This is where service providers step in and, ideally, facilitate automation – a necessity in dealing with the enormous volume of information in private debt, and it also lowers the risk of human error while helping a fund to keep costs at a minimum. The less time investment managers spend on gathering and modeling data, the more time they have to focus on the portfolio and the borrowers.

Private debt is a sophisticated asset that involves various investment strategies such as origination, syndication, secondary deals, and distressed debt. Once you take into account the lender’s subordination level, the diversity of financing instruments, fees, interest rates, and the many details spelled out in the covenants and loan agreements, you begin to appreciate the vast amount of data involved in running a private debt fund. For a service provider working in this sector, the bar is set very high. A service provider should have ample expertise in the field of private debt, and they should be able to efficiently collect, manage, and update the data on which the investment manager relies. Of course, having the latest and most powerful IT tools is key.

Other considerations on the future of private debt   

Adding yet more complexity to private debt is ESG. In the past few years, it has become important to many investment strategies, as investors are eager to put their money into structures that prioritize sustainability. This makes the task of managing and providing services for private debt funds all the more difficult because the ESG strategies of other stakeholders in deals, such as private debt sponsors or other co-­lenders, need to be taken into account. For borrowers, an ESG strategy might mean that specific covenants are introduced into the loan agreements requiring them to meet their lenders’ ESG expectations.

As with all alternative investment fields, the regulatory landscape is ever changing. Private debt will need to adapt to AIFMD II, which has not yet been voted upon, and ELTIF 2.0, which the Council of the EU adopted in early March. These will likely have a significant impact on private debt. AIFMD II could add restrictions on funds doing loan origination, which would in essence result in a close-ended fund. Also, it appears the new version of the regulatory framework will introduce a risk retention amount for funds whose strategy involves origination and selling the debt on the secondary market. AIFMD II may also introduce a maximum 20 percent diversification limit of an alternative investment fund capital invested with financial institution borrowers. ELTIF 2.0, on the other hand, might provide new opportunities for private debt, opening the field to retail investors. Still, it is quite clear that both AIFMD II and ELTIF 2.0 will require an even greater need for secured data and reporting, making the need for a trusted, experienced service provider with the right IT tools even more vital.

What to look for in a service provider for private debt

The right IT tools

to automate data management, reduce costs, and limit the risk of human error.

Expertise

in dealing with the complexity of private debt data monitoring such as covenants, interest rates, and contractual clauses.

A track record

of providing excellent service to private debtors and demanding, HNW investors.

Low staff turnover

which is key to building trust, familiarity, and a smooth working relationship.

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