La Trobe Financial private credit is as safe as houses: At least that’s what investors in this alternative asset manager have been conditioned to expect after receiving the top gong for the fifth consecutive year as Australia’s Best Non-Bank Lender in Money magazine Consumer Finance Awards.
However, the non-bank lenders' reputation recently started to unravel after the regulator ASIC commenced interim product stop orders - valid for 21 days unless revoked earlier - against La Trobe US Private Credit Fund (USPC), the 12 Month Term Account and 2 Year Account products offered under the La Trobe Australian Credit Fund and the RELI Capital Mortgage Fund.
ASIC raised a red flag over concerns that investors had made an “inappropriate level of portfolio allocation” to the funds, given the underlying 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%) of their portfolio.
ASIC said it also continues to have concerns around La Trobe's TMD (target market determination) for the USPC Fund.
Inappropriate portfolio allocation
Underlying these concerns is an inference that TMD suggests an inappropriate level of portfolio allocation given the risks of the fund and does not adequately specify an investment timeframe for retail clients.
Meanwhile, La Trobe CEO Chris Andrews welcomed ASIC's recent decision to lift the stop orders on the Australian credit funds.
"The stop orders didn't relate to the funds' performance, liquidity, advertising or the product disclosure statements. We champion transparency and welcome the opportunity to improve our TMDs for the benefit of investors," Andrews said.
He added that La Trobe will continue to work with ASIC and will have announcements regarding the USPC Fund (Class B) soon.
ASIC said the USPC fund invests primarily in a portfolio comprised of senior secured first-lien term loans issued to U.S. corporate middle market companies.
It said these U.S. companies are not rated by any rating agency, and investing in these loans involves an above-average amount of risk and volatility or loss of principal.
"Under the design and distribution obligations (DDO), financial product issuers and distributors must ensure the product's TMD is clear and appropriately defines the target market and accurately reflects the product's risks and features," ASIC said.
Lack of transparency
However, recent incidents at La Trobe Financial are by no means isolated, with influential ratings house Lonsec’s downgrading of Metrics Credit Partners’ ASX-listed Income Opportunities Trust and Master Income Trust, only fuelling ASIC’s clarion call for ‘enhanced standards’ across the private credit sector.
Lonsec’s beef with Metrics Credit Partners is related to governance concerns, including material related-party transactions, lack of separation between debt and equity committees, and lack of transparency.
Unsurprisingly, it is transparency of pre-investment information and documentation, and ongoing investment performance information, that ASIC believes is failing at the institutional end of the private credit market, which is otherwise demonstrating good operating practice.
Within its recently released interim report into private credit in Australia, ASIC has drawn a line in the sand between so-called sophisticated [institutional] investors who are prudentially regulated, and less sophisticated [retail] investors who appear to have less transparent portfolio composition and fee arrangements.
The former are typically investing in funds that offer transparent fees and valuations or have bespoke arrangements and are sophisticated enough to understand those arrangements.
However, the explosive growth of the latter segment of the market raises ASIC concerns over 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.
Quality and liquidity
The report coincides with a period of increased anxiety over private credit funds in Australia, with regulators, media and consumer bodies all asking the same questions around quality, liquidity and transparency.
Compliance aside, the regulator has also called out fee incentives, net interest margin capture, related-party transactions, and multiple capital stack exposures as potential conflicts of interest.
“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.”
What’s also keeping ASIC awake at night are concerns that loans to related developers or transfers between funds managed by the same group may happen without independent valuation oversight.
The regulator also flagged instances of:
- Funds that didn’t undertake regular valuations.
- Distributions being paid from new or existing investor capital.
- The arbitrary usage of labels and definitions, such as “senior debt” or “investment grade”.
In November, ASIC is expected to 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.”
Meaningful action
It’s unclear what regulatory measures will be taken by ASIC in response to recent industry reviews.
However, Longo added, expect meaningful action in response to these findings and reminded the market that ASIC will not hesitate to intervene where progress falls short.
While there is limited desire for increased regulation of private markets, the regulator’s commissioner, Simone Constant, recently highlighted 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.
Four key themes
Meanwhile, ASIC recently told the market it has drawn extensively 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.
Published earlier this month, the report found that around half of the estimated $200 billion market is concentrated in real estate-related lending, much of it in construction and development finance – a segment the authors said carries elevated risk.
What the report called out is less the existence of private credit than how it is packaged, priced and disclosed.
Underpinning the reports' concerns are four recurring themes: conflicts of interest – “prevalent across fee structures, valuations, related party transactions and loan structuring”, opaque remuneration, inconsistent valuations, and terminology.
As a case in point, one of the sharpest findings relates to how managers are compensated, with borrower-paid fees commonly excluded from headline fee disclosures – a practice that can materially understate the true cost to investors.
Related party transactions can further complicate the picture, with loans to related developers or transfers between funds managed by the same group, potentially occurring without robust independent valuation oversight.
The report flagged that while many funds “do not undertake quarterly valuations, some rely on internal processes without independent review”.
The report also raised concerns about the unknown amount of debt and credit risk within certain sectors, especially real estate, alongside the growing exposure of retail investors to private credit.
What should ASIC do?
The report highlighted a list of practical, measurable good practices, including “regular” fund composition reporting (number of loans, concentration by borrower, proportion of loans in arrears), independent quarterly valuations, full disclosure of all manager remuneration (including borrower fees and net interest margins), and clearer definitions of key terms such as “security” or “senior”.
“We believe there will be industry support for industry-led guidance on best practice operations and reporting for Australian private credit,” Timbs and Williams said.
Despite the market being broad and the wide range of quality and capability among private credit operators, Timbs and Williams suspect that larger and more significant participants would coalesce around practices similar to what they have outlined as good practices.
However, the authors noted that smaller, less sophisticated operators may be less interested in voluntarily signing up to improved practices.
If the market is to keep growing without sowing future losses, the report encourages industry participants to embrace transparency rather than resist it.
“The integrity of the market depends upon investors, borrowers and the broader financial community having confidence in the transparency and workings of the sector”.
