Asia has historically been a bank-financed market. Debt structures have typically been straightforward and banks have traditionally been able to service the needs of corporates for both event-driven financings as well as working capital and ancillary financing needs. However, over the last couple of years, there has been increasing appetite for Asia-focused private debt fundraising.
A number of factors have led to this. Institutional investors have been looking to diversify their portfolios and seek newer markets with higher yields. Asian corporates, which have previously been conservative in their financing structures are under-going a generational mind-shift and are increasingly looking at more complex financing arrangements, which debt funds are well placed to offer, such as mezzanine structures, non-amortising loans, PIK interest, equity-kickers, etc. There has been a burgeoning growth in Asia's "middle class" whose per capita GDP is projected to reach Europe's levels today by 2050 – the desire to expand businesses to capture this economic opportunity has led to increased use of leverage. The regional economies of Asia are transitioning from export-fuelled activity to consumption-driven growth – this is creating attractive opportunities for yield-hungry investors. Preqin’s H1 2018 Investor Outlook report has found that 30% of the investors surveyed are of the view that Asia is the best place to invest in private debt. Coupled with regulatory hurdles and mounting non-performing assets, banks have tended to be cautious about their lending activity and this gap is increasingly being filled-up by debt funds.
Market data suggests that 2017 was a strong year for Asia-focused private debt fundraising, with $6.4bn of capital being raised. Asia-focused funds accounted for 9% of all private debt funds closed in 2017, three-percentage points higher than in 2016. Sixty percent of Asia-focused funds closed in 2017 met or exceeded their initial target size. The debt fund strategies have been primarily direct lending, followed by distressed debt, special situations and venture debt.
The challenges for debt funds, particularly on the direct lending side, continue to be price competitiveness compared to banks, inability to provide working capital and other ancillary products as well as the lack of local relationships on the ground, although the latter is increasingly changing. Legal and regulatory issues have also led to private debt investors being cautious about entering the up-and-coming Asian markets. For example, enforceability of English and New York judgements is still not possible in Indonesia and a number of other key Asian markets. Security take-up in jurisdictions such as India, Vietnam and Cambodia continues to be challenging, although structures are increasingly becoming available to mitigate such issues. Finally, the legal landscape tends to be less clear than in more developed markets, making it potentially more complex to price a given risk. Debt funds which have been successful in Asia have tended to be those that have a strong understanding of the local market – sometimes as a result of having previously invested or by having a tie-up with a local player. Rigorous due diligence and frequent on-the-ground monitoring have also been key for successful fund managers.
As economic prospects continue to improve (in particular by comparison with more mature markets), the consumer base continues to swell and legal and regulatory regimes continue to be reformed, it seems likely that private debt will play an increasingly important role in funding Asia’s private sector growth.
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