On 12 September, Hogan Lovells hosted the FIS Summit Series in Hong Kong, where attendees explored the state of financial markets ten years after the Lehman Brothers' collapse. One of the break-out sessions entitled "Private credit: the rise of direct lenders and alternative funding structures", focused on the increased dominance of sophisticated private credit funds in the European, Australian and Asia-Pacific lending space and the products they deploy.

The panel included Paul Mullen, Richard Hayes and Ros O'Mally and was moderated by Alexander McMyn. We summarise here the main themes discussed on the day.

Private credit funds today: primary lenders, not alternative lenders

• McMyn tracked the development of funds' involvement over the past decade and observed that in Europe, private credit funds have long played a role in the loan markets. As relatively new entrants to the markets in the years prior to the financial crisis, these funds were initially buyers of loans in primary syndication. Increasingly, funds became the provider of last-mile financing, taking the top-slice of credit risk to borrowers in a tiered capital structure. Since the fall of Lehman and the global financial crisis, private credit funds have sharply increased their activity, taking an increasingly significant share of the market either acting alone or together with banks or with other funds.  With the private credit funds' unitranche product now being a familiar feature of European leveraged financings, they may now be the single provider of debt financing on a private equity buy-out. Indeed, Mullen remarked that in the European private equity loans market, "Funds are not the alternative lenders, they are the lenders!"
• To illustrate the rise of credit funds in Europe, Mullen observed there were only a handful of fund participants providing direct-lending prior to the financial crisis, whereas now over 80 funds are currently active in Europe. These credit funds continue to execute larger and larger transactions, now competing with the lower end of the high yield bond and loan syndications markets. Looking ahead, Mullen noted private credit funds are likely to look beyond the world of private equity and increasingly become alternative lenders to corporates seeking to raise debt-finance. Mullen also expects that private funds will continue to expand their geographic coverage – looking for improved yield at the edges of Europe, noting particular appetite for transactions in countries such as Poland and Romania. 
• In Australia, Richard Hayes has observed similar trends in the leveraged loans market to those being seen in Europe and the US. Whilst he acknowledged the European and US private credit markets may have been faster off the mark in the initial post-crisis period, today the market looks very similar to Europe and the US.  On a typical Australian leveraged buyout, at least 50 per cent of all debt financing is now being provided by private credit funds rather than traditional lenders. To highlight the point, Tanarra Credit Partners, a relatively new entrant to the market in Australia, has already deployed approximately 50% of funds raised for its initial fund and is now contemplating fund raising for its second fund in order to meet the growing demand from private equity sponsors and corporate borrowers. 
• The time lag to adopt in Australia innovative features seen in the European and US markets has also now significantly reduced. Hayes attributed much of this to the global sponsors and their advisers being acutely aware of recent developments in each of the markets in which they operate and the increasing role played by specialist debt advisers in Australian financings who are generally well informed of developments overseas and properly motivated to optimise capital structures for their clients.

Advantages of private credit funds over traditional lenders

• The reasons for private credit funds' increased activity are well-documented.  Following the financial crisis, funds had the ability to meet borrowers' demands more effectively than banks facing capital adequacy constraints and more stringent regulation.  This allowed them to step in to the breach vacated by banks in the post-Lehman world. Mullen, as a key-market participant, also identified the importance of the fund-client relationship as a vital offering larger institutional banks may find difficult to match. Typically, a single team is involved in all aspects of the deal life-cycle, including origination, execution, loan administration, refinancing and critically, through any period of distress. 

Asia and infrastructure: the exceptions

• McMyn remarked that the products that have become a feature of the European and Australian credit fund markets, including unitranche loans and the Term Loan B, have not arrived on Asian shores to the same extent.  Private credit funds in Asia are still largely restricting themselves to top-slice risk or making investments in non-performing loans in the secondary market. This trend may in part be due to the continued availability of attractive debt packages from traditional banks in certain jurisdictions, with Taiwan being a notable example. There may also be a reluctance to deploy capital into Asian jurisdictions with less legal certainty than funds have enjoyed in their more developed home markets.  The wait for the arrival of overseas funds into Asia continues, and for those funds looking to test the Asian waters, McMyn points to Indonesia and India as the most likely initial candidates suited to the offerings private credit funds will bring with them. 
• The emergence of private credit has also been slower in the context of infrastructure financing in Australia. Ros O'Mally made clear that the pace of advances by credit funds into Australian leveraged loans has not yet been matched in the infrastructure financing market, where direct-lending is still developing. However, there has been a recent increase in private debt placements into the U.S., particularly for large completed infrastructure projects – such as the recently privatized New South Wales electricity assets where borrowers are looking to overseas markets for longer tenors. More recently, O'Mally has seen 2 infrastructure transactions refinanced for tenors of 11 and 15 years into the Japanese Samurai loan market, a new development for Australia. Meanwhile, private debt funds and Australian superfunds continue to build up their internal capacity to seek opportunities to provide direct financing to infrastructure projects, including holdco financing on infrastructure deals, to achieve the return thresholds required.

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