‘Beyond warning’: ASIC tells private credit to expect ‘enforcement action’

“The events surrounding the collapse of Bathla are certainly deeply concerning, but for ASIC, unfortunately, they’re also not surprising,” Constant said.

Growth outpaces controls

ASIC said it believed Australia’s private-credit sector has expanded by 500 per cent over the past decade, yet Constant noted that the accompanying frameworks for governance and investor disclosure had failed to develop at the same pace.

“We’ve been talking about private credit for a long time now, specifically about the risks stemming from inconsistent industry standards that haven’t kept pace with the growth, significance, complexity and connections of the sector,” Constant said.

“Despite our ongoing calls for uplift across the sector, too many have been too slow to respond and what we’re seeing now, as some of those weaknesses are tested at scale for the first time by current conditions, are the first significant cracks, the first stress fractures, beginning to emerge.

“We need to see fund managers return to the foundational principle of true stewardship of the money entrusted to them.”

Constant said the broader issue was whether an increasingly important form of finance had adequate controls to withstand borrower stress, falling property values, and weaker development conditions.

“In many ways, it is a sector that tried to run before it could walk,” she said.

Property exposure under scrutiny

Throughout her speech, the commissioner repeatedly linked ASIC’s concerns to the market’s exposure to property development.

“Today, millions of Australians are exposed to private credit – some through direct fund investment, others through shares in credit fund managers, but many through their superannuation fund,” Constant said.

“As we’ve seen with Bathla, developers with exposure to private credit are particularly vulnerable when economic conditions become more challenging.”

Constant pointed to Bathla’s corporate structure as an example of unnecessary complexity, saying the group had “almost twice the number of special purpose vehicles as employees”.

She also said ASIC’s market work had identified a substantial concentration of private credit in real estate development.

“Over the past 18 months, ASIC has intensified its scrutiny of private credit. It was illuminating, it gave us for the first time, a deep understanding of the size and nature of private credit in Australia and the operating practices that existed,” she said.

‘Seriously concerning picture’

Constant said ASIC’s subsequent surveillance of 28 private-credit funds had uncovered major inconsistencies in the way funds assess, manage, and disclose risk.

The regulator found only four of the 28 funds published information about the interest rates, or interest-rate ranges, charged to borrowers and that less than half had detailed written policies dealing with credit, impairment, and default management.

ASIC also found that most reviewed funds did not adequately separate the people approving loans from those responsible for independently assessing their ongoing performance and value.

Further, among wholesale funds, only two used stress testing as part of liquidity-risk management.

“These were clearly red flags, particularly when we think about the critical risks to be managed in private credit such as credit and liquidity risk, and the fundamental importance of effective disclosure in such a widespread and growing space,” Constant said.

ASIC also identified what Constant described as “canyon-wide variations” in the use of crucial terms, including “default”.

The commissioner said that lack of common language made it harder for investors to assess risks and compare funds.

“It also highlighted the concentration of private credit in real estate development, and it demonstrated the varying standards of practice across the sector,” Constant said.

“The poorer practices, opaque remuneration and fee structures, inadequate governance arrangements, poor valuation practices, ineffective disclosure, were concerning and demanded scrutiny.”

3 months to lift standards

Constant said ASIC had set a 2027 deadline for the industry to lift practices, meaning the sector has roughly three months to demonstrate meaningful progress.

“As an industry, you need to drive this change because if you don’t, ASIC will be forced to do it for you, through regulatory and enforcement action,” Constant said.

The commissioner said every participant in the private-credit industry, “from boards to brokers,” should measure their practices against ASIC’s 10 principles for private credit funds.

“Get things wrong and you could be facing disputes and litigation, and your boards will be wishing they’d included private credit principles as a standing item on the boardroom agenda,” Constant said.

“If the industry gets things wrong at a systemic scale, history tells us there is likely to be law reform of similar magnitude.”

Constant said the sector had little time left to respond, declaring, “ASIC has made clear what good practice looks like, we are now beyond warnings, the sector should prepare for enforcement action.”

“We worry adoption of new guidelines will be too little, too late if we don’t see a move with urgency to consistently good practice across the sector,” she said.

“The clock is ticking, whether we see broader credit stress or not, certainly the tide is going out on poor private credit practices.”

Valuations move centre stage

The speech also placed particular weight on the valuation of distressed loans, with Constant warning against managers maintaining loan values at face value to preserve fees despite a borrower’s weakening financial position.

“Everyone has a responsibility, fund managers need to review loan portfolios and apply realistic, independent valuations,” Constant said.

“Carrying distressed loans at full face value to protect management fees is unacceptable. We drew a line in the sand in June for asset valuations to be refreshed. Managers who continue to avoid write-downs will face direct regulatory attention.”

Constant also said ASIC’s work suggested that disclosure shortcomings could leave even sophisticated investors uncertain about the risks they were assuming.

“Some private credit experts we have worked with over the past 18 months agree that for some funds, even the most sophisticated investors could not really be sure what they were exposed to and how it would respond to a test,” she said.

Constant revealed that Australia substantially lagged comparable markets, including Singapore, the US, the United Kingdom, and Switzerland on private-market disclosure.

“We found Australia falls well south of the line of information and disclosure of other comparable jurisdictions like Singapore, the US, the UK and even Switzerland when it comes to our private market disclosures,” she said.

[Related: Matos puts regulators on notice after Bathla collapse]