10 Special report Private markets The Economist February 26th 2022
public markets is enough for a healthy return. “Five years ago our
credit business was mostly high-octane distressed debt and spe-
cial situations,” says Jonathan Gray at Blackstone. Now the firm is
doing more, ranging from corporate-loan deals to “steadier yield
products” such as property funds that yield less (say, 5-6% a year)
but have the potential to be sold “at massive scale”.
On the market’s lower rungs there is space for specialists to
carve out niches. A number of smaller players offer credit facilities
with “ratchets”. These give borrowers a discount on interest rates
(typically up to 0.25 percentage points) if they meet certain tar-
gets. Tikehau Capital, a Europe-focused asset manager, has ar-
ranged “esgratchets” for more than 20 loans, linked to goals rang-
ing from renewable-energy use to reducing work accidents.
Not everyone sees the market’s growth as an unalloyed good. In
a report last October Moody’s called it an opaque, less regulated
“grey zone” with low liquidity and hidden leverage. Lenders claim
defaults are lower than on institutional loans, but disclosure is
thin and definitions of default inconsistent. As with junk bonds,
covenants that protect creditors if borrowers get into trouble are
being weakened as competition grows. Dan Rasmussen of Verdad
Capital says the market has been lending to small tech firms based
on flaky projected revenues.Moody’s blues
The bisrecently analysed the growth of private markets, high-
lighting benefits but dwelling more on risks. Agustín Carstens, the
bis’s general manager, called for more comprehensive, systemic
regulation of non-bank lending. Regulators are looking at what
Christina Padgett of Moody’s calls “networks of collaboration” in
private credit: the market is dominated by a small number of asset
managers with overlapping interests. This raises questions about
conflicts of interest and poorly understood risk transmission, yet
to be tested by a full default cycle. Links between lenders and bor-
rowers add further complexity. Apollo owns around 100 of the
5,000 firms with which it has a financial relationship.
“I could go back 20 years and show you the same doom-laden
reports,” says Mr Arougheti. Before covid, he says, private credit
was seen as the next shock. But nothing happened amid the tu-
mult of spring 2020. The big private-market players were, if any-
thing, a stabilising influence: many stayed in the game even as liq-
uid markets briefly seized up. Few were forced sellers. “Private-
credit funds and private-equity owners did a lot of bespoke rescue
financing and other patching up, often in tandem,” says Ramya
Tiller of Debevoise & Plimpton, a law firm.
After the breakneck growth of the past few years, a pause or
correction seems inevitable. For now, though, funds and their ad-
visers are planning on a busy first half of 2022, with numerous
credit mega-funds in the works. Some wonder if there will be
enough borrowers to absorb the capital flowing in.
The big funds brush off talk of tighter market conditions. “The
two things that drive investors to credit are volatility and higher
rates,” says Holcombe Green, at Lazard. If both materialise, money
may flow into private credit from buy-outs and growth equity, he
suggests. Most private credit is floating-rate, making it less vul-
nerable to the interest-rate risk of traditional fixed income.
Ares expects its overall business, two-thirds of which is credit,
almost to double by 2025. Apollo thinks its credit business could
double over the next five years. “People say that private credit’s ad-
dressable market is $5trn-10trn,” says Jim Zelter, Apollo’s co-presi-
dent. “We think it could be much bigger than that, if it also takes in
swathes of the mortgage markets, trade and inventory finance and
the like.” Add in “fixed-income replacement” products, less-risky
credit offering returns in the 3-8% range, and the market could be
$40trn, he says. As in all private markets, the bet is that greater
scale will more than offset lower returns.Regulation and reputationRed teeth, red tape
I
n november gary genslerof the secaddressed the Institu-
tional Limited Partners Association (ilpa). Private equity and
hedge funds matter, he said, because they are growing in size,
complexity and number, and because of who they serve, such as
retirement plans for teachers or firefighters. Caveat emptor? Not
on his watch. “It is worth asking ourselves at the secwhether
we’re meeting our mission with respect to this important slice of
the capital markets,” he said. His speech was a clear sign that priv-
ate markets could expect more red tape.
Regulation increased after the financial crisis. Many private
funds had to register with the secand start filing information
about their holdings. But it remains light compared with the
thicket of red tape entwined around public markets. Now regula-
tors, egged on by public and political animus towards pe, are look-
ing to narrow the gap. The political attack is led by Democratic
senators such as Elizabeth Warren and Sherrod Brown. They are
promoting the Stop Wall Street Looting act, designed to “rip up the
predatory playbook” and stop pe“exploiting workers, consumers
and communities”. The law would, among other things, make
funds’ gps share responsibility for the liabilities of firms they own
and curb “dividend recapitalisations”, the practice of using money
borrowed by a firm they own to give themselves a big payout—
sometimes enough to cover their entire investment.
Mr Gensler has more time for such pitchfork-waving than his
Republican-minded predecessor, Jay Clayton, who now chairs the
board of Apollo. Mr Gensler has three main concerns, which will
only grow as the industry signs up more retail clients: the opacity
and unevenness of fees and other expenses; opaque performanceCriticism of private equity is overdone. That won’t stop
regulators giving it a harder time