Navigating private debt in the Asia-Pacific region

15 February 2024
Navigating private debt in the Asia-Pacific region presents challenges that are sometimes different from those in other regions.

To understand these challenges, we spoke with two experienced private equity professionals. Our discussion covered regulatory complexities, cultural factors and other areas that fund managers should consider before entering the Asian-Pacific private debt market.

Based in Singapore, Otto Von Domingo leads the commercial team in Asia for Vistra across its fund solutions business, focusing on private equity and real estate. 

David Harris is a commercial director at Vistra who is based in Australia. He has over 20 years of experience working with private debt and private equity funds.

Why is private debt popular in Asia?

Otto: We have noticed that private debt’s popularity has risen in Asia, particularly over the last few years. Many fund managers who have not traditionally operated in this space are building debt-focused teams and adding private debt to their product suite on top of their core fund products. Demand is certainly coming from their clients who want to allocate to this asset class in Asia.

I think the reasons are driven by the market and regulatory environment. We’ve seen an inability to access capital because traditional lenders have a conservative risk appetite and are busy building their capital adequacy to meet their regulatory obligations. As a result, alternative funding sources are filling the gaps. These sources can offer better terms and much more stable returns to their investors.

Challenging market conditions also play a part. A high-interest environment has brought some companies to distressed levels, and they are unable to fulfil their covenants. Private debt managers can provide alternative funding solutions and attractive valuations.

Lastly, there’s been something of a cultural shift and change in attitude towards private debt. This is linked to lessons learned from the 1997 Asian Financial Crisis and the Global Financial Crisis in 2008. There is a sense of familiarity and a better understanding of the asset class. I think fund managers understand the risks a bit more, and relative to other asset classes, private debt provides steady and stable returns, especially in tough market conditions.

Do these same factors account for private debt’s popularity in Australia?

David: The rise in popularity of private debt in Australia is primarily because the Australian market has five or six major banks that have strict lending criteria and arguably take a very conservative approach when assessing risk. These major banks are great for businesses that have stable cash flows, simple capital structures, and simple financing needs. But what about those businesses that do not fit that stable corporate profile? Private debt funds entering the Australian market have expanded companies' choices for accessing adaptable capital that aligns with their business lifecycles, balance sheets and cash flows.

Private debt funds have also brought some much-needed competition and, more importantly, liquidity into a banking sector that the major banks have traditionally dominated.

What should alternative investment firms and investors know about Asia’s private debt regulatory landscape?

Otto: Relative to the US, and to a certain extent Europe, Asia does not have a unified regulatory landscape, so firms and investors have to look at regulations on a country-by-country basis. Some jurisdictions, such as Australia, have a more developed regulatory and legal framework and offer better protection compared to other jurisdictions where private debt is less common and less regulated.

Can you expand on the subject of private debt regulations in Australia for those new to the country?

David: Australia has a highly regulated banking sector that extends beyond traditional banks to include debt funds. One regulation governing private debt in Australia that might surprise someone new to the market is the responsible lending obligations imposed by the National Consumer Credit Protection Act 2009 (NCCP Act). This act requires lenders — including alternative investment firms participating in private debt activities — to evaluate credit product suitability for borrowers and maintain responsible lending practices. 

Key factors considered in assessing a borrower's loan repayment capacity include conducting detailed evaluations, verifying financial information, providing accurate data, and following responsible lending guidelines. The NCCP Act’s rigorous lending obligations exist to prevent consumers from entering into unmanageable debts and foster responsible lending practices in Australia’s financial industry.

To move back to the region as a whole, how is private debt fund administration different in Asia than it is in other major private debt markets?

Otto: To be honest, there isn't much difference compared to other private debt markets in a fund administrator’s ability to cater to the fund and underlying SPVs [special purpose vehicles], and to deliver tailored middle-office loan solutions. However, the variety of debt products available in the market is quite noticeable. The market for investment products is no longer restricted to traditional options. This is because more and more new investors are shifting from large institutions to high-net-worth and retail investors. This shift has led to a move from closed-ended to open-ended fund structures, which has created operational challenges for fund administrators like us.

What are the major political and currency risks in Asia that private debt fund managers and investors should consider?

Otto: Investors who plan to allocate capital in Asia must keep in mind that each country in the region has its own unique opportunities and challenges. Unlike the United States, where the investment environment is relatively uniform, Asia requires a selective approach.

From our observations, countries in North Asia — such as China, Japan and South Korea, as well as Australia and India — have relatively stable governments, well-developed regulatory and legal systems, and a good understanding of debt.

However, countries in Southeast Asia (except Singapore) are less developed and more vulnerable to political instability, which can have a significant impact on the entire economic system.

How is technology influencing Asia’s private debt market, particularly concerning fund administration?

Otto: Over the past few years, debt products in Asia have become increasingly complex and advanced. Therefore, it is crucial to have a technology solution that can offer a tailored middle- and back-office solution to efficiently manage investments. For example, we can create a bespoke dashboard using Power Apps and Power BI that allows managers to view their portfolios in detail, helping them monitor performance, manage risks, and quickly identify any potential defaults.

How can a fund administrator support a private debt fund and what part does technology play in this strategy?

David: A good fund administrator provides comprehensive support to private debt clients at both the fund and loan administration levels. Depending on the client's requirements, these services can be offered separately or as a bundle. At the fund level, that support typically includes fund structuring and setup, investor onboarding, transaction support, cash management, fund valuation and pricing, fund and portfolio reporting, and tax and audit support.

The loan administration function is a critical aspect of supporting a private debt fund throughout the lifecycle of its loan investments. The back-office team should work alongside the deal and legal teams during the loan closing process to ensure all documentation is complete, reflects the commercial terms of the agreement, and is signed off before funding and executing the wire transfers.

Throughout the life of the loan, the loan administrator ensures compliance with the loan agreement regarding repayments, covenant testing, processing rate increases on floating rate notes, and addressing borrower queries.

Other activities include managing cash collection, portfolio monitoring and reporting, default management and remediation, and managing amendments and waivers. Using a spreadsheet to monitor a portfolio of loans can result in errors and is not recommended.

A loan management system, or LMS, is an essential part of the technology stack of a private debt firm. The LMS automates and standardises interest calculations for all loan types, valuations, interest accruals, amortisation schedules, outstanding balances, borrower statements and bank reconciliations. The LMS structures the loan data to ensure slice-and-dice portfolio attribution reporting. These reports form the basis of management, risk and investor reporting, so accurate, touch-of-a-button functionality is mission-critical when supporting private debt clients.

Given some of what we’ve discussed in this area, is assessing and managing credit risk in Australia different from other jurisdictions?

David: The Australian regulatory framework provides a stable environment for governing the economy. Despite facing inflationary pressures, Australia has managed to keep interest rates comparatively low, which has helped to stabilise the credit markets.

In addition, Australia has well-established insolvency laws that outline creditor repayment in the event of corporate bankruptcy. These laws give credit firms a sense of security, which is one of the main factors they consider before deploying capital.

When establishing a private debt fund, the manager must choose a strategy that aligns with investors' expectations. Different strategies offer varying risk-adjusted returns based on the borrower's risk profile. For example, a direct lending portfolio of loans is less risky than mezzanine, special situations, non-performing loans, or distressed debt funds. The interest rate charged on the debt reflects the chosen debt strategy.

Once the type of debt strategy has been determined, the manager must evaluate the underlying credit risk and the borrower's ability to repay the loan. This evaluation includes assessing where the borrower ranks in the capital structure and what measures are available under the loan agreement in the event of a default. The assessment is based on the strength of the balance sheet and sustainable, proven cash flows for direct lending strategies, as well as future cash flows and the strength of the management team for special situations.

Projected returns may be higher in some jurisdictions outside Australia, but you have to consider the risks of lending. Those risks may include political and economic unrest, constantly changing insolvency laws and regulations, and frequent boom and bust cycles.

In the end, accurately assessing risk by jurisdiction and region is critical to success. Although the basic principles of assessing risk remain constant, regional factors play a significant role in private debt funds when assessing which strategy to pursue.cros