S&P: Risk profile of private credit funds is changing

The risk profile of private credit funds is changing following a period of rapid growth, leaving the sector open to additional regulation, S&P Global Ratings has said.

In a new analysis of the sector, S&P noted that European regulators are likely to be keeping a closer eye on private credit funds as the complexity and variety of transactions increases and new investors – including retail investors – enter the market. This evolution is set to change the risk profile of these funds.

“The opportunity for private in Europe is enormous, but it’s subject to the right guardrails,” said S&P Global Ratings credit analyst Paul Watters.

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“Ensuring a safe and sustainable flow of funds will require significant regulatory efforts and streamlining from EU authorities.”

S&P noted that the rapid expansion and innovation in the private finance sector has led to new financial stability risks around complexity, liquidity, and leverage. As the sector comes under increased regulatory scrutiny, transparency will be key to sustain investor and public confidence in the sector, the ratings agency added.

S&P’s analysis found that private credit funds have reached a tipping point, with the leading firms sitting on record-high amounts of dry powder. There has also been an expansion of private credit into new lending activities from mid-market entities to more credit classes such as asset-backed financing and the securitization of future flows.

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However, the ratings agency warned that as the sector becomes more mainstream, some LPs may underestimate the illiquidity and stability of their investments.

“Europe is in dire need of investments to improve its productivity,” the report said. “Mobilising funding from various sources, including private finance, will therefore be a necessity.

“Yet ensuring a safe and sustainable flow of funds will require significant regulatory efforts and streamlining from EU authorities.

“Additionally, it will require PC funds to manage the risks they take, while their key stakeholders – the LPs that invest in these funds and the banks that increasingly finance them – also play a part in applying market discipline.”

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