We speak to Keith Miller, Global Head of Product - Private Debt at Apex Group, to get his insights on 5 big questions in this space.
1) What are the biggest challenges that private debt managers in Europe are facing today, from both a macro and regulatory perspective?
Beginning with the macro perspective, at the start of the year it is true that European dealflow slowed down due to multiple economic factors. Obviously, the cost of raw materials and energy has impacted underlying companies, just as global supply chains have tightened and we have seen high inflation, rising global interest rates and the uncertainty caused by the war in Ukraine. That all had a significant impact on deals getting done in Q1. Despite that backdrop, private credit, compared to other asset classes, continues to have several advantages that mean it is relatively well positioned. Those include the fact that instruments are generally of shorter duration with floating rates, benefit from an amortising position and generate higher yields that offer a bit of a buffer. So, while there are challenges, in the second quarter of this year we have probably seen an uptick in deals getting done, and that is especially true in the core European direct lending markets of the UK, France and Germany.
At the same time, the banks are naturally struggling to add either new transactions or add-ons to existing facilities, which presents further opportunities to credit funds. That has created new openings for private credit at a point when the funds have probably had a bit of time to absorb the macro consequences and as such have been able to be a bit more conservative on leverage and pricing to take into account the economic landscape. Economic factors have also created opportunities for private debt managers against the public markets, which have been relatively closed out for much of the first half of 2022. Private credit managers have followed the trend towards investing in larger-scale investments – now regularly hitting the $1 billion-plus mark – and that looks set to continue.
So, there are challenges but there are also opportunities. If we enter a prolonged recession, we are likely to see increased default rates, which have been relatively low for some time, but there will also be opportunities for other strategies that debt funds have in place around distressed or special situations. Similarly, the challenges of inflation are huge, but managers can alter their strategies to invest in assets that are more inflation resilient or where costs can be more easily passed on to final consumers.
From a regulatory perspective, there are not many changes coming through that will have an immediate impact, with the biggest directive on the horizon being the new Alternative Investment Fund Managers regulation, or AIFMD 2, which will impact loan origination. That’s a challenge but also presents progress in terms of creating harmonisation in the European framework around loan origination. The published directive so far does not really impact how funds currently operate, but it does remove some of the barriers to transacting across Europe.
“We are starting to see new funds coming through in markets that have traditionally been bank-led”
2) What role can technology play in helping managers address those issues and remain compliant?
The role that technology can play really comes down to data. We saw during covid that in times of systemic stress there is a naturally enhanced focus on due diligence and on the existing portfolio. That is where service providers, like ourselves, can really provide a fund manager with support, working on everything from engaging with borrowers directly as facility agent to providing information to LPs through investor servicing and all aspects of the administrative workflow in between.
We are generally the first port of call to receive information on underlying investments, whether that is through a GP portal where the managers can get real-time breakdowns of their portfolio, or for tools that we can provide to track covenants on underlying investments. The role of technology in providing that data to managers is key and there is certainly enhanced focus on that across the market. Technology also plays a part in helping managers get a complete real-time view of their portfolio as administrators such as ourselves can deliver an integrated middle office function. We are building more connectivity with managers and providing more real-time input around the portfolio and pricing.
“The role that technology can play really comes down to data”
3) What types of requests are coming in from investors in the current environment?
Investors are increasingly aware of the quality of the information they can receive, and they are becoming increasingly savvy and knowledgeable about investment strategies and underlying portfolios. With the enhanced use of technology, we probably receive fewer direct requests from LPs, but that is because we are working with GPs to significantly increase the information flow to investors from the outset. They are asking for more accessible, quality data and GPs are now actively responding to that.
In times of economic uncertainty, investors will want to scrutinise data far more, so it is more important than ever to have that data readily available in real time.
“Going into 2023, I expect to see private credit continuing to take market share”
4) Which areas of fund administration and reporting are now ripe for technological transformation?
Technological transformation is the area in which we see the biggest change in our business as a whole. Historically, fund administrators were quite manual in nature and workflows were fairly siloed. Now we are at a point where the ability to provide a fully integrated one-stop-shop solution for a manager, across the lifecycle of a private fund, is critical. Technology, in line with operational best practice, enables that to be possible.
What that means in practice is that our suite of services covers everything from borrowers through to investors. We sign documents with the deal teams, act as facility agents and hold security on behalf of lenders. All of that information is in our systems so it can feed into an integrated middle office solution that gives managers access to real-time data. That creates efficiencies in operational processes and removes a significant amount of operational risk, and then that information feeds through to fund administration functions and investor services.
Today, information is touched a lot less frequently, but it flows through all the different parts of the operational life cycle, right through to providing investors and GPs with decision-enhancing data on market-leading portals. Technology has made all of that a reality. A career in banking used to be about automating processes and taking risk out of the system, and now we have got to the point where fund administrators can do that for private credit. There are add-ons to that, including technology solutions around ESG reporting on investments and funds, which can now all be integrated into the operational and technological workflows.
In general, we are now at the point where nearly everything has been transformed by technological developments and the range of solutions available. But, that said, it is still a people business, so while technology provides the ability to achieve these things, we still rely on a personal, tailored solution where our teams become an extension of our clients. And there is still more to do. Thinking about the next areas ripe for technological transformation, our focus is on integration with clients from a data and middle office perspective. That is where we are really going next, as well as being able to provide tailored data points that respond to the needs of an individual manager. Over time the whole process becomes infinitely more integrated and more bespoke.
5) Finally, how do you see the outlook for private debt fundraising and capital allocations in Europe for 2023?
If you look at this year, so far Europe is following global trends, with fewer new funds coming to market, those funds are much bigger in size, and they are able to deploy a lot more capital to investments that are generally global in nature. That is indicative of how the market is developing.
Meanwhile, over the last two years the private debt markets have progressed in Europe from replacing bank lending to replacing public debt markets. So, it is going to be interesting as we come out of this stressed period, depending on when that is, whether that shift is here to stay or the extent to which the public markets are going to bounce back. Going into 2023, I expect to see private credit continuing to take market share.
In addition, we are also seeing the maturing of private debt in Europe leading to enhanced fundraising in new countries. There remains a lot of concentration around the UK, France and Germany, but we are starting to see new funds coming through in markets that have traditionally been bank-led and stepping up to provide some of that smaller mid-cap lending. We are seeing that in countries such as Spain right now, and that is just a sign of the maturation of private debt in Europe as a whole, so that will continue.
In terms of strategies, we do not see a huge shift in the shape of fundraising, with the only strategy that appears to be growing being funds of funds. Again, that is probably largely indicative of the maturity of the market as there are more funds to invest in.
Generally, we are optimistic going into 2023, with the future of private debt fundraising in Europe showing a good pipeline of larger funds coming to market later this year, and we expect that to continue into next year. There are a lot of challenges, but ultimately they also present opportunities for an asset class that is well positioned to continue expanding and taking market share from both banks and public markets.
