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I’m sure that some of you saw the recent Bloomberg piece from October 3rd about the US Government Accountability Office (GAO) gearing up to probe the risks in the private credit market.
I guess it was bound to happen at some point – after all, this market has exploded in recent years and is expected to be approximately $2trn in size by 2030. And the US GAO has form for this – it has taken a look at the hedge fund industry and private equity space a few times in the past; after all, both are multi-trillion-dollar industries. And even the life settlement market, a much, much smaller space, got some GAO eyeballs back in July 2010.
So, hardly a surprise, as I said.
And it can’t be denied that there are structural risks in this market. There is less transparency in the private credit market than the public one, and if things go south, like in a recession, defaults could ripple through the financial system and local economies. No one wants a repeat of the global financial crisis, right? And there’s also the issue of interconnectedness: many of these funds are backed by pensions, insurers, and even in some cases, retail investors via ETFs or listed business development companies, so a hiccup could affect everyday folks’ savings.
But as with all these things, what makes me nervous is the potential for law-makers to be a touch over-zealous. While there are plenty of examples of regulation being a positive (yes, really!), private credit is arguably a lifeline for small and medium-sized enterprises (SMEs) across the US. These aren’t the Fortune 500 giants; they’re the local manufacturers and family-owned businesses that form the backbone of our economy. Traditional banks often shy away from them due to perceived risks or regulatory hurdles, but private lenders jump in with the liquidity they desperately need. I’ve seen first-hand through friends in the industry how this funding helps companies expand, hire more folks, and innovate without jumping through endless hoops. It’s almost like an essential service, frankly, and not all alternative investment asset classes or categories can say that. Without it, many SMEs would struggle to access capital, potentially slowing down economic growth in communities across the country. Sure, the interest rates might be higher at the moment, but the speed and flexibility often make it worth it.
The good news is that GAO reports by themselves rarely cause immediate upheaval and, even if the report – which could be many months away, given that we don’t even have a functioning government at the time of writing(!) – leans towards the negative, lawmakers then need to do their bit, which again, will probably take a while. And you never know: The report, assuming it gets written at all, could validate what many of us already know – that this market is resilient and yes, vital.
Done right, government scrutiny might lead to better standards without smothering the innovation that makes private credit so effective. ‘Done right’ are the key words here, but for example, encouraging more disclosure on loan quality or risk management could help without imposing bank-like capital requirements that would drive up costs for borrowers. I’ve always thought that smart regulation strikes a balance: protect against excesses while letting the market do its thing. And let’s not forget, private credit has weathered storms before, like during the pandemic, where it provided crucial support when banks pulled back.
Looking ahead, I suspect the GAO’s findings – again, if this happens at all – will highlight areas for improvement but also underscore the positives. After all, in an economy where SMEs employ nearly half of the workforce and represent more than 40% of America’s GDP, anything that bolsters their access to capital is a win. If oversight leads to a more mature, sustainable private credit ecosystem, that’s something I can get behind. It might even attract more institutional money, further ‘democratizing’ – to use a zeitgeist term – funding for businesses that need it most.
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Anthony D. Mascia is Managing Partner at EFSI. Connect with him on LinkedIn here.
EFSI is an independently owned, SOC-1 compliant, full-service fund administration firm. We provide accounting, reporting, administrative, and capital introduction services to a wide range of alternative investment funds including hedge funds, funds of funds, private equity funds, real estate funds, venture capital funds, and family offices. The center of EFSI’s service incorporates resilient technology and accomplished staff, providing clients a tailor-made service with exhaustive transparency. Give us a call today or reach out to our support team online. We look forward to hearing from you soon.