The proliferation of debt funds

By: Nicolas Grenie

Small- to medium-sized enterprises (SMEs) in the U.S. obtain the bulk of their funding from capital markets through debt or equity issuance. However, in Europe, the majority of loans to SMEs come from banks. Regulations like Basel III are changing this.

Credit funds (e.g. private debt and mezzanine managers) and loan origination funds are gaining traction amid declining bank appetite for lending. The Alternative Investment Management Association (AIMA) believes alternative lending could account for up to 15% or 20% of SME funding in Europe within five years. According to panelists at Super Return International in Berlin, more SMEs are approaching direct lenders because the transaction terms are more generous than those offered by banks. The fixed income streams are attracting institutional investors to allocate to the sector. Preqin, a leading source of data and intelligence for the alternative assets industry, estimates private debt funds now manage approximately $440 billion, and enjoyed inflows of $64 billion in 2014 (with figures for 2015 expected to show a similar trend).

To meet SME lending requirements and best practices, fund managers must hire individuals who are well-versed in credit relationship management and its associated risks. Excellent Know-Your-Client (KYC) systems and due diligence are crucial. Furthermore, organizations must manage exposures to non-performing loans cohesively. Underwriting loans is labor-intensive, and firms need to ensure they stay on top of the work.

European regulators are encouraging SME lending by fund managers. In France, Germany, and Ireland, it’s now easier for fund managers to underwrite loans. Germany’s Federal Financial Supervisory Authority, BaFin, exempts fund managers from having to possess a credit license to underwrite or issue loans. It is likely that the Capital Markets Union (CMU) project currently being discussed in Brussels will develop the private loan market even further, particularly because the Alternative Investment Fund Managers Directive (AIFMD) does not reference loan origination. To facilitate marketing and distribution across the EU, some managers want regulators to introduce a credit fund passport modelled on the distribution passport afforded to AIFMs or those regulated under UCITS.

However, some feel excessive regulation of this new industry could impede development at a very important stage of its growth, and regulators must be careful and pragmatic. European regulators say they’d like to see increased non-bank lending into the real economy for diversification purposes. Regulators want the development of products such as European Long Term Investment Funds (ELTIFs), which are AIFMs that invest in infrastructure and are available to retail investors. They’ve even lowered the Solvency II capital requirements for insurers investing into ELTIFs. This is encouraging.

As banks retreat from lending, private fund managers will increasingly enter the fray, and private debt funds are increasingly popular among investors. SS&C Loan Services offers a comprehensive suite of technology and outsourced services across the entire loan spectrum: accounting, reserving, credit risk analysis, middle- and back-office administration, agency or shadow servicing of commercial and residential mortgages and bank loans. SS&C Loan Services comprises three core areas covering bank loans, commercial loans and mortgages. To find out more, please contact solution@sscinc.com.