March 13, 2024 - Private markets are undoubtedly an area of global regulatory focus – as news coverage continually reminds us. But what does that really mean? And what does it portend for credit markets?

Below we take a step back and offer a (non-exhaustive) timeline of recent global regulatory inquiry in private markets – the regulatory bodies involved, their areas of focus, and any significant conclusions. Ultimately, the common theme we see is that prudential regulators desire more information to better understand private market activities, particularly in the context of financial stability, but regulatory inquiry should not be conflated with regulatory action.   Moreover, most of the focus is on the nonbank financial sector broadly, not on private credit specifically.

• In September 2023, the Financial Stability Board (FSB) – an international body focused on international financial stability – published two reports on non-bank financial intermediation. The first is a progress report focused on  “key amplifiers” of liquidity stress in non-bank financial intermediation (NBFI) such as leverage. It also sets out the FSB’s efforts to reduce excessive spikes in liquidity demand related to liquidity mismatches in open-end funds and margining practices. Private credit is not mentioned. The other, “Financial Stability Implications of Leverage in Non-Bank Financial Intermediation” identifies and takes an extensive look at the uses and vulnerabilities of on-balance sheet and off-balance sheet leverage that exist in the NBFI sector. Use of leverage in the private credit space is not cited.
• Later that month, the International Organization of Securities Commissions (IOSCO) published its thematic analysis of “Emerging Risks in Private Finance.” The report focuses on four risk areas in private finance, here comprising private equity and private credit: opacity, leverage, market integrity and risk transmission to public markets. The report includes a robust discussion of potential vulnerabilities that have not come to pass and likewise highlights the potential benefits of private credit. Probing vulnerabilities is valid and the principal aim of the IOSCO report. Asking the question, however, does not imply regulatory response. For further LSTA coverage of this report, click here.
• In November, the Financial Stability Oversight Council (FSOC) – a group established by Dodd-Frank to oversee U.S. financial stability – published updated guidance and an analytic framework on the designation of non-bank systemically important institutions (SIFIs). The updated guidance makes it easier for FSOC to designate nonbanks as SIFIs – should FSOC determine that the material distress or failure of an institution could pose a risk to U.S. financial stability, such institutions may be designated as systemically important. While FSOC does not seem to have designations in mind, it represents a clear regulatory step forward (designated entities would be subject to supervision by the Federal Reserve and prudential standards such as capital and liquidity requirements). At the same time, the analytic framework sets forth a measured approach to potential designation: identification of potential systemic risks, assessment of those risks, and responses to those risks that threaten financial stability. For further LSTA coverage of the FSOC guidance and framework, click here.
• The close of 2023 saw the U.S. banking agencies propose revisions to bank quarterly call reports that would see supervised entities break out their exposures to non-depository financial institutions. (For further LSTA coverage, click here.)
• Meanwhile, the Bank of England noted in its Financial Stability Report that it would undertake a system-wide exploratory scenario exercise designed to understand how banks and non-banks might act during very severe shocks in financial markets, and how their responses might interact to make things worse.
• In February 2024, the European Commission published a report to the European Parliament on its macroprudential view for banks, systemic risks relating to nonbank financial intermediaries (NBFIs) and their interconnectedness with banks. Furthermore, the European Commission intends to run a consultation on macroprudential policies for NBFIs this year. (For further LSTA coverage, click here.)
• Stateside we saw the Office of the Comptroller of the Currency (OCC) acting chief Michael Hsu directly address private equity/private credit and the potential risk they could pose to financial stability over time by blurring the line between banking and commerce.  Referencing his remarks, Hsu shared with Politico that “If private credit just grew … as largely kind of a closed-end structure, where there’s no maturity transformation going on, and it’s largely disconnected from other parts of the financial ecosystem — I’m not as worried.” Looking forward, he continued to share his worry is continued growth of private credit and its evolution into funds structures “so it’s more like an open-ended fund with more redemption risk, there’s more maturity transformation going on, and it starts to really get interconnected with insurance.” These are developments that are not currently observed in the private credit space.
• A couple of weeks ago the Fed published a FEDS Notes report “Private Credit: Characteristics and Risks.” The report looked to describe the current market landscape and potential risks. Built on market intelligence and data analysis, the report offers a useful window into the Fed’s view and understanding of private credit as well as some of its concerns – concerns that may be misguided in the view of credit market participants.
• Finally, the FCA recently confirmed in a series of “Dear CEO” letters that it would be reviewing private market valuation practices. This review is not targeted at private credit, although certainly private credit is in scope, and is a space to watch for FCA-supervised entities.

Given the growth of private markets and the important role they play in today’s economy, scrutiny will continue – and should not be surprising. The LSTA will continue to watch this space and update membership on developments as they emerge.