The Financial Stability Board’s (FSB) call for better data provisions within private credit has highlighted a gnawing pain in the side of the rapidly growing market.
The global watchdog, which was formed after the global financial crisis to help ensure another recession didn’t happen, partly blamed the lack of visibility into the loans and assets traded within private credit markets for growing concern voiced by economists about the sector.
The FSB’s comments came in a paper published amid warnings that the interconnectivity of private credit and mainstream banks is creating vulnerabilities that could pose a danger to parts of the global economy. The matter is of concern to financial institutions because they are allocating increasingly large amounts of capital to private credit.The board’s message was echoed by Bloomberg Head of Fixed Income, Brad Foster, at a recent gathering of market experts.
“Transparency builds confidence,” Foster told delegates to a Bloomberg pricing forum in London. “But… it’s a real challenge, and the challenge is really data. It’s not an easy problem to solve.”
Hard to Get
The US$2.1 trillion direct lending market is beset by data challenges, the FSB said. Prising data from loans agreements requires sophisticated software, technology, and skills that many of the funds and general partners (GPs) that make the market are unlikely to possess. That information resides in contracts, reports, ledgers, even handwritten notebooks.
Transforming that unstructured data into a format that is easily ingestible by investors’ systems is a task that many vendors, new and established, are clamouring to solve.
Alkymi, Solutions, and Bloomberg are among companies that have either created data management tools designed for private credit market participants or have begun offering data feeds for them.
Better Returns
The appeal of private credit markets is partly what makes them a challenge for data extraction tools. The absence of a secondary market for the loans and the less frequent pricing of assets reduces the amount of intraday market “noise” that brings volatility to more traditional markets. They also offer substantial diversification opportunities, with a wide range of credit and credit-like assets available for investment.
They do also bring greater risks. But at a time of economic uncertainty, high volatility in public markets as well as the impacts of external influences including greater geopolitical instability and increased regulatory scrutiny, concern about those risks is outweighed by the consistently higher returns the market offers. As such, private credit has become a key part of institutions’ portfolios.
That raises the pressure on market participants to step up their data games, said Leila Sadiq, global head of enterprise data content, reference, ESG and regulatory at Bloomberg.
“When privates become a part of a retirement plan, it changes the discussion in terms of the transparency and the expectations that we have around this asset class,” she told the forum.
Looking Outside
In the absence of underlying asset data, many participants look to other similar markets and assets for pointers on pricing and other important investment numbers. These proxies, however, can be misleading because the markets are not closely correlated.
Consequently, this often gives rise to “artificial volatility” in private markets, said Conrad Manet, client portfolio manager at Pictet Asset Management. By relying on public market data to price private assets, managers risk introducing market technicals and sentiment vulnerabilities that are irrelevant to private markets.
“You can have a very bullish sentiment in the leverage-owned space or a very bearish sentiment which is skewing valuations … in a way which isn’t necessarily aligned with the performance of your underlying borrower,” Manet cautioned.
Poor Quality
The chief difficulties faced by data managers at organisations that invest in private credit are the paucity of data and the fact that it is often stored within fragmented architectures.
This, said Sadiq, argues for greater focus on standardisation of data retrieval and transformation to ensure its consistency across business users, or as Manet put it, “we want to see that there is the same asset, which is partly held by one manager versus another, is valued in the same way”.
While Sadiq suggested the use of connected data meshes would serve market participants, in practice, standardisation of private markets data is proving difficult because there has been little agreement on how to do so. The immaturity of the market is partly the reason for this, but also the very data opacity that organisations are trying to mitigate is working against them.
The FSB highlighted this as a part of the data challenge.
“The absence of standard identifiers, such as ISINs or LEIs, for many private credit fund instruments limits the ability to analyse the characteristics of underlying financial instruments or borrowers,” it wrote in the paper. This also affects the ability to assess the total leverage obtained by single borrowers from multiple lenders. In addition, even when identifiers are available, authorities may not have full access to relevant information.”
The FSB said it would examine how the data challenges can be addressed, adding that without solutions, trust in the market would be undermined.
“These data challenges could hinder the ability of authorities to assess and address financial stability risks, particularly in a market characterised by significant cross-border and cross-sector activity,” it noted.
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