Minding the gap in private credit: the rise of new money and avoiding the fall

March 2025 | SPOTLIGHT | BANKING & FINANCE

Financier Worldwide Magazine

March 2025 Issue

With the rapid expansion of the private credit market – driven in part by an influx of new capital and evolving lending strategies in response to higher interest rates and increasingly sophisticated credit risk profiling – there are several opportunities presented for both lenders and borrowers, particularly as some estimates are that private credit assets under management will increase to $3 trillion by 2028.

While the rapidly evolving private credit market has recently provided enhanced returns and opportunities, potential risks remain. Challenges include market volatility, regulatory scrutiny and liquidity constraints – along with the risk of borrower defaults and disputes.

Technology boom in private credit

Since the global financial crisis in 2008, private credit has gained significant popularity among investors and borrowers – with assets under management trebling in the past 10 years alone – as sophistication of investment structuring has increased. Private credit is now being deployed across several sectors and has delivered strong returns to existing investors and continues to attract new ones, including pension funds, insurers and a growing list of private credit funds attracting wider and less traditional investors.

Where the regulated confines of traditional banking have in the past delayed rapid deployment of capital, the innovation of private credit has emerged to upend at least some established traditional banking through flexibility and speed. There is, however, evidence of alliances forming between traditional and new lending, such as a recent CitiGroup and Apollo partnership formed in 2024, which intends to target $25bn worth of private credit deals over the next five years.

Founded in 2017 and an early adopter of private credit, software investment private equity firms Thoma Bravo – a recent-buyer of UK-listed artificial intelligence (AI)-powered cyber security firm Darktrace – has also “invested over $8b across approximately 100 transactions”, according to Orlando Bravo, its founder.

Moreover, it recently raised $3.6bn for its Thoma Bravo Credit Fund III, which is to be allocated to private credit and is said to be its largest credit pool of capital to date. Guggenheim Corporate Funding meanwhile recently followed suit with the closure of its $400m “private-credit fund dedicated to lending to midsize, privately owned businesses”, and has secured contributions from the investment arm of major global insurer Allianz.

It follows that a major deployment area for private credit is technology and infrastructure. In addition to Thoma Bravo, Francisco Partners recently closed its FP Credit Partners III fund with inflows of $3.3bn, which will be allocated primarily in the technology sector, including for business transitions.

There is also plenty going on in the wider transition of energy to renewable sources, which was one of the original sectors attracting the attention of private credit and which continues to develop an overlap with technology through the growth of AI and the energy needs of data centres to power the AI-revolution, described by Apollo as “a critical bottleneck within the broader digital infrastructure”.

The background to this overlap arises from the large amounts of original private credit funds deployed, especially in Europe, on renewable energy projects as a result of the significant upfront capital requirements that were backed by investors, including global pension funds, who possessed capital upfront and required long term predictable returns, typically funded from power prices. It is expected these projects will continue to benefit from the growth of private credit, notwithstanding headwinds in that sector from the new US administration.

Competition and diversity in the market therefore looks sets to continue to push private credit to the forefront of financial offerings over the next five years and beyond. However, these developments may experience strong regulatory and legal scrutiny as some practices may expose lenders and investors to a higher risk of loss.

Regulatory spotlights

In a highly regulated market, such as traditional lending, where reserves and capital adequacy requirements have traditionally controlled risk, there are questions surrounding checks and balances for private credit, the positive answers to which will help foster the development and continued growth in the provision of such credit.

The speed at which the asset class has grown in popularity has meant there is less long-term data available for risk-assessment models in private credit and less is currently understood about the implications a default spike or failure could have on valuations. Relevantly, private credit is typically associated with high floating interest rates which leaves borrowers exposed to losses during an economic downturn.

So, while the 2022-23 upward interest rate environment led to an increase in interest in private credit on the lending side, as investors chased yield, it equally reflected a degree of turmoil for some private credit borrowers who, subject to their hedging strategies and borrower strength to manage terms, saw their debt payments increase.

Unchecked, this could lead to a deferred realisation of losses. However, analytics of private credit are becoming more sophisticated, with firms traditionally associated with ratings all increasing their research and focus on the asset class; Fitch, S&P and Moody’s have all developed their coverage of private credit in the past 12 months.

The interconnected relationship between private credit and financial institutions, such as hedge funds, and private equity firms, means regulation in this area is likely to be centred around supervisory, reporting and data collection practices aimed at mitigating the risk of a spillover loss to investors and systemic institutions.

This can already be seen by the European Union’s recent amendment of the Alternative Investment Fund Managers Directive in February 2024, which address liquidity, diversification and credit assessments.

In the US, elements of the regulatory approach are uncertain under the new Trump administration, and while the regulatory approach is predicted to favour capital, it is not expected to abandon disclosure requirements, yet these will inevitably be reassessed, as all existing regulatory frameworks come under scrutiny.

There is, in any event, recent evidence of increased focus at the highest regulatory level in the US by the Securities and Exchange Commission (SEC) of private credit, as demonstrated by an August 2024 $1.8m penalty imposed on Sound Point Capital Management for its alleged failures in managing material non-public information (MNPI). The SEC has since emphasised that advisers must evaluate how their roles as lenders could expose them to MNPI that may impact their other wider trading positions.

There is thus a need for closer attention to disclosure regimes, since fund managers may find themselves in the dual position where they are acting as both lender and investor, thereby leading to allegations of conflicts of interest. It also shows that policy development is needed to maintain safe storage of MNPI; the SEC called for written policies within Sound Point to avoid the misuse of MNPI across teams and products.

Disputes arising from private credit

The introduction of new and diverse players in the funding of established areas such as energy, as well as new areas such as AI technology, is destined to bring about familiar disputes on a renewed scale, as well as new disputes altogether.

Traditional areas of dispute include restructuring, which is an area where traditional lenders have historically held a degree of sway. However, private credit has different stakeholders backing their contributions and have already shown a willingness to engage more aggressively to achieve corporate control in the event of default, with the goal of maximising returns and minimising their losses in circumstances where traditional bank lenders may have deferred debt or engaged differently.

This trend has blended traditional restructuring with corporate governance issues and brought about early disputes around the world as global capital has met local circumstances.

For example, Indonesia has attracted billions of dollars in foreign investment to secure interests in its extensive nickel reserves in view of, among other things, the global energy transition that is dependent on nickel for batteries. A recent $560m dispute over debt highlighted how private credit was able to successfully assert itself against a local conglomerate and mine owner, the Bakrie Group.

In that case, US firm Varde Partners and Hong Kong-based Tor Investment Management were able to succeed before the Jakarta Commercial Court in the summer of 2024 in decisions that were ruled ineligible to proceed to the country’s Supreme Court – reflecting the credit investors fight to vote on any restructuring deal for one of the local conglomerate’s companies.

In a more traditional arena, US-based Main Street Capital took control of the board of US restaurant chain Buca di Beppo in late 2024. The increased use of rights to take control of boards are being used by private credit lenders, including because their loans are not traded, so private credit lenders do not have the same options to sell off their debt and cut losses.

Therefore, private credit lenders may more readily step in to take board control and achieve better outcomes to repay debt. That said, the convergence between public and private lending markets is taking shape as shown by State Street and Apollo Global Management filing in September 2024 for an exchange traded fund to bring private, illiquid assets to the public market.

Overall, in addition to regulatory oversight of private credit – which may bring standalone government litigation – there exists scope for significant dispute between providers and users of private credit in courtrooms and boardrooms alike. This is increasingly likely to occur on a global scale given the nature of the assets funded by private credit, particularly if the predicted growth in the sector comes to fruition.

Adam McWilliams is a partner and Xavier Casey is an intern at Quinn Emanuel Urquhart & Sullivan UK LLP. Mr McWilliams can be contacted on +44 (0)20 7653 2052 or by email: adammcwilliams@quinnemanuel.com.

Adam McWilliams and Xavier Casey

Quinn Emanuel Urquhart & Sullivan UK LLP