Private Debt: Private Market's "Petit Prince"

Private debt increasingly popular with investors

The private market industry is up against a major challenge. In the last two years, interest rates have risen faster than at any time since the 1980s. On average from March 2022 to July 2023, monetary tightening amounted to +525 points. The ECB¹ may well have announced a 25bp cut in key rates at the beginning of June, but it is far from certain that central banks will move ahead swiftly with this inversion of short-term rates and no one knows where they will land.

With the geopolitical context remaining uncertain, and the overall trend remaining inflationary, the promise of returns for natural investors in the unlisted market (i.e. professionals) is struggling to be fulfilled. The real economy seized up in 2023, and with it investment projects in private equity, infrastructure and real estate. Many asset management companies postponed their plans to launch funds until 2024. Given the macroeconomic environment, investors (limited partners, or “LPs”) have sought alternatives. And many of them have turned to private debt.

The “prince” of the Private Market

Private debt funds were looked at askance following the 2007-2008 financial crisis and then considered unattractive when liquidity was widely accessible and key rates negative. But they have now become a game changer for the asset management market. They now rival with underlying equities, delivering an average return of around 10%. Their success is such that private debt fundraising is expected to total some US$3,500 billion between now and 2028.

Private debt is the choice of "princes" for LPs because by design this market has the dual advantage of providing liquidity and offering more regular payouts for investors.

Besides the macroeconomic context, private debt is surfing on another favourable factor: the segment is opening up to retail investors – spurred onwards by the phenomenon of “platformisation” – providing general partners (GPs) with technological leverage to facilitate fund-raising.

An inexhaustible source of projects to finance

With access to credit becoming increasingly complicated, private debt funds are an attractive alternative for those seeking financing. Private debt investment has a dual objective: yield and choice of investment universe. Given the number of successful projects, investors looking to invest in the real economy can pick and choose from a broad range of themes, including the financing of energy transition projects or residential projects and the assignment of receivables (e.g. commercial, real estate, car leasing, etc.).

However, Maryam Noury Arab, securitisation expert at Société Générale Securities Services (SGSS), points out: “While the inflationary context naturally directs attention to the private debt sector, securitisation has never ceased to fulfil its role of supporting the real economy by providing a sustainable source of financing for our flagship industries, relieving congestion in the banking sector and helping many companies to finance their balance sheet with customised structured vehicles”.

A changing industry : focus on the French market

The development of private debt has come hand in hand with new challenges for unlisted players

While private debt investments have long been made through generic vehicles such as Specialised Professional Funds (FPSs) or French Limited Partnerships (SLPs), specialised vehicles such as Specialised Financing Organisations (OFSs) have emerged on the market. Their many advantages include:

• In assets, a broader investment universe,

• In liabilities, an expanded universe of investors with the European passport; and for managers the possibility of offering the issue of debt securities in addition to units and shares.

In addition, the securitisation market has undergone profound changes over the last decade. To boost transparency and improve risk management, the regulator adopted the STS label in 2019 and strengthened the obligations on securitisation vehicles with the Pacte Act in 2020, confirmed by the AMF in April 2021. Depositaries must now carry out position keeping and a line-by-line check of the existence of receivables. This alignment with the AIFMD regime stands as a major challenge for unlisted players given the high volume of receivables observed on these vehicles, mainly securitisation funds (FCT). Securitisation today is intended to be more transparent, efficient and secure for investors.

Consistent with the words of  Antoine de Saint-Exupéry, “As for the future, your task is not to foresee it, but to enable it”, SGSS, armed with the desire to support its clients in the private market segment, and particularly in private debt, is constantly strengthening its system to meet market expectations and thus be able to manage funds with high volumes.

Private debt set to prosper

Across the private market, dry powder, i.e. all the amounts committed but not yet called by management companies, has never been so substantial, enjoying a record year in 2023 at over US$3,900 billion.

GPs currently have an un-invested war chest that they will have to reinvest at some point. If interest rates fall and central banks succeed in achieving a soft landing, and if inflation stabilises with the absence of any other macroeconomic shock, then the situation in the private market segment should normalise. We are therefore likely to see a gradual return to private equity investments, with investment in private debt expected to remain robust.

Resolutely forward-looking, the private debt sector will continue to adapt to the emerging needs of the real economy, such as FinTech financing solutions and ESG support.

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Julien Aïdan and Amandine Bozier, Private Markets Fund Product Engineers, Societe Generale Securities Services

¹ European Central Bank