ASIC reveals private credit market red flags
Need to know
- ASIC has identified four key areas of operation in the Australian private credit funds sector requiring improvement to ensure the sector aligns with global standards: valuation, conflict management, fee transparency, and terminology.
- ASIC commissioned a review of the private credit funds sector and on 22 September 2025 released Report 814 Private credit in Australia.
- With ASIC calling for improved standards and meaningful action, it is expected to increase its oversight and guidance on private credit.
- Our investment funds team can help you navigate these developments and meet expectations for greater transparency, governance and regulatory alignment.
Background
In light of recent regulatory activity by ASIC in the private credit space (including surveillance of retail and wholesale credit fund operators and managers, and the imposition of design and distribution stop orders in respect of a number of funds), ASIC has commissioned a review of the private credit funds sector. The review was led by infrastructure investment executive Richard Timbs and former banker and chief risk officer Nigel Williams.
An extract of the report provided by Timbs and Williams was released by ASIC on 22 September 2025 and is known as Report 814 Private credit in Australia (Report 814). The report acknowledges the important role that private credit plays in Australia’s capital markets with the sector size estimated at around $200 billion.
It highlights the contribution of the private credit market to economic growth from both a supply and demand perspective – with its ability to fill funding gaps left by banks, while also providing investment opportunities for investors seeking diversification and yield.
In ASIC’s accompanying media release – ASIC signals opportunity for industry to lift private credit standards – published on 22 September 2025 announcing the publication of the report, it is ASIC’s view that Report 814 also reveals ‘concerning behaviours that fall short of market expectations and more importantly that are inconsistent with existing financial services law’.
In particular, the report outlines that segments of the market aimed towards wholesale and retail investors adopt practices that are sub-standard compared with international practices and are more likely to have issues relating to valuation methodologies, conflicts of interest and opaque fee arrangements.
The report highlights that the concentration of Australia’s private credit market is in higher-risk real estate construction and development, which may present as a systemic risk for ‘small and self-managed superannuation funds and ‘sophisticated’ investors’ in a downturn given Australia has not yet witnessed a prolonged downward credit environment.
Red flags
Report 814 outlines four key areas of operation that require improvement to ensure the sector aligns with global standards, supports market integrity and protects investors – in particular, to ensure investors fully understand the liquidity and credit risk they are taking for the returns being offered.
Conflicts of interest
Conflicts of interest can arise in a variety of operational areas, including in respect of related party transactions, valuations and fee structures.
- In terms of fee structures, where fund managers take greater than 0% (and up to 100%) of upfront or arrangement fees, they may be incentivised to write more business, churn through or extend loans, regardless of the quality of the decision.
- Managers can commit to a target investor return for investors but take higher returns (through a net interest margin) by negotiating higher interest rates with borrowers and through performance fees calculated on ‘outperformance’ generated by the net interest margin.
- Report 814 notes that while clearer and more quantifiable disclosure of such fee structures is desirable, the existence of such arrangements could encourage behaviour from managers that is more in their own interests than the interests of investors.
- Valuations may be performed by employees whose remuneration may be affected by the performance of the loan portfolio and decisions could be made that will result in higher management fees (for example, a decision not to write down a stressed loan). Less frequent valuations may also be undertaken in an effort not to write loans down, which would result in lower management fees.
- For related party arrangements, the transfer of loans between funds managed by a common head entity may introduce conflict risks concerning asset valuations for both the selling and purchasing funds.
- Where a manager holds both debt and equity interests in the same entity, the potential for conflict arises, especially if the underlying entity experiences financial distress. Loans between related entities or transfers within the same corporate group may be made without robust governance processes in place.
Valuations
There are a number of areas where valuation practices may require further scrutiny, particularly around frequency, independence and the recognition of impairments.
The report suggests that best practice would involve valuations being conducted at least quarterly by an independent party, regardless of whether a fund is listed or unlisted, on the basis that internal valuations create the potential for conflicts.
In terms of impairments, it is noted that managers may be reluctant to impair loans as despite heavy sub-investment grade exposure, several funds show no impairments This is surprising given global default data suggests there should be economic provisioning for expected credit losses and impairments in most funds with comparable sub-investment grade exposure.
Fees
There is a range of fee arrangements in the market, with some favouring managers and others that are investor-friendly. Many are not explained adequately or simply enough.
In particular, the total level of manager remuneration relative to fund size can be difficult or impossible to quantify. In terms of the different fee arrangements, Report 814 outlines that there are a number of different fee arrangements, including:
- those where managers:
- retain up to 100% of upfront fees paid by borrowers;
- share upfront and other associated loan fees with investors in varying split levels; and
- retain or share default interest (ranging from 100% of default interest being provided to investors to varying levels of split between the manager and investors, to 100% to managers); and
- arrangements involving net interest margins.
The problems associated with some fee arrangements include:
inconsistent disclosures across the market and a lack of transparency (for example, some funds where borrower fees are paid to the fund may have higher disclosed management fees in comparison to funds where borrower fees are paid to the manager, but the total fee cost may be lower);
the total level of manger remuneration relative to fund size can be difficult (or even impossible) to quantify, given the retention of fees paid by borrowers are excluded from management fee disclosures; and
the arrangements where higher borrower fees are retained by the manager being described as an ‘alignment of interest’ between managers and investors, notwithstanding that investors’ capital is at risk whilst the manager is negotiating the loan, and the quantum of the fees are not disclosed although they are often a multiple of the fund management fees.
In relation to net interest margins, the use of interposed special purpose vehicles which on-lend to borrowers at higher interest rates than the fund lends to the special purpose vehicles is described as ‘potentially manufacturing an arbitrage by taking both sides of the same transaction but providing investors with a lower rate of return than they are charging the borrower for essentially the same credit risk’.
The report notes that it is highly unlikely a borrower will be aware of the interest rate an individual borrower is being charged, nor the effective interest rate being paid to underlying investors through distributions from the proceeds of the relevant loan.
Further, in relation to managers taking amounts relating to ‘default interest’, the report puts forward that managers benefiting financially from a default on a loan they have originated raises questions about whether this is appropriate. While there is work involved for the manager in managing default scenarios, this is arguably part of their role and should be reflected in the management fees charged.
The position put forward in the report in relation to fees is that consistent with international practices of most major global fund managers: all borrower fees should be paid to investors and managers should charge transparent management fees to reflect their role in administering the loans.
Any remuneration received by managers directly from borrowers should be disclosed as a percentage of fund assets, on the basis that ‘it is the investors’ capital at risk and the investors’ capital supporting the manager’s fee generation’.
Terminology
Key terms are inconsistently defined and used by managers. For example:
- the nature of any ‘security’ is unclear,
- the term ‘senior debt’ is used without confirmation that no other claims rank ahead (particularly in borrower structures that use special purpose vehicles which could subordinate a security),
- it is unclear whether loan-to-valuation ratios (LVRs) in real estate lending are based on cost, current or completion values which have very different implications, and
- the term ‘investment grade’ is also used based on internal methodologies, without formal rating agency involvement.
Recommended ‘good practice’
Report 814 sets out a list of items representing industry good practice for the operation of the Australian private credit market. These include:
- Quarterly fund composition reporting and disclosure, including:
- the number of loans and borrowers in a portfolio,
- the percentage of loans and/or related borrowers representing greater than 5% of the fund,
- the proportion of distributions paid from cash income from investments and the proportion paid from other sources,
- the number of loans and percentage of the fund by value not paying cash interest or paying from principal drawdown,
- the percentage of the fund where loans may be stressed or impaired, and
- the percentage of the fund invested in credit rating bands.
- A requirement for additional information to be provided when terms such as ‘investment grade’ are used and further information to be provided on the source of any ratings.
- Quarterly independent valuations (or, at least, auditing and sign off being undertaken quarterly by an independent third party).
- The disclosure of all fees as a result of managing investor money (including any interest earned) disclosed as a proportion of funds invested.
- Transparent disclosure and independent sign off on related party or inter-fund transactions.
- Clear leverage policies and liquidity mechanics and potential impacts, with stress-testing and transparent redemption mechanics; and
- Clear definitions and explanations of key investment and real estate terminology.
It is expected there will be industry support for best practice operations and reporting, and it is proposed that industry bodies, such as the Financial Services Council, Australian Investment Council, the Property Funds Association and Alternative Investment Management Association could lead the work in this area in terms of participating in industry initiatives and testing thinking.
Where to from here?
ASIC Chair Joe Longo stated that ‘ASIC expects meaningful action in response to these findings and will not hesitate to intervene where progress falls short’.
Credit fund operators and managers targeting wholesale and retail investors should look to provide greater transparency on fees, risks and loan valuations and align themselves with the good practice principles to the extent possible.
Lending structures should be reviewed for potential conflicts of interest, including in related party transactions and fee arrangements, to identify the potential for misalignment between managers and investors.
ASIC is expected to increase its oversight and guidance on private credit, especially around conflicts, transparency and investor protection.
Report 814 states that ‘improved standards and disclosure across the board would be expected to build trust and confidence in the Australian private credit market’, meaning that further regulation in this area is likely – particularly to align Australia’s credit market with existing models in the US, Europe and the UK where products allow retail investors to have ‘exposure to private credit while maintaining high levels of protection and regulatory oversight’.
The report also urges ASIC to consider implementing a reporting framework that would allow it to continue obtaining market data relevant to any systemic risk concerns, separate to its ongoing surveillance of private credit participants.
How we can help
With ASIC’s increased oversight, our investment funds team is committed to helping fund managers navigate this evolving regulatory landscape.
We can help you address the growing demands for greater transparency, governance and regulatory alignment. Reach out for a tailored discussion on how the HW Funds team can help.
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