Amid growing concerns about the risks lurking in private debt markets, global securities regulators are calling for increased oversight, and proposing measures to curb conflicts of interest in the loan and securitization markets.
In a new report, the International Organization of Securities Commissions (IOSCO) warned that private finance markets are inherently opaque, which makes it tough for both regulators and market players to assess the nature of the risks in these markets.
“IOSCO is concerned that the sector may be tested going forward and respond in ways that uncover hidden risks, such as excess corporate leverage,” it said — adding that linkages between these private markets and other parts of the financial system may result in these risks spilling over into public markets.
“Private financing activities have seen unprecedented growth since the [global financial crisis], and the changing macro-financial environment could expose vulnerabilities,” said Kate Collyer, chair of IOSCO’s committee on emerging risks, in a release. “It is critical that regulators can monitor developments in private markets and understand emerging risks, particularly in a sector where transparency is more limited.”
At the same time, IOSCO is also seeking improved conduct in the leveraged loan market.
In a separate consultation paper, IOSCO set out a series of proposed “best practices” for participants in the leveraged loan and collateralized loan obligations (CLOs) markets.
While these sectors have traditionally enjoyed low default rates, the structure of these markets have evolved significantly in recent years, amid robust economic growth and rock bottom interest rates, the paper noted.
“The [leveraged loan] market has experienced an evolution in both the characteristics of the borrowers and in the investor base. The former has partially shifted from traditional industrial sectors towards technology and healthcare, and on average, the credit quality of corporate borrowers has deteriorated,” the paper noted — and, the investor audience has shifted from banks to other players, such as asset managers and CLO managers.
These changes, combined with the prolonged low-rate environment, have led to shifting market practices — including the rise in covenant-lite loans, increasing complexity in loan documentation, and the use of overly-optimistic cash flow adjustments in these vehicles, it noted.
In response, the consultation paper sets out proposed good practices for players in the leveraged loan and CLO markets.
“These good practices are designed to support sound [leveraged loan] and CLO market practice and further IOSCO’s market integrity and systemic risk objective,” said Mhairi Jackson, chair of IOSCO’s committee on regulation of market intermediaries.
“The proposed set of good practices are an important step towards mitigating some of the vulnerabilities observed in our work, particularly the possible conduct and conflicts of interest risks observed across the intermediation chain – from [leveraged loan] origination through the distribution of the CLO notes,” added Christina Choi, chair of IOSCO’s committee on investment management.
The proposals are out for comment until Dec. 15. IOSCO aims to finalize the report by the first quarter of 2024.