A notable consequence of the 2008 financial crisis is that many regulators around the globe recognized the need to curb the activities of financial institutions; their activities were viewed as placing significant stress on the banking industry and had led to a number of government bail-outs. As a result, previously dominant lending institutions had to reconsider their credit activities and this created an opportunity for alternative financial institutions to fill that void.
Basel III is a global regulatory standard which encourages banks to hold sufficient, high quality liquid assets that are able to meet liquidity needs over a short period of time or extended stress periods. This needs to be accomplished fully in Europe by 2019. Across the shore, the Volcker Rule restricts the amount of capital US banks are able to allocate to illiquid assets by 2016. Preqin’s Private Debt Online service shows that banks currently account for 2% of investors allocating to private debt funds, and it would seem likely that regulation may lead to this number decreasing going forward.
Banks were not the only institutional investor to catch the attention of regulators. At present, insurance companies account for 10% of the total number of investors within the private debt universe. In 2009, the Council of the European Union adopted the Solvency II Directive which regulates the activity of Europe-based insurance companies and is expected to be implemented by January 2016. This directive requires Europe-based insurance companies to hold more liquid assets. The issue of liquidity will once again be a concern when insurance companies consider private debt investments. On this premise alone, it is highly likely that insurance companies will scale back private debt investments from their balance sheets due to their illiquid nature.
Conversely, Preqin’s Private Debt Online service shows that the presence of more deregulated financial institutions is growing within the asset class, with public and private sector pension funds forming the highest number of investors at over a third (35%) of all active investors in private debt, followed by foundations (12%). It would seem regulation affecting the investment activity of banks and insurance companies, which requires them to hold more liquid assets on their balance sheets, has led to a gap in how middle-market companies are funded. Alternative lenders are increasingly moving into this space, seeking to secure capital from a more diverse base of investors. As such, regulation can be considered a contributory factor toward the shift in the make-up of investor types allocating capital to private debt.