Growth Opportunities Abound for Asia’s Private Debt Industry Despite COVID-19 Headwinds

The private debt industry in Asia is poised for expansion, with room to close in on more developed private capital markets like the US and Europe 

The private debt industry in Asia has surged in recent years, supported by rising investor interest and a growing need for capital. The number of private debt investors in the region increased from 115 in 2014 to a record 477 at the end of 2019, while assets under management (AUM) held by Asia-focused private debt fund managers more than doubled from $28bn to $64bn over the same period, according to data from Preqin Pro. A booming middle class and burgeoning SME market in Asia have led to resilient economic growth, which has encouraged a shift away from traditional bank financing and toward private credit.

Despite the ongoing headwinds posed by COVID-19, the private debt landscape in Asia offers attractive opportunities – especially for industry participants that understand the unique nuances of each distinct market in this diverse region.

Why Private Debt in Asia?
The attraction of investing in Asia is ultimately about tapping into the long-term, positive growth trends at play on this side of the world, explained Sabita Prakash, Managing Director at Hong Kong-headquartered investment manager ADM Capital. In tandem with this growth, Asia remains a “supply-constrained market,” offering a “plethora” of sectors that are still opening, and that will continue to provide a lot of opportunities for fund managers, she added. 

Beyond these general growth trends, Asia also offers unique levels of diversity across the region. “In the last five years, correlations in Asia have come down a bit, allowing access to idiosyncratic risks that can be put together in portfolios in a very profitable manner,” said Prakash.

From an LP’s perspective, in addition to diversification benefits, private debt offers an attractive “mid-risk, mid-return profile,” which has boosted the asset class’s popularity among investors more recently, noted Yusun Chung, Private Assets Director at Schroders. Due to this primary characteristic, interest in private debt will continue to grow in Asia, she added.

These unique opportunities, though, are not without their own set of challenges for fund managers and investors. 

The Challenges of Investing in Asia
Asia has typically been classified as a single region by investors, and yet the ecosystem is highly diverse, with each country characterized by its own unique risks and opportunities. The combination of differing perspectives, business practices, and regulations – such as those around capital controls – further compound the complexity of deal-making and maximizing returns at both the transaction and fund level in Asia.

Although many fund managers conveniently view Asia as “one region and continent, the differences between countries are huge,” said Prakash. Two uniquely challenging nuances to be mindful of as a private debt investor, she added, is the overlap of legal and cultural aspects. 

“For instance, across Asia, there are many countries where personal guarantees work very well, not because they are easily exercisable, rather, it is an issue of losing face if personal guarantees are not honored,” she explained. Considering both legal and cultural factors in structuring transactions for return, as well as downside protection, in each local market becomes exceedingly complex. 

In addition, while ‘watertight’ contracts cover some blind spots and allow fund managers to seek recourse under a legitimate legal framework if needed, it is equally, if not more, important to forge good relationships with borrowers in Asia. This is especially so in some of the more emerging Asian countries where “the provenance of legal structuring may not be very proven yet,” noted Prakash.

At the fund level, private debt fund managers need to plan early when accounting for differences in taxation laws across Asia, explained Anulekha Samant, Tax Partner at KPMG. This requires setting up a tax efficient “treaty platform” for their holding structures that will invest across the region. It is particularly important for the credit space in Asia where transactions are highly structured, leading to various potential income streams such as interest, capital gains on sales, and equity kickers. Each also presents its own tax implications, she said, adding that fund managers must consider the entire lifecycle of their investments to make sure they are getting the best outcomes.

Four Key Lessons Learned from COVID-19
Prakash identified what she calls “the four Ds” to illustrate the key lessons that have been learned as a result of COVID-19. The first is that “digital works.” Digitally enabled businesses have outperformed their traditional counterparts in the face of lockdowns and physical restrictions. These businesses will be well placed to tap not only equity capital from venture capital funds, but also from the private debt market.

Second is the importance of “diversity.” Many businesses will be compelled to diversify their revenue streams and resources across geographies, as well as sectors, to better hedge against market uncertainties. Third, “debt moderation” will be key for companies seeking to survive in the face of significant fat-tail risks. The current economic environment will test not only the commercial viability of businesses, but will also refocus attention on the sustainability of cash flows and the ability of companies to repay debt obligations. Lastly, it comes down to the “determination” of borrowers to do what it takes to overcome new obstacles and challenges.

Bright spots are also emerging in certain areas within the private debt space. Infrastructure debt, especially lending to operating infrastructure assets, is a sub-sector that has seen increased investor demand post-COVID-19. These assets typically exhibit more “resilient characteristics compared to other private debt, or corporate debt investments,” explained Chung. “Observing the performance of infrastructure debt funds that we have at the moment, through the COVID-19 crisis, we are even more confident of the resilience of these strategies during volatile market conditions.”

A pick-up in distressed debt deal activity could also be on the horizon for fund managers. Compared with three or four years ago, the distressed debt space has grown slowly, and may expand quite dramatically due to COVID-19 – so it is something we will look out for, explained Prakash. That said, selectivity will be particularly important to discern good assets that may simply need liquidity due to not securing financing in time for business needs, or those facing unique business risks in the ‘new normal’ that are in need of a turnaround, or assets facing distress due to exposed governance issues.

What’s Next for Private Debt in Asia?
As investor interest in Asian private debt rises, bringing with it more capital targeting the region, there is ample room for the industry to grow. Looking at regional private debt-backed deal activity on an annual basis, North America and Europe still represent a significant majority of aggregate deal value globally each year. In fact, in 2019 both regions accounted for around 96% of the total value transacted, while Asia made up only 3.3% – despite the latter holding 7.5% of global private debt AUM the same year, Preqin data shows. The figures reveal a notable gap for Asia to catch up with the more established private credit markets.

The stage is set for Asian private debt to close in on these developed markets. In certain countries, such as South Korea, there is already evidence of growing LP appetite to step up exposure to private debt to hedge against economic volatility. Furthermore, beyond the key role of private debt in backing large-scale infrastructure projects in Asia, the growth of the asset class will also be driven by the needs of the SME segment – which remains under-served by traditional banks, as well as ‘shadow banking’ systems, present in many jurisdictions. Smaller firms that are looking to shore up liquidity are likely to explore alternatives to venture capital and private equity funding, providing the necessary catalyst for more sustainable growth in the private debt market in the region.

About the Asia Investment Conference (AIC)
The AIC is a curator of strategic high-level events among investors and key business decision-makers. These events are led and anchored by IJK Capital Partners, an investment and advisory firm with offices in Shanghai, Singapore, and Hong Kong. This article has been adapted from a webinar hosted by the AIC and SANNE Group titled Private Debt in Asia: Taking Centre Stage. For more information on this webinar, please visit: www.asiaconf.org.

About SANNE Group
SANNE is a leading global provider of alternative asset and corporate services. Established for over 30 years and listed as a FTSE 250 company on the Main Market of the London Stock Exchange, SANNE employs more than 1,800 people worldwide and administers structures and funds that have in excess of £315bn of assets. SANNE operates from a global network of offices located in leading financial jurisdictions, spread across the Americas, Europe, Africa, and Asia-Pacific. For more information on SANNE, please visit: www.sannegroup.com.