The challenges of investing in private debt – a US / Europe comparison
From time to time, I receive newsletter emails with the headline “X invested Y million in Z”. Anyone who has played an active role in a process that led to such a headline knows how supercharged the word “to invest” is with painful processes – all nighters, all the strategizing, research, analyses and so on.
For such a transaction to successfully complete, a tonne of things have to fall into place, and if you don’t happen to be working for a corporate service provider who just signs deal by deal for his clients, the pride of having closed a deal will need to last a while.
To name a few obvious things that have to go right:
- The investor needs to understand the asset
- The investor needs to want the asset
- The asset needs to be available to the investor
Sounds trivial? It isn’t when it comes to the trending asset class of private debt. Especially when comparing the sector in the US versus the sector in Europe, data and availability are two key areas where the market in the US is miles ahead, as well as having several other structural advantages.
Language, the Marketplace and Logistics are the three core components of every trading environment. It’s simple: You go to the store (marketplace), you say how many tomatoes you want at what price (language) and then you pay and carry them home (logistics).
In all three categories the European lending market is less developed than the one in the US. And since language (data), marketplace (pan-European loan exchange) and logistics (settlement) are underdeveloped, non-existent or highly fragmented, it is a logical consequence that investors have a hard time understanding the asset, therefore not all of them want it, and for those who want to invest, the availability is not really great.
In the US large lending platforms have a highly visible and broad availability of historical loan data, while the availability in Europe is much more tricky and access to data is bespoke. Not only does the high degree of fragmentation among lenders lead to smaller, statistically less significant data sets, but also oftentimes the smaller portfolios do not justify substantial investments in data teams that clean and prepare data for capital market participants.
However, it is not only the availability and quality of data itself that is a bit behind in Europe. On the investor side of the equation, the later evolution of European originators has also caused the credit knowledge of investors for platform lending to lag behind.
The combination of both of the above factors, together with the heterogeneity of the European market, is creating a situation in Europe comparable to the language confusion in the ancient Babylon.
As a consequence of the delayed evolution of alternative lending in Europe, the asset class itself is missing in a surprising number of investment strategies. More specifically, the idea of investing in private debt is omnipresent; it is the execution of that promise which is behind. We know investors who have been repeating to us for four years in a row that private debt investments are so important that they are on the agenda for “next year”.
Finally, the availability comes down to the settlement issue. While in the US every major platform has a rather easy-to-use investor hub, with a fund or a securitisation solution, this structuring piece is often missing in Europe. The core reasons here again are maturity of the overall market and heterogeneity of the lending landscape, including heterogeneity of regulatory frameworks, which still make cross-border investments a pain in many cases. Although we are supposed to live in a harmonised regulatory environment, in reality we are not when it comes to local lending licenses and transfer of assets.
Long story short, the higher degree of heterogeneity in Europe together with a belated start of maturation, results in a situation today where private debt investments in Europe are more difficult to realise than in the US and the tickets are typically smaller. What a great opportunity!
Market participants who master this complexity will typically see higher risk-adjusted returns. The reason is simple: The complexity in availability results in less competition and the heterogeneity of the market results in more specialised origination and opportunities.
CrossLend provides data technology which allows originators to have state-of-the-art data-related communication with their investors and which helps investors to maintain operational efficiency when investing in 10+ originators. CrossLend’s marketplace technology helps market participants to find each other and trade and then finally settle via digital securitisation.
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