Private credit is rapidly emerging as a viable alternative to traditional banking in Asia, adapting to regulatory challenges and meeting the demand for flexible financing amid increasing pressures on conventional lenders.

• Private credit in Asia doubles, still room for growth
• Flexible financing attracts borrowers in higher-interest rate environment
• Local knowledge crucial for success in diverse Asian markets

In the evolving landscape of Asian finance, private credit is emerging as a powerful alternative to traditional banking. While private credit assets under management in Asia Pacific roughly doubled to about $120 billion by the end of 2023, this represents just 6-7 percent of global transactions, highlighting both the sector's rapid growth and its significant potential for expansion.

This growth is being fuelled by a convergence of market dynamics and structural changes in the region's financial landscape. “A key factor for the orientation towards private credit is the higher-for-longer interest rate environment,” says Beelee Seah, Singapore-based banking and finance partner at Norton Rose Fulbright. This environment has effectively narrowed the pricing gap between bank-funded facilities and private credit funds, making the latter increasingly attractive to borrowers, Seah explains. 

Traditional banking in Asia accounts for over 80 percent of total credit, creating a unique market dynamic. Unlike their U.S. and European counterparts, Asian banks maintain large capital buffers and less complex loan portfolios, enabling their dominance.

“Documentation terms have remained relatively robust, with stronger covenants and lender protections and far lower acceptance of the ‘trapdoors’ which have been used by sponsors in other markets to remove valuable assets from the credit net,” notes Andrew Brereton, Singapore office managing partner at King & Spalding.

However, this banking landscape has created distinct opportunities for private credit providers, particularly in serving middle-market companies and sectors that face difficulties accessing traditional bank funding. The situation is particularly pronounced in emerging markets, where small and medium-sized enterprises account for a significant portion of GDP – reaching over 40 percent in some Southeast Asian countries – yet often struggle to secure traditional financing.

The market's evolution is particularly evident in its transformation from primarily special situations lending to a broader spectrum of financing solutions. "Private credit funds offer companies access to flexible capital which banks generally cannot provide," says Brereton.

This flexibility manifests in various forms, including high levels of (paid-in-kind) PIK interest and preference shares with debt-like characteristics that qualify as equity for accounting purposes. For sectors that have become increasingly unbanked, such as mining and oil and gas, private credit has emerged as a crucial source of capital, filling gaps left by traditional lenders, Brereton explains. 

Further, the substantial amount of dry powder in the hands of private credit funds has led fund managers to offer increasingly competitive pricing while still exceeding their privately negotiated hurdle rates with investors. The competitive pricing, combined with greater flexibility in structuring deals, has made private credit an increasingly attractive option for borrowers, particularly in the underserved small and medium enterprises sector.

REGULATORY CONSIDERATIONS

Legal frameworks significantly shape the private credit landscape across Asia, with variations in acceptance and structure. “The threshold question relates to market access,” Brereton points out. “These vary widely across APAC, from countries such as Australia and Hong Kong which freely allow direct lending, to jurisdictions such as India, Malaysia, and South Korea where offshore financing often requires more careful structuring to comply with local regulations,” he says. 

While US and European regulators have increased scrutiny of private credit, Asian regulators have generally taken a more measured approach due to banks' dominance. “There is perhaps less of an immediate concern from Asia-based regulators as the source of debt funding in Asia is overwhelmingly provided by regulated banks (at least for now),” Seah explains. 

Brereton agrees: “There is far less evidence that regulators in Asian countries are scrutinising private credit as an asset class or considering the introduction of specific regulation in relation to the private credit industry.” 

“In Singapore, there are clear, publicly available records of registered security granted by Singapore entities and these can be immediately retrieved online via ACRA. By contrast, in certain other Southeast Asian countries, their equivalent security registers may not be publicly available and privately held security registers may not be up-to-date or correctly maintained.” 

• Beelee Seah, Norton Rose Fulbright

In Singapore and Hong Kong, common law systems provide robust creditor protections and predictable enforcement mechanisms. This legal certainty has helped these markets emerge as regional hubs for private credit activity. 

“In Singapore, there are clear, publicly available records of registered security granted by Singapore entities and these can be immediately retrieved online via ACRA. By contrast, in certain other Southeast Asian countries, their equivalent security registers may not be publicly available and privately held security registers may not be up-to-date or correctly maintained,” says Seah.

Singapore's IRDA also provides a clear workout regime for restructurings and protections against problematic transactions.

Singapore is also an attractive jurisdiction from a structuring perspective, Brereton adds. “Many private credit lenders will favour deal structures that involve a Singapore-incorporated holding company providing a single-point enforcement, particularly where the underlying operational assets are based in less predictable jurisdictions such as Indonesia or Vietnam,” he explains. 

Hong Kong's private credit market has experienced substantial growth, with assets under management increasing from approximately $15 billion in 2020 to $25 billion by the end of 2023. 

The market is gaining momentum as banks tighten lending criteria amid pressure from declining property valuations. The mid-market segment, where private credit deployments have grown by 75 percent year-over-year in 2023. Alternative lenders are stepping in to fill the approximately $8 billion funding gap left by traditional banks' reduced lending appetite. 

The trend has been further amplified by the growing presence of regional private credit funds, with over 15 new funds establishing operations in Hong Kong since 2022, collectively raising more than $12 billion in dry powder specifically targeting opportunities in the Greater China region.

India has met strong demand with dynamic regulatory measures fostering a thriving private credit environment. India-focused private debt funds grew to $17.8 billion in 2023 from less than a billion in 2010, with predictions of accounting for 30 percent of private credit raising by 2025. 

Key among India’s regulatory reforms has been the introduction of credit protection regimes under the Insolvency and Bankruptcy Code, 2016, Seah points out. “While the IBC is certainly not new legislation, its impact has been monumental since its inception in 2016 and it has enhanced creditors’ negotiation power and, in turn, encouraged Indian debtors facing distress to participate in consensual out-of-court workouts, which often involve restructuring both the financial aspects and the operational aspects of the debtor’s business,” he notes.

ADAPTING TO SE ASIA MARKETS

Southeast Asian markets present a more nuanced picture, with each jurisdiction offering unique challenges and opportunities.  While there is interest in Indonesia and Vietnam, loan deployment is still nascent, as private credit funds often favour India, Japan, and Korea for superior risk-adjusted returns. "That said, we are seeing the establishment of private credit funds with a specific South-East Asia strategy,” Seah notes.

Given this increasing demand, lenders have adapted their approach in the region. “Onshore security in these jurisdictions is often viewed as 'defensive,’” Brereton explains. “Lenders don't expect to proactively enforce this security, given the challenges involved, but they will take it anyway to ensure that they at least have a level playing field with other creditors.”

They focus on monitoring cashflows and mitigating risks, often favouring structures with offshore holding companies for predictable security enforcement, Brereton adds. 

These legal considerations dovetail with the unique cultural dynamics and relationship-based business practices that characterise Asian markets. “Given the importance of local relationships to the success of many businesses in Asia, we have seen private credit lenders increase the level of pre-deal counterparty diligence,” Brereton points out.

In certain Asian jurisdictions, a local presence is critical, adds Seah. “Deal team members who are on-the-ground who understand local practice and culture can often more readily satisfy the requirements of regulatory approvals,” he notes. “With private credit funds being laser-focused on downside risk, they must understand these local nuances to be able to properly weigh the risks of financing Asian borrowers in such jurisdictions against the value of anticipated returns.”

The importance of local relationships is particularly evident in Southeast Asia's family-owned businesses, where successful private credit deals require a deep understanding of both financial and cultural factors. "Given the sensitivity and personal investment of those shareholders in that business (often made over decades), any lender-side solution should always be proposed early in the financing process and navigated with care, respect and adherence to local cultural norms," says Seah.