ESG and democratisation driving greater transparency in private market space: Napoli, Clearwater

Net zero target initiatives are driving increased interest in ESG, which, combined with the democratisation of the private market space in general, is leading to broader transparency efforts in the private credit segment, according to Jon Napoli, Solutions Consultant, Clearwater Analytics.

In an interview with Reinsurance News, Napoli discussed shifting market dynamics in the private credit sector amid an acceleration of technological advances and the need for conviction in covenants, at a time when insurance companies are increasingly looking to the private credit space.

As highlighted recently by global ratings agency Moody’s, private credit is on the rise, and insurers are poised to keep growing their holdings in a market that has the potential to offer structural advantages for an array of institutions.

In fact, according to another rating agency, AM Best, insurers’ private credit holdings grew by almost 6% in 2023 to almost $1.7 trillion.

Recently, the dynamics of private credit markets have shifted, with a resurgence in syndicated lending, a greater focus on ESG in Europe, and the rise of the secondaries market.

“Currently the focus is on emissions level data for funds, but we’ve begun to see broader interest in social and governance data being leveraged for evaluations. The focus on emissions is largely driven by net zero target initiatives,” said Napoli.

A growing number of global insurers and reinsurers have now set net zero targets, and while these vary somewhat, most have committed to intermediate targets by 2030 with a view to reaching net zero greenhouse gas emissions across their entire business by 2050.

This is in line with governments and unions around the world, many of which have committed to achieving net zero by 2050.

While ESG has become more of a focal point, the private credit space has also witnessed a resurgence of syndicated lending, which Napoli explained, while notable, is really more about rebalancing levels seen previously.

The discussion then turned to the rise of the secondaries market, traditionally a good way for investors to de-risk their balance sheets and get more liquidity.

Napoli commented: “We’ve observed a positive correlation between follow on investments and transparency where general partners (GPs) that provide higher degrees of transparency tend to have an easier time of fund raising from existing investors. As a result, fund managers and GPs may consider data transparency and reporting quality to provide a competitive advantage as the market develops further.”

Next, Napoli discussed technological advancements such as automation and artificial intelligence, which can help carriers impove their investment books and beyond.

He explained that while data transparency and reporting quality can play a competitive advantage for fundraising, re/insurers are also actively pursuing better resources and technologies to manage their alternative investment portfolios with greater efficiency.

In a recent study conducted by Clearwater Analytics, escalating operational challenges associated with the rising popularity of private markets flagged data standardisation (28%) and reporting (19%) as the most pressing areas for improvement. These data points highlight the vital role that advanced technology can play.

“Furthermore, improvements in technology and the rise of AI have enabled increased transparency by automating private market processes. As automation drives efficiency, firms are better able to scale and meet greater demand from new audiences,” Napoli noted.

On top of all of the above, Napoli told Reinsurance News that new audiences have played a significant role in the shifting private credit market dynamics, with new demands and expectations, as well as new interest in different vehicle types.

“Interestingly, there has been a move towards hybrid and evergreen type vehicles that may have to do with democratisation of the asset class, as newer players like retail investors seek to enter the space to get exposure to private markets,” he said.

As the market has matured and with the introduction of more retail-friendly structures, retail investing in the private credit sector has increased. Some estimates suggest that the market for private credit could hit $3.5 trillion by 2028, and this growth is attracting capital from retail investors.

In the past, retail investors were unable to access the private credit asset class due to consumer protections which typically restricted the types of investment options available, but the dynamics have shifted in both the U.S. and Europe.

In the U.S., for example, retail investors can gain exposure via funds known as business development companies (BDCs), which enable small and mid-size firms to access pools of capital otherwise not available. And in Europe, there’s been notable growth in European Long-Term Investment Funds (ELTIFs), which act similarly.

To end, Napoli provided some thoughts on covenants and the need for conviction.

Commenting on evaluating GPs and fund managers, he explained that one of the more important things beyond transparency is evaluating terms and conditions / covenants built into private credit agreements.

“Additionally, identifying players in the market that have a track record of investing and running deals across multiple interest rate climates, beyond the low yield period we had since the 2008 global financial crisis, as well as the relatively recent higher yield period we find ourselves in today,” he said.

While it’s still unclear exactly when interest rates will fall, Napoli noted that it will be interesting to see how funds perform once this happens. Markets broadly watch like hawks for any indication of a shift in rates, however, private credit tends to be insulated from this risk by the nature of the covenants and structure of the deals themselves.

“One of the key concerns in the market is how quickly interest rates fall when they do go down and what the impact will be to the market.”

“Our stance is that it’s unlikely there will be an impact on private credit from a refinancing perspective as most direct financing deals have restrictive covenants in place to protect them from refinancing risk. Additionally, from an interest rate perspective, most deals have a fixed for floating rate structure, meaning returns will not be impacted either,” said Napoli.

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