Agefi Luxembourg - avril 2025

AGEFI Luxembourg 26 Avril 2025 Fonds d’investissement Opinion - by Bruno COLMANT, Ph.D. in Applied Economics (ULB), Member of the Royal Academy of Belgium W e aremaking a colossal error of judgment by ob- servingTrump’s trade stra- tegy, which everyone knows is suicidal, startingwith theUnited States itself, in a scenario reminiscent of theGreat Depression of the 1930s. However,wemustlookatthingsthe otherwayaroundandaskourselves what Trump wants. He essentially demandsthreethings:toreindustrial- ize the United States by attracting for- eigncompanies,toweakenthedollarto boostAmerican exports, and, above all, tofindcompliantcreditorsforitspublicdebt, thefinancingofwhichwillneedtobeimposedon the rest of theworld at a very lowinterest rate. The tariffchaos of earlyApril is thus thefirst step ina massiveplantorealigncurrencyparities.Herearethe phases, knowing thatDonaldTrumpwants to reindustrializetheUnitedStatesandmaintain theU.S.dollarastheworld’sreservecurrency. Thefirststepistodeploytariffchaostocreate leverage for negotiation, with the United States having defined three zones based on their degree of dependency: the vassals (the United Kingdom, and likely Mexico and Canada), the neutral countries (the Euro- peanUnion),andtheenemycoun- tries, such as China. The announcedcustomsduties followthis gradation. The second step is to adjust these customs duties based on how open countries are to American exports, such as militarymatters.Inthiscontext, it is clear that Europe’s rearmament will be American and that the balance of payments between theUnitedStatesandEuropewillinfluenceAmerica’s willingnesstoremainassociatedwithNATO.Donald Trump does not want to limit American imports; he wantstoincreaseAmericanexports.How?Byimpos- ing prohibitive customs duties and then negotiating. Negotiating what? Negotiating that European part- ners preferAmerican products overAsian ones, that companies set up in theUnited States, and, most im- portantly,thatforeignfinancialinstitutions,including central banks, subscribe to long-term U.S. public bonds. And Trump will place the Federal Reserve underWhiteHousecontrolwithamassivemonetary realignment, about which I have written so many notes over the past months. Incidentally, if the coun- tries in question prove compliant, they will benefit frommilitary support associatedwithNATO. Finally,itwillinvolveimplementingadepreciationof thedollar(whichmightreplacetariffbarriers,orrather benegotiatedunderthethreatoftariffbarriers)under thenameoftheMar-a-LagoAccords,whichwillrival the Bretton Woods agreements of 1944 or the Plaza Accordof 1985. The Mar-a-Lago Accord will resemble the Bretton Woods system devised in 1944 (where currencies were linked to each other through fixed parities de- fined with gold) but without the gold link. Vassal countries,perhapsneutralones,willpegtheircurren- ciestothedollar.Inreturn,theywillgainaccesstothe American market and benefits in terms of security andaccesstothedollar.It’sworthrecallingthat,every day,theUnitedStatesexchanges(whatfinancierscall swaps) tens of trillions of dollars with other central banks to ensure global monetary liquidity. Without accesstotheseswaps,acountry’sbankingsystemcan collapse instantly. Theseparitieswill lead to a signifi- cant depreciationof the dollar. There will be no escape from this plan, which will make theUnitedStates roar. Europe, once again,will be defeated. If it accepts these parities, its export po- tentialwillbeunderminedatthecostofarecession.If itdoesnotacceptthem,customsbarrierswillberaised at the cost…of a recession.And thiswill work. It has alwaysworked.TheUnitedStatesistheworld’slead- ing economic power, and the dollar remains the world’s reserve currency. It’s abit simplisticbut quite straightforward.Therestisjustemotionsandpolitico- media posturing. AndwhataboutEurope?ItistrappedbetweenAmer- ican customs duties andChinese imports. It’s easy to understand: behind this monetary realignment, the euro’s survival is at stake. Trump rewrites the rules of the monetary game I n the aftermath of the global fi- nancial crisis of 2008, private debt has emerged as a signifi- cant asset class, gaining traction among investors seeking alterna- tive financing sources. This surge in interest underscores a broader transformationwithin financial markets, where both investors and borrowers are seeking enhanced flexibility anddiversification.As the private credit landscape conti- nues to evolve, the importance of robust valuationpractices and heightened regulatory oversight becomes increasingly critical, espe- cially in the context of economic fluctuations and changing finan- cial conditions. The Impact of the 2008 Financial Crisis The 2008 financial crisis was a turning pointforprivatedebt.Thecrisisprompted regulatorstopressurefinancialinstitutions toadoptmorecautiouslendingmeasures, leading investors to seek alternative sources of financing. While traditional bank lending continues to be a primary source of debt, regulatory changes imple- mented post-crisis have increased capital requirements, thereby reducing the avail- ability of financing for riskier borrowers. Unlikeconventionalbanklending,private debtisoftenpreferreddespitehigherbor- rowing costs, as providers of this asset class are more accommodating to bor- rowers,customizingcontractterms,intro- ducing covenants, and establishing collateral requirements. (1) Private debt has experienced remarkable growth since then, with fundraising fig- uresillustratingthistrend.Accordingtoa recent study by Pitchbook published in Q1 2024, private debt fundraising in- creased from $116.1 billion in 2014 to a peak of $302.1 billion in 2021. (2) Further- more, the Alternative Credit Council (ACC), in collaboration with EY Luxem- bourg in their latest Financing the Econ- omy report, estimates that the global private credit market could reach a stag- gering $3 trillion, reflecting a robust ap- petite for non-bank financing solutions. (3) Interest Rates and ValuationMethods The private credit market is significantly influenced by interest rates and inflation, bothofwhichplayacrucialroleintheval- uation of these instruments. Prior to 2022, theeconomicclimatewasrelativelystable, with interest rates hovering around 0%. (4) During this period, most financial assets were measured at amortized cost under theInternationalFinancialReportingStan- dards(IFRS). IFRSdistinguishesbetween equity and debt instruments, with equity measured at fair value under IFRS 13, while debt instruments can be valued ei- ther at fair value or amortized cost, de- pending on the results of the business model test and cash flow test. (5) The busi- nessmodel test assesseswhether a finan- cialassetisheldtocollectcontractualcash flows, while the cash flow test evaluates whether the contractual terms of the fi- nancial assets give rise to cash flows that are solely payments of principal and in- terest on the outstanding principal amount. (6) Prior to2022, the stabilityof in- terest rates meant that most financial as- sets were measured at amortized cost underIFRS,astheintentiontosellwasnot the primary concern. However,withtheriseofinflationin2022, whichreacheditshighestlevelssince1980, the Federal Open Market Committee in- tervened by increasing the federal funds targetrateforthefirsttimesince2018.This led to a rapid escalation of interest rates, reaching 525 basis points by September 2023. (7) Consequently, private debt instru- mentsbecamemoreattractivetoinvestors, generating a need for potential sales and necessitatingashiftfromamortizedcostto fair value assessments. At the same time, there was a growing concern for greater transparency,particularlyasrisinginterest rates heightened the risk of potential losses. This increased scrutiny aimed to ensurethatvaluationsaccuratelyreflected market conditions, and safeguarded in- vestor confidence. Transparency and ValuationConcerns Despite the significant growth of the pri- vate credit market, concerns regarding transparency and asset valuation have emerged. Unlike public markets, where securities are traded regularly and prices are determined transparently, private credit valuations oftendependon thedis- cretion of fund managers. This lack of transparency raises questions about the true valuation of assets and the ability of investors tomake informeddecisions. One alarming trend is the increase in “payment-in-kind” (PIK) loans, where companies opt to defer interest pay- ments, promising to settle them at the loan’smaturity. While this practice does not necessarily indicatefinancial distress, it raises concerns about the financial health of the companies involved. Fur- thermore, PIKloans areoftenvaluedsur- prisingly high, with approximately 75% valued at over 95 cents on the dollar by the end of September. This discrepancy raises doubts about the consistency of valuations, especiallywhencompared to similar loans in thepublicmarket,which are often valued lower. Another critical issue is the variance in asset valuations among different fund managers. An article published by Bloomberg provided cases for such vari- ance,citingtheexampleofane-commerce company, where some managers valued its loans at 65 cents on the dollar, while others assessed them at 84 cents. These discrepancies highlight the lack of stan- dardization in valuation processes and raise questions about the accuracy of esti- mates provided to investors. (8) Regulatory Focus and Future Outlook for ValuationPractices The increasing attention from regulators underscores the necessity for greater transparency in theprivate creditmarket. Between2022and2025,globalregulatory bodieshaveintensifiedtheirfocusonval- uation practices within the private debt markettoenhancetransparencyandmit- igate systemic risks. In 2022, the IPEV Guidelines were updated to include spe- cific sections on private debt, providing clearerguidanceonhowtovaluethesein- struments. (9) The International Organiza- tion of Securities Commissions (IOSCO) has also issued reports emphasizing the importanceofrobustgovernanceandval- uationpractices to address potential risks associated with private finance. In 2023, IOSCOreleased a report highlighting the needforenhancedregulatoryattentionto mitigaterisksinmoneymarketfundsand bond markets, including collateralized loan obligations. (10) Additionally, the Financial ConductAu- thority (FCA) has initiated a review to ensure that valuationpractices inprivate markets are robust and transparent. This initiative aims to address concerns about the adequacy of current governance and methodologies, ensuring that assetman- agers apply rigorous valuation frame- works andprovide detailed reporting to protect investors and maintain market integrity. (11) InDecember 2024, the Finan- cial StabilityBoard (FSB) underscored the rapid growth of non-bank financial inter- mediaries,suchashedgefundsandinsur- ers, which now constitute nearly half of global financial assets. The report empha- sizes the need for enhanced monitoring andmanagementofnon-bankcreditrisks, improved counterparty credit risk man- agement in linewithBasel Committee on Banking Supervision (BCBS) guidelines, and increased transparency through pri- vate disclosures. These measures aim to mitigatesystemicrisksassociatedwiththe expansionof private debtmarkets. (12) The BCBS has set a work program and strategicprioritiesfor2025/26,focusingon Basel III implementation, riskassessment, safeguardingresilience,digitalization,and liquidity.AkeyareaofinterestistheCom- mittee’s analysis of banks’ interconnec- tions with non-bank financial interme- diation,whichincludesprivatecreditmar- kets.Thisworkaimstoassessandmitigate risks arising from banks’ exposures to non-bankfinancial entities. (13) Moreover, the European Securities and MarketsAuthority (ESMA) has provided guidanceonvaluationpracticesformoney marketfunds(MMFs)investinginprivate debt. Ina response to theEuropeanCom- mission in November 2024, ESMA pro- posedthatsuchMMFsshouldnotusethe amortizedcostmethodforassetvaluation, regardlessoftheinvestorbaseortheassets held.Thisproposalaimstopreventpoten- tial distortions in the valuation of private debtinstrumentsandensureamoreaccu- raterepresentationoftheirmarketvalue. (14) Atthesametime,currentmacroeconomic conditions, including interest rates, have alsoimpactedprivatedebtvaluationprac- tices.As of 28March2025, theFederal Re- serve’s effective federal funds rate stands at 4.33%. This rate reflects the interest at which depository institutions lend bal- ances held at the Federal Reserve to one another overnight. The Federal Reserve hasmaintainedthisrateinlightofongoing economic assessments, providing a broadercontextforevaluatingprivatedebt instruments.Elevatedinterestratescanaf- fect the attractiveness of private debt, in- troducing volatility that underscores the necessityforrigorousandtransparentval- uation practices capable of adapting to these dynamic financial conditions. (15) AccordingtotheACCreportincollabora- tionwithEYLuxembourg,themajorityof private credit managers anticipate ex- panding their operations in both mature andemergingprivatecreditstrategiesand markets.Asset-backedlending(ABL),real estatefinancing,andinfrastructurefinanc- ingnowrepresent a considerable share of the market, together making up 40% of private credit assets under management. TheEuropeanandAsia-Pacificregionsare set for notable growth, fueledby ongoing bank pullbacks, greater borrower aware- ness,andenhancedregulatoryclarity.Fur- thermore, there is robust investor interest inprivatecreditassets,especiallyinsectors thatprovidediversificationandalternative return sources. Government initiatives aimed at attracting more investment in public energy and infrastructure projects are likely to create significant opportuni- ties for private credit funds. (16) Conclusion The private debt market has experienced significant growth, attracting attention frombothinvestorsandregulators.How- ever, challenges related to transparency andvaluationpersist.Toprotectinvestors and ensuremarket stability, it is crucial to enhance transparency and establish stan- dardizedvaluationmethodologies. As the sector continues toexpand, private credit managers must adapt to evolving regulatoryexpectationswhileseizingnew opportunities in alternative lending. The industry’s ability to address valuation challenges and maintain investor confi- dencewillplayacrucialroleinshapingits future. A collaborative approach among regulators, investors, and fundmanagers will be essential in ensuring that private creditremainsaresilientandtrustedasset class inglobalmarkets. Vincent REMY, Partner, Private Debt Leader Christophe VANDENDORPE, Partner, Strategy and Transactions Leader Valerio Carlo CIOLI, Manager, Strategy and Transactions EY Luxembourg 1) The Rise of PrivateDebt, DrummondCapital Part- ners,15May2024 2) Global Private Market Fundraising Report, Pitch- book,22May2024 3) Financing the Economy: The Future of Private Credit,ACCandEYLuxembourg,November2024 4) Considerations for Interest Rate Risk Modeling in anElevatedRateEnvironment,CommunityBanking Connections,2024 5) International Private Equity and Venture Capital ValuationGuidelines,IPEV,December2022 6)FinancialInstruments,IFRS9,IFRSFoundation 7) Considerations for Interest Rate Risk Modeling in anElevatedRateEnvironment,CommunityBanking Connections,2024 8)BloombergNews28.02.2024 9) International Private Equity and Venture Capital ValuationGuidelines,IPEV,December2022 10)IOSCOAnnualReport2022 11) The FCA’s review of valuation methodologies in privatemarkets,IQ-EQ,12November2024 12)G20watchdogurgesgovernmentstoaddressnon- bankfinancialrisks,Reuters,18December2024 13) Basel Committee work programme and strategic prioritiesfor2025/26 14) ESMA’s Response to the European Commission consultationonthereviewoftheEUmacro-prudential policyframeworkforNBFI,ESMA,22November2024 15) Federal Reserve Board - H.15 - Selected Interest Rates(Daily),31March2025 16) Financing the Economy: The Future of Private Credit,ACCandEYLuxembourg,November202 4 The Rise of Private Debt: Navigating Valuation Challenges