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Mind the gap: Navigating regional varieties in APAC private debt investing

Amid soaring financing demand in the Asia-Pacific region, international private debt investors should weigh in on the sector with local presence to address differences in language, currency and legal system.

Cranes on a sunset sky (123rf)
Cranes on a sunset sky (123rf)
While the demand for private debt investments in the Asia-Pacific region is expected to continue to soar, private credit investors -- which offer nonbank financing to companies or development projects there -- should take advantage of opportunities and be mindful of gaps in between countries, experts said.

During the two-day PDI APAC Summit Virtual Experience 2021 that ended Thursday, international investors, asset managers and other investment professionals flocked to discuss opportunities that the budding private debt market in the region can offer, and risks that stem from cultural and legal differences.

“I can see that search for yield will come to Asia, and that will drive a lot of the fund inflow in Asia,” said Raymond Chan, managing director and head of APAC credit at the Canada Pension Plan Investment Board. “I would expect there would be a lot of refinancing at a more creditor-friendly terms of financing.”

According to Private Debt Investor, a publication that hosted the virtual event, funds have globally targeted a total of $326 billion in private debts as of end-2020. Of the total, those targeting the Asia-Pacific region, excluding multiregional funds, accounted for 5 percent. The ratio fell from 7.8 percent as of end-2019.

The fundraising of Asia-Pacific-focused funds also slightly dipped, from $5.8 billion in 2019 to $5.4 billion in 2020, which also excludes multiregional funds.

More negotiating power

While the transaction has been a bit slow to recover from the pandemic, the market is still brimming with new private financing opportunities, as companies in countries including China, India, Australia and New Zealand are in need of nonbank financing due to lenders‘ heightened regulations on upper caps of financing available, among others.

“We are seeing many small and medium sized companies having difficulties obtaining financing from traditional banks in Asia,” said Lee Soo-cheon, chief investment officer of SC Lowy.

“If you look at real estate financing, not just in India but even the rest of Asia, including Hong Kong, Singapore and Korea, there are a lot of lending limitations imposed by the regulator. As a result, people cannot borrow more than certain loan-to-value ratios and as a result they have to go out in a nontraditional financing to borrow money.”

Companies -- particularly smaller than $50 million in size -- that have few alternative sources of capital will allow for favorable commercial terms to private debt investors, as well as decent downside protections, said Mei Colani Li, head of private credit at VI Asset Management.

“Businesses of that typical size are still family-owned, and they are too big to tap traditional domestic lenders,” she said. “When you have a family owned business, typically they don‘t want (private equity firms) coming in to dilute their ownership or tell them how to run their businesses. So what happens is, alternative lenders such as private credit lenders tend to have more negotiating power.”

In the meantime, the Asia-Pacific region is witnessing a growing demand for innovative technology solutions to allow businesses to operate on a daily basis in the wake of the COVID-19 pandemic. This means private debt financing needs for projects that aim to achieve fiber connectivity or build data centers are up for grabs.

“It‘s a large and explosively growing sector and there’s never been a better time to providing alternative credit solutions in this space,” said Kevin Smithen, chief commercial and strategy officer of Digital Colony and Colony Capital.

Boots on the ground

Despite the growth potential, the question remains as to how to get access to a region home to more than 20 countries that use different languages.

Unlike in established private debt markets in Europe or the United States, investors would have to deal with different currencies and jurisdictions in Asia-Pacific debt investing.

“If you look at Europe and the US, in terms of language, bankruptcy process they are plain vanilla. It‘s much easier to digest at a given culture,” Lee of SC Lowy said.

“But in Asia, we have a very diversified culture, language, even the bankruptcy process for different countries. I think understanding one each different country, I think it is a big challenge.”

Panelists of the event said that, select countries in the Asia-Pacific region, including Korea, Australia, Japan, Singapore and Hong Kong, have so far introduced the European commercial law and the bankruptcy law in the US, while such procedures to bring in standardized framework are underway in countries like India.

Such regional varieties leave private debt investors hesitant to target all of the countries across the region. Even within a certain country, culture and regulations may vary by provinces or cities. Professionals say having local presence is key to understanding the complexity that the variety in the Asia-Pacific region offers.

“This is rather telling us very loud and clear that, at this challenging period of time, having trusted advisers and partners on the ground actually (gives) a lot of support in terms of executions of deals,” Chan of CPPIB Asia said.

To international investors, finding select legal systems that investors would feel comfortable with and having presence there can be a starting point, which would later engender a network of partners dedicated to financial, legal and other due diligence aspects.

“Coming to any investments, it is very important that when you are investing in any countries, it’s about firstly working with the right people and secondly it is a process whether we can have the healthy ecosystem,” said Celia Yan, head of China and co-portfolio manager of the Asia Pacific Private Credit at BlackRock.

“The most important thing is you are willing to know the region and people well, and if things go wrong, who will you go to, to be able to resolve the situation very quickly.”

Fragmented, fledgling market

In what is largely seen as a fragmented market, some investors targeting the Asia-Pacific region are making sure to mitigate the uncertainties.

For instance, the World Bank Group dealt with the regulatory reform in part of the Asia-Pacific region to ensure that a corporate insolvency framework comes into place, before its member International Finance Corp. went out to do private debt investment. This laid the groundwork for IFC‘s distressed asset recovery program that helped the Asia-Pacific region offload $34 billion of nonperforming loans.

This is, by and large, a matter of financial stability, said Rosy Khanna, regional industry director for Financial Institutions Asia Pacific at IFC.

“We are pushing on old fronts with respect to the regulatory and legal reforms,” Khanna said. “These two are absolutely critical in order to move the market to ensure that financial system as a whole remains robust, efficient and sustainable over time. … We are pushing ahead to see where and what sorts of platforms we can create on the market that have the basic framework for out-of-court settlements, for example.”

Also, private debt investors in the fledgling market are learning to understand the counterparty risks and the lack of exit strategies.

Scrutinizing risk factors through a background check of borrowers is important, in the region where even companies that receive fairly high credit scores could be prone to default.

“China is trying to have risk price properly in debt financing, proper credit rating and how you do that without scaring the market,” PAG founding partner Chris Gradel said.

Another point is the lack of investors in the Asia-Pacific region to buy private debt that a debt asset owner put up for sale. Unlike in the US, there are not that many financiers who can just immediately fill in the hole if the dislocation happens.

“You have to deal with the fact that there is no secondary exit for your situation,” said Anil Gorthy, senior portfolio manager at Avenue Capital Group. “For the distressed, it’s not a trading but a buy-to-hold and working out.”

PDI said the summit ticket will allow attendees to access on-demand content of the PDI APAC Summit. It added the PDI Japan Korea Week Virtual Experience 2021 begins on Nov. 9-11.

Investors, global credit leaders and strategic partners in Korea and Japan are expected to discover new fundraising opportunities, gain immediate insights and navigate volatility in the post-COVID era. Booking is now available.

By Son Ji-hyoung (