The corporate credit market is undergoing a significant transformation. Since the 1980s, large companies have turned away from traditional banks, relying instead on the bond market for financing. Now, private capital firms are taking a larger share of this space through direct lending and structured products such as collateralised loan obligations (CLOs). Hedge funds are also gaining ground, particularly in leveraged loans and corporate bonds. Additionally, the rapid growth of fixed-income exchange-traded funds (ETFs) is enabling retail investors to access the bond market while enhancing liquidity.
These innovations are expanding options for both borrowers and investors, improving the availability of credit. This expansion could lead to increased business investment, more hiring, and overall economic growth. According to a recent report by the Oliver Wyman Forum, this trend is most prominent in the United States but is also spreading to Europe and Asia. These developments reduce some risks by tapping into long-term capital sources like insurers and pension funds, rather than relying on banks that depend on volatile deposits.
Alternative credit providers have been present for many years but saw accelerated growth after the global financial crisis. These providers typically offer higher yields than standard investment-grade debt, making them appealing to investors, particularly in the low-interest-rate environment that followed the crisis. At the same time, banks have been more cautious due to heightened capital and liquidity requirements imposed after 2008.
Consequently, previously niche segments of the credit markets have expanded considerably. Private credit, provided by firms and business development companies, has quadrupled globally since 2013. Meanwhile, leveraged loans, extended to borrowers with substantial debt or weaker credit, have nearly doubled in size. Together, these two segments now account for around 20% of corporate credit in the United States.
This shift is not limited to the US. In Europe, private credit has grown at an average rate of 17% annually since 2018, representing about 2% of corporate credit. In Asia, growth has been even more pronounced, averaging 20% annually.
There are several risks to monitor as corporate credit markets evolve. Key questions need to be considered, starting with the liquidity promises being made. Bank runs and margin calls have historically triggered or worsened financial crises. In the United States, banks have provided $2 trillion in committed credit lines to nonbank entities, with about 50% currently being used.
Another concern is how financial chains are developing and whether they are becoming increasingly leveraged. For instance, US hedge funds hold over $800 billion in credit derivatives, while private equity firms have placed nearly $70 billion of debt on their portfolio companies so far this year. The complexity and opacity of these exposures make it challenging to accurately gauge the risks involved.
There is also the question of traditional institutions’ exposure to corporate credit and nonbank entities. While banks have lost market share in corporate lending, they remain key lenders to nonbank financial institutions. In the US, life insurers owned by private capital firms manage $600 billion in assets, representing 11% of the life insurance sector. Policymakers and financial leaders must consider all channels of exposure when assessing the broader risks.
In addition, the performance of novel high-quality assets in a crisis is uncertain. Regulated financial institutions need access to these assets, often created through securitisation. However, this process can lead to products with differing claims on corporate assets, potentially creating conflicts between senior and junior debt holders. Some of these structures remain untested, particularly in the fast-growing CLO market, which now includes over $115 billion in unrated private credit loans.
Finally, there is the question of how a crisis might unfold and which institutions will have the capacity and willingness to act as buyers during turbulent times. Nonbank entities play an increasingly important role in providing market liquidity but lack the safety nets available to banks, such as central bank support. It is also unclear whether banks or nonbanks would have the stronger incentive or ability to offer credit support during a prolonged crisis.
Adjusting regulatory frameworks to keep pace with these changes will take time. However, policymakers must remain alert to signs of excessive risk accumulation. Equally important is that executives and investors take responsibility by demanding greater transparency into fund holdings and leverage, as well as conducting stress tests to assess resilience.
Increased scrutiny of these evolving markets now could help preserve the benefits of this transformation while reducing the chances that the current credit boom could spark the next financial crisis.
Volta Finance Ltd (LON:VTA) is a closed-ended limited liability company registered in Guernsey. Volta’s investment objectives are to seek to preserve capital across the credit cycle and to provide a stable stream of income to its Shareholders through dividends that it expects to distribute on a quarterly basis.
