Danny Dieleman: Private markets do not need to be shackled
This column was originally written in Dutch. This is an English translation
The ECB, DNB and the Bank of England are currently delving deep into private markets. They are examining growth, interconnectedness and hidden risks. What does this mean for investors?
By Danny Dieleman, Founder of D-Squared Capital
Since this spring, various European regulators have been taking a close look at private markets. In its Financial Stability Review, the ECB devoted particular attention to private credit. Bloomberg reported that the ECB is requesting data from twenty European banks. The Bank of England is currently conducting the Private Markets System-Wide Exploratory Scenario (PM SWES). And DNB recently published a report on insurers, pension funds and private assets.
Regulators see benefits: private credit broadens lending and enhances financial stability. At the same time, they also have concerns. The market is growing rapidly and lacks transparency. Banks, insurers and funds are becoming increasingly intertwined, and leverage may create additional vulnerabilities. Furthermore, the sector has not yet weathered a prolonged period of stress.
However, reliable data is lacking. Regulators do not maintain a central dataset, and commercial datasets lack consistency and independence. Supervision is also fragmented. The ECB only monitors the twenty largest banks. DNB only supervises insurers and pension funds. Participation in the UK’s PE SWES by banks, insurers and asset managers is voluntary. Consequently, there is no insight into the actual risks within the sector. Regulators’ concerns cannot therefore be addressed.
The BoE does not test individual institutions, but examines the entire ecosystem of private markets. Banks, asset managers and investors will soon calculate the impact under a hypothetical extreme, yet plausible, scenario. They will also report on the management actions they would take in response to this scenario. The BoE will publish the aggregated results in early 2027.
I expect the BoE to encounter significant reconciliation issues. For example, institutions do not use a single, unambiguous definition of a default. Exposure, too, can be measured in several ways. Nor are there unambiguous definitions for underlying risk drivers.
A logical outcome of the PM SWES is that clear definitions and reporting are needed for private markets. Existing banking frameworks offer a logical starting point for this. This will provide a consistent picture across the entire ecosystem, which is a major benefit.
The PM SWES study lacks the rigour of a banking stress test. Participation is voluntary and results remain aggregated. It is therefore not a ‘pass or fail’ test, as is the case with banks. We should therefore not expect any compulsory capital increases or restructuring.
Nevertheless, regulators are taking an important first step. They are now gathering insights across the entire market. Armed with knowledge of best practices from all institutions, regulators can gradually raise the bar for everyone.
This is good news for investors. Transparency, unambiguous definitions and quality help everyone to move forward. There are also benefits for the institutions themselves. The systematic and consistent tracking of exposures is extremely valuable for internal risk reporting. Reports for the regulator are then a by-product.
However, I am not in favour of far-reaching standardisation. Uniform capital rules, in particular, will erode business models in the long run. All institutions will optimise within the same framework, which will leave less scope for distinctive and alternative investment strategies. It is precisely this diversity that keeps the market healthy and stable.