The private credit market is undergoing significant transformation as it seeks to integrate more deeply into public markets, highlighted by the emergence of private credit exchange-traded funds (ETFs). These developments are drawing increased scrutiny from regulators, particularly the Securities and Exchange Commission (SEC), and raising questions about transparency and liquidity.

Private Credit ETFs Under Scrutiny

Apollo Global Management Inc. and State Street Corp. have been at the forefront of efforts to bring private credit into the ETF arena, a move that promises to democratize access to investment opportunities traditionally reserved for institutional investors. However, the SEC is set to review recent filings for private-credit ETFs, including Apollo’s, amid concerns about how retail investors can exit these funds during market stress.

Critics, including securities law experts and consumer advocates, have voiced concerns over the lack of detailed information regarding the liquidity of these funds. Elisabeth de Fontenay, a Duke University law professor, described the ETF filings as lacking specificity, likening them to “cut-and-paste” jobs from standard ETF filings.¹ The SEC’s decision on these proposals, expected in the coming months, could either pave the way for similar funds or impose regulatory barriers, with the caveat that the agency is likely to experience policy shifts after the recent U.S. presidential election.

The regulatory focus is on issues such as liquidity, conflicts of interest, and disclosures. The rapid growth of the private fund sector, now exceeding the size of the U.S. banking industry, adds complexity to the oversight of these ETFs. Consumer advocates have drawn parallels to the 2008 financial crisis, warning of potential liquidity strains like those seen in the auction-rate securities market collapse.

Addressing Regulatory Concerns

To comply with SEC rules, the State Street-Apollo ETF plans to cap illiquid investments at 15% of its net assets. However, the lack of transparency regarding how this limit will be maintained raises questions. The fund intends to invest primarily in investment-grade debt securities, including private credit sourced by Apollo, which some experts argue may not align with traditional definitions of liquidity.

The SEC may require additional disclosures on how firms will manage conflicts of interest and select underlying private credit assets, many of which include collateralized loan obligations (CLOs). Apollo’s plan involves sourcing private credit assets, providing valuations, and offering intraday trading liquidity. Apollo pledged to purchase a certain amount of the asset-backed and corporate finance investments held by the ETF, up to a daily limit, at prices that it sets. State Street will serve as the investment adviser.

The Broader Context of Private Credit

Moody’s highlights the necessity for increased transparency and regulatory scrutiny as the private credit market evolves. Historically, private credit has been relatively less regulated, allowing asset managers to expand into areas involving less sophisticated retail investors. Moody’s suggests that developing secondary trading platforms for private credit could enhance transparency and allow retail investors to liquidate investments more easily, although this idea faces resistance from some market participants as it could erode the direct lender liquidity premium.

The private credit market, defined as direct lending to middle-market companies, is currently valued at around $1.5 – $2.0 trillion and is projected to grow to $2.7 trillion by 2027.² The market’s growth has drawn attention from regulators concerned about potential risks, such as inadequate valuations and the riskiness of borrowers.

Conclusion

As private credit seeks integration into public markets through ETFs, balancing innovation with regulatory oversight is crucial. The sector’s evolution underscores the need for transparency and risk management, particularly as it engages with retail investors. While the potential for democratizing access to private credit is significant, ensuring robust regulatory frameworks and market discipline will be key to navigating the challenges ahead. The SEC’s impending decisions on private-credit ETFs will likely shape the future trajectory of this dynamic financial landscape.

At Stout, we collaborate with our clients across all alternative asset classes, including private credit, to navigate the complexities of the portfolio valuation process while effectively managing regulatory and other risks. Our innovative tools, technology, and independent advisory capabilities are designed to meet diverse client needs. We invite you to reach out to learn more about how we can assist you.

¹ Lydia Beyoud, “Apollo’s Race Toward Private-Credit ETFs to Face SEC Scrutiny,” Bloomberg, November 1, 2024.

² Abby Latour, “More transparency, regulatory scrutiny ahead in private Cred — Moody’s,” PitchBook, October 17, 2024.