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The Financial Services Regulation Committee publishes its report ‘Private markets: Unknown unknowns’

• Report: Private markets: Unknown unknowns (HTML)
• Report: Private markets: Unknown unknowns (PDF)
• Inquiry: Growth of private markets in the UK following reforms introduced after 2008
• Financial Services Regulation Committee

Overview

Global private markets have grown rapidly, from less than $4 trillion in global assets under management in 2008 to around $16 trillion today, and approximately $185 billion in the UK. Whilst private markets have delivered strong returns for investors and provided tailored finance to UK companies and infrastructure projects, concerns have been raised about the implications of their rapid growth and interconnectedness with banks and insurers for the UK’s financial stability. Our inquiry sought to shine a light on the drivers and consequences of the growth of private markets.

Post-Global Financial Crisis regulatory reforms, particularly to bank capital requirements, have contributed to the growth of private credit, as banks have reduced direct lending to UK companies relative to non-banks and other types of lending. In addition, banks are increasingly relying on an ‘originate to distribute’ model of lending, in which private credit plays a significant role. SME demand for borrowing has been subdued for some time. At the same time, the availability of SME finance has been squeezed by a combination of changes to bank capital and the fact that private credit has not entered the SME finance market. Addressing constraints on smaller and specialist banks’ ability to lend could increase the finance available to SMEs, should demand increase.

Although there is clear evidence of the growth of private markets, there is insufficient data to conclude whether private credit is systemic, meaning there are considerable ‘unknown unknowns’. The Bank of England is right to shine a light on these developments through its System Wide Exploratory Scenario, but it must move swiftly; the Government, the Bank of England, the Prudential Regulation Authority, and the Financial Conduct Authority must continue proactively to monitor developments in private markets.

Key recommendations

The Committee’s key findings and conclusions include:

• Reforms introduced after the Global Financial Crisis – particularly bank capital and liquidity regulatory requirements – have, as intended, encouraged the banking system to retreat from riskier lending, leaving certain segments of the economy, including SMEs, less well served by banks.
• Banks are increasingly relying on an ‘originate to distribute’ model of lending, in which private credit plays a significant role.
• The availability of SME finance has been squeezed by a combination of changes to bank capital and the fact that private credit has not entered the SME finance market. Addressing constraints on smaller and specialist banks’ ability to lend could increase the finance available to SMEs, should demand, which has been subdued for some time, increase.
• The growth in collateralised loan obligations and significant risk transfers in the UK may pose a potential risk to the UK’s financial stability. The Bank of England and the Prudential Regulation Authority should pay close attention to the development of these markets.
• Throughout the inquiry, the Committee asked for data from the regulators, academics, and industry trade bodies and firms. However, the Committee was not able to obtain extensive or detailed data on the growth of private markets in the UK, the growth of lending provided by private credit, or the scale of the interconnections between banks and private markets. The Committee is concerned that this might represent a gap in policy and rule makers’ evidence base.
• The Committee was concerned by the apparent passivity on the part of HM Treasury about the concerns raised in its inquiry. It noted that HM Treasury has a responsibility to maintain financial stability, so that the risk that the taxpayer serves as a backstop to the financial system is mitigated.
• The Committee was concerned by the apparent passivity on the part of HM Treasury about the concerns raised in its inquiry. It noted that HM Treasury has a responsibility to maintain financial stability, so that the risk that the taxpayer serves as a backstop to the financial system is mitigated.

Chairman’s comments 

Lord Forsyth of Drumlean, Chairman of the House of Lords Financial Services Regulation Committee, said:

“There were too many unknown unknowns to determine whether private markets pose a systemic risk to the UK’s financial stability. Our inquiry sought to shine a light on the implications of the rapid growth of private credit markets. 

“The Bank of England, the Financial Conduct Authority, and the Prudential Regulation Authority are right to be vigilant and to monitor the dramatic growth of private markets and the implications for financial stability.

“Post-Global Financial Crisis reforms have altered the UK’s lending landscape to the disadvantage of SMEs.”