Private debt’s rise from a niche allocation to a mainstream alternative has given borrowers access to a wider range of financing options. Competition with traditional lending has been a key part of the growth story, particularly as banks have been through a prolonged risk-off period while private capital has had the freedom to match investors’ specialist expectations with borrowers’ bespoke structuring needs.
Growth however was the easy part of the story for private debt. What matters now is not how much capital can flow into the sector. Instead, it is about how well the market holds up when credit conditions deteriorate, investors seek liquidity and confidence is truly tested.
Illiquidity at the core
The US market has already started to reveal what stress looks like. Redemption requests have recently become a point of contention as investors seek exits amid fears of defaults and lower returns.
This experience matters because it exposes the central tension of the private debt model: investors may expect periodic liquidity however the underlying assets are privately negotiated, inherently illiquid and often difficult to trade quickly at fair prices. Put simply, entry is usually easier than exit.
That tension should not be misunderstood. Illiquidity is not a flaw in private debt. It is one of the reasons the asset class offers a return premium in the first place. Investors are compensated for tying up their capital in assets that are not designed to be converted into cash on demand.
The real obstacle begins when discipline erodes while trying to make a fundamentally illiquid asset behave like a liquid one.
Regulators are reacting
This discipline is important because private debt is no longer a niche asset class. Regulators recognize that alternative investments have become increasingly interconnected with the broader economy, playing pivotal roles in funding businesses and supporting employment. This is growing further as broader retail distribution, and regimes such as ELTIF 2.0, are opening private market alternative strategies to a wider audience.
The Bank of England has taken a significant step with its second System-Wide Exploratory Scenario. This financial fire drill seeks to understand what could happen if the economy faced a serious downturn and private markets came under pressure. In other words, could a downturn be amplified if capital becomes scarce and market participants move to de-risk at the same time.
In Europe, recent reforms to AIFMD also acknowledge the need for a more robust approach. Open-ended funds will no longer be able to simply rely on generic liquidity policies. Instead, managers are expected to select and calibrate tools that are aligned with the fund’s strategy and liquidity profile. ESMA’s work on loan-originating alternative investment funds reinforces the same messages of sound liquidity systems, robust stress-testing and redemption terms that match the underlying assets.
Challenges for the model
The upcoming chapter will be a far more demanding test of the private debt model. As geopolitical turmoil and macroeconomic stress become more commonplace, the credit quality of underlying borrowers is being put under greater pressure. The resilience of private credit platforms will now be judged by how well they preserve value. This requires discipline not only in origination and underwriting but also in ongoing credit monitoring throughout the life of each loan.
Valuation then becomes the next challenge. In an inherently illiquid asset class where key inputs are often unobservable, different valuers can arrive at different conclusions depending on their approach, models and assumptions. These divergences can become even more pronounced in situations of financial distress.
This is important because it reflects the central tension of private debt, trying to provide liquidity to an illiquid asset class. Investors need to enter and, with ever increasing importance, exit at a fair net asset value.
Building trust with investors is critical for the next phase of growth in private debt.
Managers who treat their valuation practices seriously have recognized that it is more than just an accounting exercise. It is a governance control mechanism supporting reporting credibility, equitable fee distribution and, most importantly, robust decision-making.
Time to shine
The onus is now on the market itself to not only lay down the easiest subscription path for investors, but also to prove that it can provide robust valuation governance, sensible credit risk management, credible liquidity frameworks and transparent communication with investors.
That is how the next phase of growth for private credit, particularly in Europe, will be achieved. The asset class has already proved its ability to attract and deploy capital. Now it must prove it can build real trust with investors.