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1、RewiringThe FinancingMachineHowprivate credit and hedge funds are transforming corporate credit2Rewiring The Financing MachineContentsExecutive Summary 31.A System Rewired 6Drivers of change 8Evolving landscape for investors 10Evolving landscape for companies 122.Shocks And Grounding 16Improvements

2、in risk distribution 17Continued importance of banks 19Potential channels for crisis 213.Avoiding Buildups 24Short-term promises 26Financial chains 27Accumulation of exposures 29High-quality assets 30Dynamics in crisis 324.A Safer Future 35Appendix A:Glossary 37Appendix B:Endnotes 39Executive Summar

3、yThe corporate credit ecosystem is undergoing a major evolution,bringing both significant benefits and risks.Most analyses focus on important individual components of this transformation,such as the rise of private credit funds.However,a sound understanding of how risk allocations are being restruct

4、ured requires a broad and integrated view of the market.We provide a framework for understanding evolving business models and assessing both the benefits and potential problems arising from this rewiring.This holistic view is necessary for financial institutions and policymakers to foster sustainabl

5、e growth.Nonbanks like private capital firms and hedge funds are taking market share from banks.They have become significant players in credit origination and distribution through direct lending,as well as the issuance of structured products like collateralized loan obligations.They have expanded li

6、quidity via exchange-traded funds and cross-asset hedge fund strategies.This evolution is improving credit availability as it expands options for investors and borrowers while reducing certain types of risks.For example,liquidity transformations are reduced when“permanent capital”sourced from insure

7、rs and pension funds can be deployed against long-term assets.We focus on the United States,which has the largest and most developed nonbank sector,but the trend toward increasing credit expansion outside the regulated banking sector is happening globally.These changes must be considered holisticall

8、y as they share a common underlying exposure corporate credit.Different products vary in their liquidity and risk profiles,but innovation and competition are blurring the lines between products,complicating risk assessments and comparisons.Banks and various types of nonbanks are ever more interdepen

9、dent,while nonbanks are becoming increasingly concentrated and diversified.Growth is at the top of the agenda for banks and nonbanks;corporate credit can help fuel this growth.Demand for this broad universe of fixed-income products is expected to expand as an aging population raises allocations to i

10、nvestments that promise steadier returns.Alternative asset managers are betting on increased demand from a wide range of investors,butprivate wealth and retail clients are likely to have a higher liquidity preference than long-term investors such as insurance companies and pension funds.Meanwhile,re

11、cession riskmeans the supply of investable opportunities may not keep up with demand.If demand from investors outstrips supply,competition could lead to a lowering of standards and greater use of opaque structures.3Rewiring The Financing Machine|Executive SummaryWe recommend focusing on five key que

12、stions to balance the benefits and risks of this market evolution.First,what short-term liquidity promises are being made?If products targeting private wealth and retail investors introduce more short-term promises,then the benefits from reduced liquidity transformations may bereverted.Alternative a

13、sset managers have begun to expand their offerings of liquid creditinstruments.A trend currently at the fringes but worth watching is nonbanks providing credit lines and contingent funding to corporates.Next,how are financial chains evolving and are they becoming more leveraged?Todays securitized pr

14、oducts dont exhibit the kind of excessive leverage that helped trigger the 2008-2009 global financial crisis,but that has been driven by market practice,not regulation.Funds use various strategies to increase leverage,and the amount of financing they obtain has recently grown.These multiple layers o

15、f exposure,along with a lack of transparency,make it difficult to accurately assess the associated risks.Additionally,how large are exposures to corporate credit and nonbanks?Given the widevariety of increasingly interconnected products,all avenues of exposure need to beconsidered comprehensively.Ba

16、nks may have lost market share in corporate credit,butthey are major lenders to nonbanks and are the primary providers of contingent fundingfor both nonbanks and corporates.Insurers and pension funds are key investors inclosed-end private credit funds.Next,will novel high-quality assets perform in a

17、 crisis?Higher quality assets,desirable for regulated financial entities,are often created through securitization,as is the case for collateralized loan obligations.Increasingly,they are also being achieved by using legal structures to make more senior or stronger claims on corporate assets.Some of

18、these structures are untested and could lead to more credit risk than expected.Finally,how might a crisis play out,and what entities will have the capacity and risk appetite to become buyers in a crisis?Nonbanks have become more critical for market liquidity,but they lack the support channels from c

19、entral banks that banks enjoy.There are also questions about whether banks or nonbanks have greater incentives and means to provide credit support to firms in a prolonged crisis.4Rewiring The Financing Machine|Executive SummaryThe hard-learned lessons of the global financial crisis must not be forgo

20、tten.Asset managers must meet the demand for credit products by building the capacity to analyze and manage risk in preparation for the next credit cycle.Regulated institutions,in particular,have been fueling and benefiting from the growth in corporate credit but if they are not careful of the poten

21、tial buildup of systemic risk,they could be stuck holding the bag.Adapting regulation and supervision will take time.In the meantime,it is critical that executives andinvestors proactively enforce market discipline.They should demand transparency intofunds and leverage and conduct more stress testin

22、g that allows mapping out of risks.Policymakers should recognize that alternative asset managers play multiple roles in relation to other nonbanks,as fiduciaries,competitors,and owners.With efforts already underway to close data gaps to have greater visibility and oversight into these changes,policy

23、makers must be forward-looking about potential interconnections,especially with the possible expansion of products into less sophisticated investor bases.Further,financial stability is not the only concern,as these changes to market structure also have implications for monetary policy,market integri

24、ty,and distributional concerns around access to credit and to investment opportunities.In the best case,nonbanks can support credit expansion with greater efficiency and safer risk distribution.5Rewiring The Financing Machine|Executive SummaryA System RewiredUnited States corporate credit markets ha

25、ve expanded significantly,growing 75%to$11.2trillion in the last decade.1 The rapid rise of private credit financing to corporates provided by alternative asset managers has garnered headlines and policy attention within credit markets,but it is not the only growth story.Leveraged loans,2 which are

26、loans to companies with a large amount of debt or poor credit histories,have been around since the 1980s and have had a recent resurgence,nearly doubling since 2013.3 These two segments provide nearly 20%of corporate credit.Meanwhile,corporate bond volumes have continued to grow as they are increasi

27、ngly packed into ETFs and traded electronically.Exhibit 1:Evolving corporate credit marketExpanding creditUS corporate creditI(outside investment-grade bonds),Amount outstanding/deployed,USD trillionsEvolving market structureIllustrative2000200520102015202020250.00.20.40.60.81.01.21.41.6Bank loans H

28、igh-yield bonds Leveraged loansOriginationLiquidity and market makingDistribution and structuringBonds Investment-grade syndicated loans Private debtII IncreasinglynonbankBilateralloansIncreasingly nonbankN/ALeveragedloansBanksIncreasingly nonbankInvestment banksI.Corporate credit excludes loans to

29、financial institutions.II.Private debt outstanding is estimated by multiplying the North American share of debt capital raised by PitchBook figures of global private debt outstanding.Sources:US Federal Reserve;PitchBook Data,Inc.;ICE;Morningstar;Oliver Wyman Forum analysis4These changes rely on alte

30、rnative asset managers increasingly taking on roles previously dominated by banks.In corporate bond markets,hedge funds play a growing role in market liquidity through more active trading and market-making.Further,private capital firms are both originating and structuring credit.For instance,special

31、ized funds purchase syndicated term loans from banks,securitize them,and sell debt and equity tranches mainly to institutional nonbank investors through collateralized loan obligations(CLOs).5 Private credit funds go one step further and originate loans directly,a form of bilateral lending that is c

32、ommonly referred toas“direct lending.”67Rewiring The Financing Machine|1.A System RewiredThis rewiring has created a more diverse and interconnected landscape for companies and investors.Well-functioning corporate credit markets are critical for businesses to invest in growth and innovation and for

33、investors who need safe,steady streams of cash flows with quantifiable risk.Understanding the drivers and connections within corporate credit is vital to mapping its impact on the economy.Drivers of changeA combination of factors is driving this rewiring.Banks have de-risked in response to regulatio

34、n and their own lessons learned from the 2008-2009 global financial crisis(GFC),creating a gap,particularly in the riskier parts of the market.Banking regulations adopted following the crisis,such as revised Basel Committee standards,increased bank capital requirements and liquidity ratios,constrain

35、ing banks ability to make new loans.7 In the US,the Volcker Rule restricted banks from engaging in proprietary trading,which,along with increased capital requirements,decreased banks ability to make markets.8 Likewise,capital requirements made managing CLO funds uneconomical to banks,while the Volck

36、er Rule imposed limits on underlying investments made by CLO funds if they were to be held by banks limits partially loosened under regulatory guidance in 2020.9 Additionally,the roughly decade-long period of extraordinarily low interest rates and ample liquidity meant that funding advantages that b

37、anks get from deposits were a less significant source of competitive advantage relative to nonbank originators.Investor demand for different types of corporate credit has only grown.The period of low interest rates led to a search for yield,and the COVID-19 stimulus added further liquidity to market

38、s.As fewer firms are issuing publicly traded debt and those that do are going public larger and later,10 exposure to middle markets has become a more important source of diversification for investors.Meanwhile,institutions like banks and insurers that must satisfy regulatory requirements have a stro

39、ng demand for investment-grade assets.11 Investors have also become more willing to hold illiquid instruments in the private market for their relatively high yield spreads because growing electronic trading has reduced spreads in the public bond market.12Nonbanks have developed competitive advantage

40、s beyond simply taking space vacated by banks.Nonbanks benefited from post-GFC talent migration away from banks,13 while access to growing amounts of real-time information has helped level the playing field between banks and nonbanks.Visibility into post-trade data increased transparency of prices a

41、nd market data,14 and a wide variety of data brokers also increase the available information on firms.158Rewiring The Financing Machine|1.A System RewiredWhile equities have long enjoyed robust trading in public markets,corporate bonds have only recently enjoyed newfound liquidity.Hedge fund bond ho

42、ldings have been on the rise,as technology improvements have enabled the deployment of multi-asset strategies and portfolio trading,creating new high-yielding opportunities in public markets.16 Corporate bond exchange-traded funds(ETFs)have also grown significantly,fivefold in the last decade.This a

43、llows investors to deploy new strategies because ETFs trade on equity market infrastructure and have more hedging mechanisms available.17 Broadly,this has tended to reduce yields in public debt markets,leading some investors to search for alternative sources of alpha.Exhibit 2:Corporate credit shift

44、sEvolving liquidity provisionHoldings,USD trillionsCorporate bond trading evolutionDaily trading volume,USD billions2005200020102015202020250.000.100.200.300.400.500.600.700.800.90ETFs(corporate bonds)Broker-dealers(corporate bonds)HF LLsIHF bondsInvestment gradeHigh-yieldCorporate bond ETFs20142016

45、201820202022051015202530I.Hedge fund holdings of leveraged loans are estimated by multiplying Federal Reserve figures for leveraged loan assets of all hedge funds by SEC reported adviser main office locations in the US(percent of NAV).Sources:US Federal Reserve,SEC,SIFMA,LSTA,Oliver Wyman Forum anal

46、ysis18Private capital firms have found that competitive edge in origination.Private credit funds have developed tailored processes that can provide more flexible terms than banks.For example,their deals can combine elements of both debt and equity,and the equity stake can provide an incentive to be

47、more flexible if the borrower runs into trouble.On the funding side,private credit funds have discovered,and fostered,a strong desire by pension funds and insurers to buy longer-term credit instruments that pay above-market rates in return for a loss of liquidity.These funds can also be more agile t

48、han banks,providing speed of execution that many borrowers value.9Rewiring The Financing Machine|1.A System RewiredNonbanks also have found advantages in distribution and securitization.While banks pulled back post-GFC from structured entities,private capital firms and hedge funds saw an opportunity

49、 in CLO markets.Private capital firms tap into their relationships with institutional investors to market and distribute CLO tranches.These assets combine higher yield and lower default rates compared to corporate bonds,as CLOs have less exposure to very low-rated firms,a focus on securitizing only

50、senior debt,and the ability to defer interest payments on junior tranches.19 Meanwhile,the underlying instrument for many CLOs,leveraged loans,trade over the counter among institutional investors.As a result,hedge funds have significantly increased their exposure to leveraged lending since 2013,boos

51、ting their share of outstanding leveraged loans from an estimated 15%to nearly 25%by 2023.20 Evolving landscape for investorsAs nonbanks strive to meet the demand for corporate credit,a diverse landscape of investment opportunities has developed,spanning a wide range of credit quality,liquidity,and

52、strategies.While most high-yield bonds are unsecured,both leveraged loans and private credit direct lending are typically secured against the borrowers assets.Private credit has facilitated direct investor exposure to the middle market while offering a product with tighter covenants relative to bond

53、s and leveraged loans.21 These funds are closed-ended,with shares that are not easily tradable.The resulting“illiquidity premium”is part of what provides higher yields than leveraged loans or high-yield bonds.22 Leveraged loans provide less premium over high-yield bonds than private credit.23 Still,

54、with the increasingly popular CLO structures,investors can increase their returns on leveraged loans if they are willing to buy lower-rated tranches.Large institutional investors,particularly insurers and pension funds,are adapting to the diverse financial landscape through various strategies,from i

55、ncreasing direct holdings to allocating more funds to alternative asset managers.24 The relationship between private capital and insurance firms,in particular,has grown increasingly intertwined.Some private capital firms have even purchased insurers outright,a move that serves dual purposes:It grant

56、s private capital firms access to insurer balance sheets while providing insurers with long-term assets to match their liabilities.The largest asset managers are expanding their reach as they diversify the strategies they offer toend investors.Over the past several years,traditional asset managers h

57、ave been acquiring alternative asset managers and vice versa,giving rise to a new label for these firms:diversified asset managers.25 It is not uncommon to see a combination of mutual funds,hedge funds,private capital funds,and other retail products offered by the same firm.Bringing this massive bre

58、adth of investing options under one firm is convenient for investors,but it also contributes to concentration,as the 20 largest US asset managers control over 40%of the countrys assets under management(AUM).2610Rewiring The Financing Machine|1.A System RewiredThe rapid growth of bond ETFs and busine

59、ss development companies(BDCs)closed-end funds investing in private debt that are often publicly listed indicates growing interest in expanded corporate credit options from retail investors,even if they cant access the same range as large institutions.Bond ETFs have grown fivefold in the last decade

60、,reaching$750billion at the end of 2022.27 Similarly,publicly traded BDCs have nearly tripled in the past decade,reaching almost$150 billion at the end of 2023.28 While mutual funds still hold alarger share of the bond market and are double the size of bond ETFs,their share has declined as investors

61、 move to alternatives.29Exhibit 3:Diverse credit landscapeEarly 2000sNew or newly at scaleCorporate bondsLarger firms,publicly listedMostly unsecuredLiquidDirect(bonds)/indirect(mutual funds)Shorting/CDSLeveraged loansLarger firms,unlistedSecured mezzanineHighly liquid(ETFs)ETFs and bond index funds

62、Via ETFs derivativesCLOsMiddle marketSecured seniorLiquid(bonds,leveraged loans)Diversified private credit and CLOsVia ETF shortsBDCsNot liquid(direct lending)Multi-asset vs.idiosyncraticVia closed end fundsPrivate credit fundsIndirect via fund financeAssetsEvolution based off sizeable and accessibl

63、e options to investorsFirm typeCredit exposureLiquidityExposureHedgingSource:Oliver Wyman Forum analysis11Rewiring The Financing Machine|1.A System RewiredEvolving landscape for companiesCompanies are also benefiting from these more diversified funding sources and terms.Nonbank originators have supp

64、orted companies with business models less likely to receive bank financing,such as those with high levels of debt but large operating margins in IT and life sciences.30 While spreads are higher for private credit,there are advantages in speed of execution and flexibility of terms.These advantages ar

65、e available not only at the outset of a private credit deal,which tends to close much faster than a bank loan,31 but throughout the loan life cycle.Private credit lenders have flexible mandates that allow them to extend maturities,provide additional equity capital,or renegotiate terms as needed.32 H

66、owever,not all companies have benefited from expanded financing options,especially as most private credit deals are with private-equity-sponsored corporates.33Direct lending may also improve the alignment of financial incentives between originators and investors.In contrast to the originate-to-distr

67、ibute model of commercial banking,in which lenders make loans to later sell them,private credit firms have developed an“originate-to-suit”model.34 Originate-to-distribute has been criticized,as originators may have fewer incentives to screen and monitor borrowers because they pass credit risk onto i

68、nvestors.35 By contrast,in the originate-to-suit model,asset managers are also responsible for ensuring the investors suitability for the asset.36 Private credit funds also tend to maintain a closer relationship with their borrowers(for example,seeking board representation)and can more easily refina

69、nce or negotiate to avoid defaults.37 Diversity in debt holder composition has helped companies increase their resiliency to credit shocks in public bond markets,38 and these additional options could further enhance flexibility.12Rewiring The Financing Machine|1.A System RewiredExhibit 4:Product ran

70、geBorrowerprofileSize$175 million up to$100 billion+of EBITDA$200 million$5 billion of EBITDACategoryCorporate bondsSyndicated lendingTRADEABLENON-TRADEABLEIG syndicated loans$200 million$5 billion of EBITDALeveraged loans$20 million$5 billion of EBITDA,recently also largerPrivate credit direct loan

71、s$200 billionand belowBank loansBilateral lendingRatingBoth IG and HYIGHY but securitization produces IG exposuresBoth IG and HY(diversity of strategies)Mostly IGBorrowingtermsTypicaldeal size$300 million$500 million$300 million$5 billion+$200 million$500 million+$200 million$1.5 billion with recent

72、 deals reaching over$5 billionWide rangeUsageIssued by corporations to raise capital for a variety of reasonsProvide support for short term commercial paper borrowings or for working capitalOften provides acquisition financingBroad range of uses including financing for operations and acquisitionsBro

73、ad rangeof uses PricingLower costs vs loans for higher-rated public firmsLower pricing for companies with strong following among loan investorsFloating rate and priced at a spread over a benchmark rateContinuously renegotiating(floating price)Can offer more competitive terms based on deposit relatio

74、nshipAdditionalconsider-ationsSpeed ofexecutionSlow due to underwriting,especially for initial debt offeringSlow driven by long due diligence,underwritingSlow driven by long due diligence,underwritingSpeedy underwriting and executionVariable,depends on existing lending relationshipFlexibilityof term

75、sMinimal,standardized termsStandardized terms Favorable restructuringEasier refinancingCustomized terms specific to the borrowerMore challenging to refinanceFlexible and bespoke to borrowerCan include equity(e.g.,structured equity)Less flexibility,agreement is based on standard documentationGovernan

76、ce N/AN/AN/ACould include board representationN/ASource:Oliver Wyman Forum analysis13Rewiring The Financing Machine|1.A System RewiredA GLOBAL SYSTEM REWIREDNonbank involvement in corporate credit is a global phenomenon,coinciding with the rapid rise of global corporate debt,which now approaches 100

77、%of world GDP.39 The extent of nonbank participation varies by region,shaped by historical market structure.Nonetheless,nonbanks are steadily increasing their share of corporate credit globally whether through capital markets or alternative lending and,in doing so,deepening their connections with ba

78、nks.Nonbanks have expanded their share of financial assets in Europe from 39%to 49%and in Asia from 21%to 28%since 2008,according to the FSB.40 Nonbank participation tends to increase with deep capital markets and bond markets are growing,albeit from a small base.Companies outside of the US are stil

79、l more likely to rely on loans than bond markets.In Europe,only around 12%of corporate debt is financed through bonds,with bond usage only slightly higher in Asian countries like China and Japan.41 In Asia,Chinas public corporate bond market has grown faster than any other major economy.It grew from

80、 a minimal share of the global market in 2008 to nearly 20%today as its economy grew from 7%to 17%of world GDP.42 One of the key factors limiting the growth of corporate bond markets in the EU is market fragmentation,as the lack of standardization around regulations,tax policies,and legal frameworks

81、 particularly regarding bankruptcy creates barriers to cross-border financing.43 European authorities recognize these barriers and have a high-level commitment to a“Capital Markets Union”to overcome them,although progress on this has been slow.44Private credit is growing globally.This growth is most

82、 notable in the US,where private credit represents around 7%of all corporate credit,45 but there are signs that other regions may begin to catch up.In Europe,private credit has been expanding steadily,growing 17%annually since 2018 and representing 2%of corporate credit.46 In Asia,private credit has

83、 grown 20%annually over the last five years,although today it is only around 5%of the total private credit globally.47 Growing nonbank holdings of leveraged loans and collateralized loan obligations(CLOs)is similarly a global phenomenon.CLOs in Europe have grown to roughly a quarter the size of the

84、US market;48 however,Europes fragmentation has also impacted its leveraged loan and securitization markets.49 This means some of the innovations observed in the US have not reached Europe.For example,private credit CLOs,which package mostly unrated direct loans from private credit funds,remain soley

85、 a US phenomenon.This might be on the brink of change,as observed by the European Central Bank(ECB).50 In Asia,the leveraged loan market remains far less developed.51 It is constrained,at least in part,bythe dominant market share held by conservative banks.52As we explore below,all this nonbank acti

86、vity in corporate debt means growing interconnections between banks and nonbanks globally.In addition to common exposures to companies that banks and private markets both finance,banks lend directly to private funds and fund investors.While the US has the largest fund finance market,this market is a

87、lso growing in Europe and Asia,with deals increasing in size and evolving from relationship-based to syndicated.53 Another notable example of these interconnections is the market for synthetic risk transfers(SRTs),which allows for transferring loan risk from banks to nonbanks,primarily credit funds

88、and other asset managers.The SRT market in Europe is the largest globally,encompassing over$100 billion in loans,54 with most of these transfers aimed at mitigating risk from corporate loans.55 14Rewiring The Financing Machine|1.A System RewiredExhibit 5:Nonbanks across jurisdictionsUnitedStates1276

89、3%40(158%of GDP)FinancialassetsIEquity tradable marketsIIINonbank as%of local assetsII2002USD trillionsUSD trillions2022Composition of firm financing%Equity(tradable and non-tradeable)BondsLoansOther657 1216UnitedKingdom3346%3(105%of GDP)EuroAreaV10225%11VI(66%of GDP)Japan3724%5(127%of GDP)China771%

90、11(66%of GDP)8(31%of GDP)Non-financial corporate bond marketsIVUSD trillions0.5(15%of GDP)1.8(13%of GDP)0.8(18%of GDP)4.8(27%of GDP)59%46%33%28%24%59201558 26651Global45542%101(100%of GDP)18.6VII(19%of GDP)43%56281345028175I.Figures for EOY 2022.Global figures for 29 countries which report to FSB;II

91、.Many nonbanks are incorporated in cross-border financial centers like the Cayman Islands,which may affect these percentages;III.Figures for EOY 2022.Please note this includes financial firms;IV.Data from BIS;V.Due to data availability issues for Euro Area in 2002,the first nonbank%reflects 2003;VI.

92、This data point includes all 27 EU countries;VII.Fixed income market data is sourced from BIS the same dataset in SIFMA is 2%different($130 trillion).We used BIS data due to improved granularity.Sources:FSB,SIFMA,BIS,Oliver Wyman Forum analysis56 15Rewiring The Financing Machine|1.A System RewiredSh

93、ocks And GroundingThe rewiring of corporate credit through the growing role of nonbank institutions like private capital firms and hedge funds has introduced benefits beyond the expanded options for investors and firms discussed above.These changes remove some credit risk from the banking system and

94、 decrease risks associated with banks funding long-term loans with short-term deposits.However,this does not mean a“debanking,”as banks continue to play a crucial role in this evolving landscape.Despite these improvements,new channels for crisis can emerge.Risk distribution improvements depend on th

95、e assumption that risk can be assessed and appropriately managed,which becomes more challenging as products proliferate based on a common underlying exposure corporate credit.Market participants and policymakers need to be on the lookout for a reemergence of pre-GFC dynamics,in which interconnection

96、s across thesystem produce chains that may obscure risk rather than reduce it.Improvements in risk distributionPerspectives differ on whether financial risk can genuinely be reduced or merely shifted and redistributed to institutions and balance sheets better able to manage it.Innovations in corpora

97、te credit are,at a minimum,supporting risk distribution,reducing reliance on liquidity transformations through better matching of borrower and investor needs.For example,direct lending facilitates better maturity and liquidity matching for borrowers and lenders.Alternative asset managers are increas

98、ingly selling debt to investors that may be willing to hold it to maturity,like insurers and pension funds.These arrangements reduce the mismatches that have triggered past crises,such as when banks fund long-term loans or bond holdings with short-term deposits.Insurers and pension fund investors ca

99、n also reduce their“reverse maturity transformation,”as these longer-dated assets better align with their commitments.Alternative asset managers refer to this approach as tapping a permanent source of capital.Unlike bank deposits,this funding is either not subject to run risk from end investors or h

100、as structural impediments to runs.These shifts also come with their own challenges for these large stewards of capital.The lack of price discovery and supervisory pressure to monitor asset performance,paired with the opacity of borrowing firms,make valuation more difficult.57Securitized products all

101、ow investors to target specific risk exposures and manage concentrations across industries,geographies,and loan types.In corporate credit,CLOs have become the dominant structured product.Unlike collateralized debt obligations(CDOs),which played a pivotal role in the global financial crisis,CLOs fare

102、d well in the crisis,and there are those who argue they are even more robust today thanks to better capitalization and stronger collateral.58 CLOs are backed directly by diversified corporate loans,not other structured products,avoiding the“leverage on leverage”pitfall that plagued CDOs.59 Most CLOs

103、 have limited their collateral 17Rewiring The Financing Machine|2.Shocks And Groundingpurely to leveraged loans,given that banks the largest buyers of senior tranches face restrictions on the types of CLOs they can buy.Yet while CLOs have thus far avoided the mistakes of CDOs,market discipline,not r

104、egulation,has held CLOs to a higher standard.Supply and demand for credit exposure will determine how these lightly regulated products continue to evolve.Banks now have many opportunities to selectively de-risk.Selling leveraged loans to nonbanks and buying back the highest-rated CLO tranches is jus

105、t one way banks optimize returns while reducing risk.Providing financing to nonbank lenders can also be less risky than investing directly in a portfolio of loans,especially if the nonbank is well-capitalized and the financing is more senior.This is equivalent to“tranching”if the banks held the unde

106、rlying loans,they would get the whole exposure,including first losses.Synthetic risk transfers,where banks essentially pay nonbanks for insurance to cover loan losses,are another growing trend to help banks reduce risk-weighted assets.60 On the other hand,transferring risk outside the regulated bank

107、ing system makes it more challenging for regulators to detect the accumulation of systemic risk.Specialization in risk-taking can itself support market liquidity.61 The willingness to trade in times of crisis and uncertainty depends not only on balance sheet capacity but also risk appetite.During th

108、e March 2020 COVID-19 crisis,bond markets experienced significant turmoil and reduced liquidity.Open-ended fixed-income funds faced significant selling pressures,and dealers did not expand their market-making in response,citing challenges in managing internal risk appetite and balance sheet limits g

109、iven the extreme uncertainty of the time.62 Likewise,pension funds and insurers,typically considered to be end investors,did not act countercyclically to buy cheap assets due to their own temporarily lowered risk appetite.63 Risk-taking nonbanks entered the market,including distressed debt funds tha

110、t atypically bought longer-duration investment-grade bonds.64 Hedge funds also increased their bond positions,and dealers with stronger relationships with hedge funds were more likely to continue market intermediation.65 This ability to support market liquidity requires,however,that these nonbanks a

111、re not themselves the focal point of crisis.As a critical complement,this increased risk-taking is using less liquidity transformation.While open-ended fund structures are immensely popular among mutual funds,credit fund managers tend to utilize closed-end fund structures.Hedge funds are increasingl

112、y employing longer lock-up periods,with about 45%of net asset value(NAV)having a more than one-year lock-up and only 5%being redeemable in a day.66 In cases where liquidity transformation is the business model,recent innovations may present some advantages.Corporate bond ETFs,unlike equity ETFs,samp

113、le their benchmarks instead of replicating them precisely.67 Trading over equity infrastructure on a portfolio basis changes the economics of market making,and the ease by which trades can be hedged opens ETF markets to different sets of participants.During the COVID-19 turmoil in March 2020,bond ET

114、Fs continued to trade(albeit at widened bid-18Rewiring The Financing Machine|2.Shocks And Groundingask spreads)while many of the underlying bonds essentially stopped trading.68 However,it is important to note that most investment funds are still open-ended,including money market funds,which saw sign

115、ificant runs in the 2008 crisis.Exhibit 6:Hedge fund transformationsPortfolio liquidityFor qualifying hedge funds,share of aggregate NAVLock-up periodFor qualifying hedge funds,share of aggregate NAVAt most 1 day1 day to 3 monthsOver 1 year3 to 12 monthsAt most 1 day1 day to 3 monthsOver 1 year3 to

116、12 months20142016201820202022202420222024010203040506020142016201820200102030405060Note:Per the SEC,based on minimum period for withdrawal requests.Source:SEC Private Fund Statistics69 Continued importance of banks The evolution of risk redistribution outside of traditional banking does not diminish

117、 the importance of banks.Instead,it is reshaping their business models.Properly priced,banks can make solid profits serving nonbanks in various ways,as evidenced by the competition to work with them.Bank funding is critical to most nonbanks and goes beyond just corporate credit.70 Banks play a centr

118、al role in many phases of private capital transactions through the provision of finance,even coordinating and participating in the origination of loans.71 In the United States,global systemically important banks(G-SIBs)provide nearly 90%of lending to hedge funds,72 with 19Rewiring The Financing Mach

119、ine|2.Shocks And Groundinghedge fund borrowing more than doubling in the last decade.73 Other major nonbanks that relyheavily on bank funding include special purpose vehicles,finance companies,and broker-dealers.74 While the true extent of bank-nonbank interconnections is challenging to assess,75 ba

120、nks are undoubtedly still vital players.In many ways banks have benefited from the expansion of nonbanks into corporate credit.In CLO markets,banks earn fee income from selling the underlying loans and buy back the higher rated tranches while avoiding the riskier equity.76 The rise of NAV loans and

121、subscription finance to private capital has provided a revenue source for banks beyond the traditional leveraged buyout(LBO)financing popular with private equity firms.With hedge funds expanding their activities in credit markets,especially through multi-asset strategies,the opportunity in prime ser

122、vices is set to grow.77 Exhibit 7:Bank and nonbank interconnectionsHedge funds1,800Loans,reverse repos,derivatives,equity investments,prime brokerageDeposits,repos,derivativesEstimated USbank exposureNonbank reliance on banks for fundingUSD billions Type of funding(bank assets)Bank reliance on nonba

123、nks for fundingType of funding(bank liabilities)Private capital650(Secured)revolving credit,loans,co-investingDeposits,distressed equityBroker-dealers1,300Reverse repos,derivativesRepos,derivativesSPVs260Loans,CLOs,equity investment,debt securitiesDepositsFinancecompanies200Loans,debt securitiesDepo

124、sitsInsurance companies,pension funds 360Derivatives,debt securitiesDeposits,repos,debt securities,derivativesCCPs40Reverse repos,derivatives,initial margins,default fundRepos,derivativesMutual funds15Loans,derivatives,fund sharesDeposits,debt securities,derivatives,repoMMFsShare0-1%1-5%15-25%50%+0-

125、Secured borrowing(e.g.,repos)Unsecured borrowing(e.g.,CP,CD)Sources:BIS,SEC,US Federal Reserve,OFR,Fitch Ratings,Federal Reserve Bank of NY,Oliver Wyman Forum analysis7820Rewiring The Financing Machine|2.Shocks And GroundingPotential channels for crisisThe function of the financial system is to matc

126、h those with funds to invest with those who have good uses for funds.This matching process is complex,as many of those with money also want to preserve access to their funds and not have them locked up.Different financial transformations help address this:Maturity transformations allow short-term fu

127、nds to be invested into longer-term assets,allowing investors to withdraw their funds or roll over the debt.Liquidity transformations provide the promise of immediately available money at a pre-specified price.Finally,credit transformation utilizes the fact that investors have different risk prefere

128、nces by issuing claims with various risk/return profiles(for example,senior secured debt,junior unsecured debt,and equity).This matching process is inherently risky because it must contend with two key challenges:(1)increasing the supply of money and assets to fuel productive economic activity and(2

129、)contending with moments of crisis,when market participants all want access to their funds at once in some trusted form of money.These two challenges require a delicate balance,as financial activity in good times gives rise to chains of finance that produce high-quality assets thought of as“money su

130、bstitutes”that is,they are believed to have a stable value,but may come into question in bad times.79 This is one of the main reasons central banks are liquidity providers of last resort:The demand for money peaks in a crisis.If the financial system were always to safeguard liquidity for the very wo

131、rst event,it would have too much liquidity locked up during regular times and would underinvest in the economy.This is why banks hold a special place in the financial system,constrained and protected by a massive apparatus of regulation and supervision.Deposits are themselves one side of maturity,li

132、quidity,and credit transformations.Banks issue deposits and expand available liquidity for economic activity,with deposits treated as having stable value given policy tools such as deposit insurance and the expectation of central bank support.But banks are constrained in issuing deposits by a combin

133、ation of business judgement and regulatory requirements.80While nonbanks will perform only one or two financial transformations,they can come together in a chain of connections to produce money substitutes.The global financial crisis imparted critical lessons on how systemic crisis can unfold:Obscur

134、e channels of financial transformations produce a variety of assets billed as high quality.As financial institutions acquire these high-quality assets in place of lower-rated investments,they can free up capital and increase their financing for the nonbanks producing such assets.Exposure to these as

135、sets accumulates in excess,building up systemic risk that has not been priced in(or understood).The risk becomes especially concerning as exposures build up for financial institutions that have a short-term critical function,for example,providing contingent funding for other institutions or playing

136、a role as a market maker.Channels that helped fuel the growth of these assets come to a halt during a crisis,and exposed financial institutions cannot execute their critical function,with potential further knock-on effects.21Rewiring The Financing Machine|2.Shocks And GroundingExhibit 8:Channels for

137、 crisisLoanoriginationCredit transformationFinancialstep“Tranching”Redistribution of idiosyncratic riskNew layersof financial transformationsPotential systemic risk buildupExposureaccumulationby key entitiesOutputGeneration of“high-quality”assetsMore,different“high-quality”assetsFundingand/or liquid

138、ity“release”Source:Oliver Wyman Forum analysisDuring the financial crisis,subprime mortgages were aggressively originated and bundled into mortgage-backed securities,CDOs,and other instruments,then further bundled into more complex products.This growing universe of securities received inflated ratin

139、gs from credit agencies due to flawed models that didnt recognize the buildup of concentrated risk.81 Exposures accumulated on bank balance sheets,both explicitly and implicitly,through guarantees and credit lines to nonbanks producing these securities.When housing prices declined,and defaults incre

140、ased,the actual risks of these securities were exposed,leading to a credit freeze,institutional failures,and a global economic crisis.This series of interlinked practices and misaligned incentives ultimately brought the financial system to a halt.Its critical to assess the extent to which similar dy

141、namics might recur today,especially as a diversity of products are being originated based on the same systemic exposure to corporate credit.In essence,the collateral base for private money substitutes has expanded significantly from real estate to a wide range of corporate assets.This base is procyc

142、lical by nature.Suppose theres a crisis in the corporate sector.If liquidity chains depend on the corporate sectors underlying value,that value will collapse when it is most needed to supply funds back into the real economy.22Rewiring The Financing Machine|2.Shocks And GroundingAvoiding BuildupsSo f

143、ar,these innovations in corporate credit do not appear to have created undue risk.Both the Federal Reserve and the International Monetary Fund(IMF)point out that private credit funds specifically do not pose a systemic risk,given that they engage in limited liquidity and maturity transformation with

144、 minimal leverage.82 The risks to lenders,typically institutional investors,are deemed moderate due to these funds secured nature and modest borrowings.83 More broadly,longer-term lock-ups across private credit,hedge funds,and most BDCs,further help mitigate the potential amplification of market str

145、ess via forced asset sales during crises.However,the demand for corporate credit products and therefore the supply of funding to private credit funds is expected to rise significantly in coming years,and its unclear if available investment opportunities can keep pace.An aging population will likely

146、increase allocations to fixed-income products.84 Simultaneously,alternative asset managers are targeting a broader investor base,including high-net-worth individuals and potentially retail investors.85 These newer investors will likely prefer more liquid assets,undoing some of the benefits of reduce

147、d liquidity transformations.On the supply side,the macroeconomic outlook is uncertain.A recent Oliver Wyman Forum survey of CEOs found that volatile inflation,high interest rates,and geopolitical instability are among business leaders top concerns.86This evolving landscape is intensifying competitio

148、n among banks and nonbanks and increasing connectivity between once-distinct market segments.Private credit is beginning to target larger deals and firms,87 while large asset managers are restructuring themselves to expand corporate services.88 Direct lending is being used to refinance debt originat

149、ed in syndicated lending markets and vice versa.89 Banks,facing new regulations under the Basel III endgame proposals,may further limit their activities,creating additional opportunities for nonbanks.90 On the other hand,banks have a renewed advantage in a high interest rate environment due to ready

150、 access torelatively low-cost deposit funding.We highlight five factors to consider to balance the benefits and risks of this evolution.Exhibit 9:Key linkages to monitorAccumulation of exposuresHow exposed are critical financial institutions?What is the nature of the exposure?High-qualityassetsWhat

151、safeguards the value of high-quality assets being produced?Whats the level of visibility into their underlying risk?Short-termpromisesWhat short-term liquidity promises are being made?By whom to whomare these promises being made?FinancialchainsAre financial chains getting longer and more complex?Wha

152、t is their reliance on leverage?Dynamicsin crisisWhat entities will have the capacity and risk appetite to become buyers in crisis?What about longer-term dynamics?12345Source:Oliver Wyman Forum analysis24Rewiring The Financing Machine|3.Avoiding BuildupsShort-term promisesLiquidity challenges are of

153、ten what lead to a crisis.Interlocking promises of payments frequently become channels of transmission in times of stress,as failures to get paid trigger failures to pay.In this way,sudden liquidity demands can have a domino effect from runs and interbank lending freezes to margin calls and credit l

154、ine drawdowns.Shocks can propagate as institutions sell different assets to meet margin calls,stay within risk limits,or provide cash to their creditors,depressing asset valuations.This loop can then impact the real economy as funders respond by tightening lending,exacerbating a downturn.Given these

155、 potential risks,its crucial to understand the nature and extent of these promises,including whos making them and to whom.The conflicting promises to pay made to and by nonbank actors in the corporate credit ecosystem could become sources of volatility in times of stress.Not all nonbanks are equally

156、 vulnerable,as the nearer an entitys structure is to being closed-end the more resilient it tends to be.As explored above,private credit funds with genuinely permanent capital are best positioned to weather storms but a crisis will test whether that capital is truly permanent.It is critical to keep

157、an eye on how these credit products are being used in the market and their possible interconnections.CLOs,for example,may demonstrate greater resiliency to runs in a downturn because they also do not promise redemptions.91 However,asset managers may be relying on CLOs for liquidity due to their abil

158、ity to trade rather than redeem the instruments which could still lead to falling prices and knock-on effects.92More uncertain liquidity promises originate from retail-oriented investment vehicles like BDCs,interval funds,and ETFs.This fast-growing sector caters to mass-affluent investors seeking bo

159、th private credit returns and liquidity.BDCs,which mainly offer retail access to private debt,have tripled to over$300 billion since 2018.93 Interval funds,which allow periodic redemptions ranging from 5%to 25%,have grown 40%annually for a decade and now exceed$80 billion.94 Beyond existing leverage

160、d loans and CLO ETFs,prominent asset managers are now planning to launch private market ETFs.95Nonbanks are also making liquidity promises to borrowers that could be strained in a downturn.For instance,private credit funds are expanding their offerings to include revolving credit lines that compete

161、directly with banks,and revolving credit now comprises 9.5%of all private credit loans.96 Further adding to the complexity,private credit and syndicated lending are being offered to cash-strapped firms with terms that include payment in kind(PIK),providing them the ability to roll interest payments

162、into the principal rather than deliver cash.This creates further liquidity management challenges that may reveal themselves only in a downturn.Nonbanks may be able to meet unexpected outflows with contingent funding from banks,who serve as liquidity providers of first resort and can rely on central

163、bank support in a crisis scenario.US banks have$2 trillion in committed lines to nonbanks,with average utilization rates at about 25Rewiring The Financing Machine|3.Avoiding Buildups50%.97 Banks also play a contingent financing role for companies,that being one of the portions they typically retain

164、in leveraged loan deals.98 These credit lines normally serve various narrow purposes,such as helping private funds manage capital calls with subscription credit.99 This type of support may not be available in a crisis.Financial chainsWhile nonbanks dont typically perform all the financial transforma

165、tions that banks do,bank-like risk can reemerge through financial chains and layers of financial transformations.Structured products involve credit transformation,new vehicles make investments more liquid,and leverage adds maturity transformation,making for a trifecta of financial transformation.Of

166、particular concern is the“layering”of leverage,or“leverage on leverage,”as financial chains become longer and add leverage at different points of interconnections.This can happen,for example,through fund finance,as nonbanks borrow against their assets and LP commitments;through the use of“synthetic

167、leverage,”or creating leverage through the use of off-balance sheet activities like derivatives;or through financing via wholesale money markets.These layers of leverage increase opacity,making it more difficult for investors,regulators,and market participants to identify potential vulnerabilities.M

168、oreover,the expansion of these financial chains makes the system more interconnected,increasing the chances of contagion and spillovers.Exhibit 10:Evolving leverageDebtCLOsPrivate funds that issue secured notes to invest in leveraged loans750InstrumentCategoryEstimate sizeUSD billionsDescriptionPrim

169、arily issued byPrivate capital SPVHybrid structuresPrivate credit feeder funds;SPV securitizes debt to niche and risky borrowersUnknownPrivate capital SPVFundfinanceSubscription linesRevolving facility secured by fund investors commitments 750(YE 2022)Private capital fundsDividend recapsPE-sponsored

170、 companies raise debt to hand cash to investors50-100PE portfolio companySyntheticleverageCredit defaultswapsOne party pays another to protect against a borrower defaulting on their debt3,100Hedge fundsOther nonbanksTotal return swapsReturn on portfolio of assets swapped for interest payments200Priv

171、ate capital fundsHedge fundsSynthetic risktransfersIAllows a bank to transfer risk of their credit portfolio to a nonbank entity60Private capital fundsAsset managersI.Synthetic risk transfers are agreements often composed of derivative products(e.g.,credit default swaps)in which the reference loan p

172、ortfolio remains on the bank balance sheet while risk is transferred to investors.Size estimate reflects the value of the underlying pool of assets for SRTs in North America.Sources:ICLG,Guggenheim Investments,Fitch Ratings,Morningstar LSTA,OCC,International Association of CreditPortfolio Managers(I

173、ACPM),Oliver Wyman Forum Analysis10026Rewiring The Financing Machine|3.Avoiding BuildupsWhile generally less leveraged than banks,nonbanks do use leverage to support returns and generate liquidity for their investors.More broadly,the US Securities and Exchange Commission(SEC)reports that private mar

174、ket funds finance roughly half of their assets with borrowing.101 But this estimate may be misleading because private fund leverage can sit at various levels,including the underlying investments in the fund,other special purpose vehicles(SPVs),and the private capital firm itself.Notably,CLOs and hyb

175、rid fund structures are themselves forms of leverage that utilize SPVs to issue debt in order to finance the purchase of corporate credit assets.This type of leverage is often not included when accounting for private fund borrowings.Borrowing at the fund level is referred to as“fund finance.”While t

176、his private market leverage is more prevalent in private equity,it also exists in private credit.A meaningful fraction of private credit funds make use of subscription lines,which are credit facilities secured by the funds capital commitments,a market sized at$750 billion.102 In private equity,both

177、general partners(GPs)and funds buying stakes from GPs use debt to finance their shares,and there is no reason to believe private credit funds would be different.To the extent that private equity firms load their portfolio companies with debt,the$50 billion to$100 billion dividend recapitalization ma

178、rket can be seen as a form of leverage in the system103 beyond the substantial debt added through the LBO process itself.Dividend recaps add leverage to firms balance sheets to pay back limited partners who invested in the broader private equity fund.104Rating agencies can facilitate leverage by pro

179、viding standardized credit quality assessments,helping expand the pool of potential investors.Private credit funds and BDCs are also receiving credit ratings that attest to their role as high-quality investments,although the universe of rated entities is still small.105 While most of this informatio

180、n remains private,multiple rating agencies are issuing ratings to these funds,and public reports suggest that most of these funds are rated as investment grade.106 Rating agencies have also begun to rate fund finance products the first one being subscription lines107 and at least one agency is also

181、rating NAV loans.108 These ratings allow insurers to reduce capital charges against these loans and make it easier for private credit funds to issue them and for institutional investors to participate as lenders in fund finance.109 Credit rating assignments by banks are aligned to credit policy stan

182、dards and are often more stringent than general credit ratings.Further,individual ratings do not reflect the correlation risks that investors will need to manage as they hold these products.Derivatives are another means for nonbanks to gain leveraged exposure to corporate credit,including through no

183、vel methods like synthetic risk transfers(SRTs).Banks seeking to expand lending without raising new capital under Basel III constraints are turning to SRTs to free up balance sheet capacity.110 The SRT capital structure uses derivatives like credit-default swaps to offload the risk of mezzanine and

184、first-loss tranches primarily to credit funds and other alternative asset managers.111 Beyond the synthetic leverage already present,market estimates suggest that between 10%and 50%of the$25 billion issued in SRTs in 2023 was financed through borrowing.112 Another common strategy for private funds i

185、s total return swaps,which allow them 27Rewiring The Financing Machine|3.Avoiding Buildupsto gain exposure to a larger notional amount of credit assets than they could purchase outright.113 The OCC quarterly report on credit derivatives places the TRS market at roughly$200 billion.114However,hedge f

186、unds are by far the largest players in the world of derivatives.US hedge funds hold over$15 trillion in aggregate derivative value compared to only$150 billion among private capital funds.115 Macro and relative value funds have the highest synthetic leverage,but credit-focused funds that trade corpo

187、rate debt have more than three times their NAV in gross notional derivative exposures.116 This translates into over$800 billion in credit derivatives among large US hedge funds today,117 as we also see credit hedge funds becoming the most in-demand strategy in 2024,according to a recent industry sur

188、vey.118 Financing through wholesale money markets appears limited.Corporate bonds in some repo markets are modestly on the rise but remain small relative to other uses.119 Notably,theres no indication that top-rated CLOs are being used as collateral for repurchase agreements,obligations to central c

189、ounterparties,secured borrowing,or as margin for derivative trades.However,if these products continue to expand,such uses could emerge.This would likely increase demand and create more complex financial interconnections.Lastly,life insurers have been critical providers of leverage to alternative ass

190、et managers and are themselves more leveraged than banks.While private credit originally aimed to provide assets that matched the maturity of life insurance liabilities,we see life insurers beginning to use shorter-term funding to finance alternative and other investments.Leverage through nontraditi

191、onal funding has nearly reached$400 billion,with nearly half being funding-agreement-backed securities(FABS),a deposit-type contract.120 The total number of FABS has doubled in the last four years,and there is limited publicly available information on who holds these instruments.121Accumulation of e

192、xposuresBanks and other critical financial institutions must maintain a holistic view of their exposure to corporate credit,including indirect exposures via nonbanks.As the nonbank sector grows in size and complexity,its interconnections with traditional banking have become a key concern for regulat

193、ors and policymakers.While direct exposures through credit lines,securities financing,and derivatives are easier to track,the full extent of banks vulnerability to nonbanks remains unclear.This opacity is primarily due to potential indirect exposures arising from common asset holdings their value in

194、 a crisis heavily depends on whether nonbanks engage in fire sales.Further,nonbanks finance their activities from multiple sources,making it difficult for a single bank to see the complete picture.This lack of transparency enabled the widespread contagion of the 2021 meltdown of 28Rewiring The Finan

195、cing Machine|3.Avoiding BuildupsArchegos,a family office that caused over$10 billion in losses across six major banks.122 Had banks been more informed about Archegos positions and the interconnected exposures among themselves,they likely would have taken steps to mitigate their risk exposure.The cha

196、llenges in mapping out exposures is further compounded by cross-border connections,with cross-border bank claims on nonbanks totaling$7.5 trillion in 2020.123 Of particular concern is the high concentration of lending exposure;in 2019,the FDIC found that just four large banks accounted for roughly h

197、alf of all lending to nonbanks.124Yet banks are not the only critical financial institutions that face growing direct and indirect exposures to corporate credit.Insurers and pension funds are key investors in closed-end private credit funds,accounting for roughly$400 billion of the entire market.125

198、 In 2021,pension funds were the largest investors in private credit funds,accounting for 31%of aggregate private credit fund assets,while insurers account for 9%of the market.126Insurers and life insurers in particular have been unique in their relationship to alternative asset managers as a range o

199、f partnership models have emerged.At one extreme,private capital firms have been purchasing life insurers,thereby gaining access to the insurers balance sheet while providing the insurer with long-term assets to match their liabilities.This has proved to be a popular approach.The AUM of US life insu

200、rers fully or partly acquired by private capital firms is nearly$600 billion,127 representing about 11%of the US life insurance industry.128 These PE-owned insurers allocate the same share of their cash and invested assets to investments in alternative assets as other life insurers,but have more tha

201、n twice the share of holdings in structured products.129High-quality assetsAmong the accumulation of exposures,it is essential to track the dynamics of how high-quality assets are produced because they can fuel systemic risk buildup,as explained in the prior section.High-quality assets are in high d

202、emand from regulated financial entities,in large part due to regulatory requirements.Available investment-grade assets in financial markets have evolved significantly in recent years,driven by innovations in structured products,changes in credit markets,and the growing influence of alternative asset

203、 managers.These assets can be constructed through securitization.Whats novel in the latest market structures is that investment-grade assets are also being produced by ensuring more senior and secured claims on corporate assets,which is akin to securitizing the corporate balance sheet.Securitization

204、 can be a powerful source of improved risk distribution but it has also been prone to misaligned incentives and mispricing of risk in the past.As discussed above,CLOs are the dominant structured product in corporate credit and have,to date,avoided some of the challenges of the past.CLOs have been on

205、 the rise and are estimated at$750 billion outstanding,130 29Rewiring The Financing Machine|3.Avoiding Buildupsand triple-A rated CLOs have experienced steady growth,as observed in the figure below.However,the total amount outstanding is still far below the market size of over$2.7 trillion reached b

206、y non-agency residential mortgage-backed securities during the global financial crisis.As the structured product market grows,it is important to watch how underlying loans and structures evolve.Recent anecdotal evidence suggests that CLO demand has been outpacing supply.131 The dramatic rise of cove

207、nant-lite loans from 1%in 2000 to over 90%of the US leveraged loan market today suggests that CLOs may rest on a potentially riskier foundation than before.132 Furthermore,new kinds of CLOs are being structured with private credit loans rather than traditional leveraged loans.133 These“middle market

208、”CLOs are more opaque because the underlying loans are not publicly rated although many are assigned“credit estimates”134 and they are growing quickly,reaching a market size of over$115 billion by late 2023.135Any novel securitization process warrants a closer look,especially re-securitizations,give

209、n their ability to concentrate risk as we saw during the GFC.One instance of this today is collateralized fund obligations,which use an SPV to bundle and securitize shares from various private capital funds.They are now buying stakes in CLOs and other syndicated loans as well.136 Other novel securit

210、ized products include private credit funds securitizing niche loans held in SPVs,137 and private credit feeder funds,which are separate SPVs attached to a single fund selling securitized LP shares in that parent fund.138 And while not the same as re-securitization,the emergence of CLO ETFs is anothe

211、r way these products are repackaged and resold with added financial transformations.Its a tiny market at just over$10 billion,but growing quickly,139 and provides retail investors easy access to these increasingly complex structured products.Exhibit 11:Expansion of corporate-based prime instrumentsO

212、utstanding amounts of AAA investmentsAAA grade investments,2005-2025,USD billionsAAA CLOsAAA CMBSAAA BondsAAA ABS201020152005202020250100200300400500600700Sources:NYU Stern,ICE Indices,Guggenheim Investments,Morningstar LSTA,Oliver Wyman Forum analysis14030Rewiring The Financing Machine|3.Avoiding B

213、uildupsOutside of securitized products,the production of higher quality assets in private markets has been achieved by focusing on capital structures accessing the senior-most debt of the company and claims on collateral.This is part of what makes riskier middle market firms suitable for investments

214、 by insurers,which require high-quality assets.The reliability of these legal mechanisms is still being tested while further innovation piles on.Super senior structures have emerged(although seemingly rare)where the introduction of new debt creates a newly senior tranche,allowing one lender to surpa

215、ss the priority of others with existing senior claims.141 The increased marketization of asset-backed lending is another step in this evolution.These loans offer first-lien claims on a firms assets,further distributing competing claims for seniority among investors.Notably,Barclays analysis notes th

216、at first lien creditors can often lose out to more junior debt holders who employ aggressive restructuring tactics prior to default.142 Seniority on claims is not always what it seems.Dynamics in crisisThe dynamics of financial markets during crises are often unpredictable,especially as actors roles

217、 shift based on their capabilities,incentives,and regulatory constraints.Understanding potential dynamics requires mapping out which entities will have the capacity and risk appetite to become buyers or lenders during a crisis which also critically depends on these entities themselves not being the

218、focal point of a crisis.A price collapse in corporate credit products can be exacerbated if market makers cannot continue making markets.Dealers are not ones to catch a falling knife,so they depend on the availability of investors willing to buy in such a market.As discussed in a prior section,the M

219、arch 2020 bond market turmoil saw open-ended bond funds exacerbating the crisis while hedge funds and distressed asset funds provided support by purchasing discounted assets and corporate bond ETFs improved liquidity through facilitating trading.In private credit,the lack of tradeable markets impede

220、s a potential run and ensures losses are kept with capable end investors.On the other hand,as new interconnection points are introduced,the risk of potential contagion increases.Dynamics during a recovery could also change.Some believe that firms increasing reliance on nonbank lending could deepen a

221、 crisis,as nonbanks have historically been more likely to curtail lending relative to banks.143 This has been driven by nonbanks more transactional relationships with firms,which could be changing as alternative asset managers more actively cultivate relationship businesses.However,there is also the

222、 risk that nonbanks ability to provide support dries up under stress without direct channels for policy support.Further,working through the complex arrangements of debt subordination could lead to prolonged strife among nonbanks.14431Rewiring The Financing Machine|3.Avoiding BuildupsFINANCIAL STABIL

223、ITY POLICYRESPONSEThe evolution of corporate credit markets is part of broader transformations occurring across the nonbank sector.Although this report primarily examines developments in the United States,its important to note that many of these shifts are taking place globally.To assess trade-offs

224、of evolving market structures,policymakers must be able to monitor and regulate the buildup of various risks across the economy(e.g.,credit,liquidity,leverage)and intervene if necessary both to prevent risks from leading to a crisis and,if necessary,to manage a crisis.Multilateral organizations have

225、 put forward principles for regulators to follow and many jurisdictions are increasing their efforts to monitor and regulate nonbanks.However,on both a global and national scale,regulations typically provide only patchwork coverage for nonbanks,and having access to the right data to map out risks fu

226、lly remains a critical challenge.Globally,the FSB is leading the charge in nonbank monitoring and policy coordination.It was established in the aftermath of the global financial crisis to identify how policy makers could coordinate to improve market resiliency.G20 leadership first called on the FSB

227、to strengthen oversight and regulation of nonbank financial intermediation in 2010.145 Since then,the FSB has issued policy guidance covering a wide range of subtopics,began publishing an annual global monitoring report in 2012,and conducted detailed project roadmaps for risk assessments and regulat

228、ory support.146IIOSCO,BIS,CPMI,IMF,andothersWorking closely with other multilateral institutions,I the FSB has offered a series of sector-specific recommendations(for example,promoting the resilience of MMFs,managing liquidity risk in open-ended funds),with attention turned more recently to overall

229、levels of leverage in the sector.147 Given the wide range of recommendations,the FSB also issues stock-taking exercises to assess the levels of adoption,finding,for example,that many member jurisdictions now mandate that derivatives clear through a central counterparty per its recommendations148 whi

230、le progress in adopting its MMF reform recommendation has beenuneven.149The ongoing challenge for these efforts is that the nonbank sector is continuously growing and diversifying.The gaps in data and regulatory oversight continue to increase roughly half of nonbank domestic funding sources are unkn

231、own.150 Yet monitoring nonbank balance sheets is critical to gauge changes in risk-taking that have implications for financial stability,such as the aggregate leverage of broker-dealers or total AUM of MMFs.Data gaps are also significant around how nonbanks manage their financial risk internally.For

232、 example,little is known about how hedge funds manage their liquidity risk or how pension funds utilize derivatives to gain leverage.151Each jurisdiction has its own challenges.TheUnited States the jurisdiction with the largest nonbank sector regulates nonbanks through a wide range of agencies,makin

233、g it challenging for any single regulator to have a comprehensive view of market developments 32Rewiring The Financing Machine|3.Avoiding Buildupsand interconnections.More recently,the US Financial Stability Oversight Council developed a framework to designate nonbanks as systemically important enti

234、ties,where appropriate.152 For the European Union,which has a smaller nonbank sector,the challenge is not just managing risk but also safely growing nonbanks and promoting capital markets union.In May of 2024,the European Commission issued a consultation on macroprudential policy for nonbank financi

235、al intermediation.153 Yet even if regulatory efforts effectively increase financial stability,policymakers will still need to plan for how to manage nonbank risk in a crisis.Central banks provide direct support tobanks in times of crisis,but a breakdown in money market lending could prevent nonbanks

236、 from accessing the banking sector.The UnitedKingdom experienced this firsthand with a 2022 crisis in its gilts market,and the Bank of England subsequently proposed a new liquidity facility specifically targeting insurance corporations and pension funds the first of itskind globally.However,this is

237、unlikely to be the lastincident of its kind,and the extent of centralbank assurances to nonbanks under stress remains an open question in most jurisdictions.33Rewiring The Financing Machine|3.Avoiding BuildupsA Safer FutureCredit provision is crucial for global economic growth.While US firms hold 20

238、%of assets in cash to insure against financing challenges,154 significant funding gaps persist for long-term projects.As a prime example,the G20 Global Infrastructure Hub projects an$800 billion annual infrastructure financing gap by 2040.155 The climate transition gap is even more stark current ann

239、ual flows of$1.3 trillion fall far short of the projected$9 trillion in annual need by 2030.156Nevertheless,credit expansion must be sustainable.The lessons of the global financial crisis must remain top of mind even if the world before 2008 may seem like the distant past.Asset managers must meet th

240、e demand for credit products by building the capacity to analyze and manage risk in preparation for the next credit cycle.Regulated institutions,in particular,have been fueling and benefiting from the growth in corporate credit but if they are not careful of the potential buildup of systemic risk,th

241、ey could be stuck holding the bag.Adapting regulation and supervision will take time in the meantime,it is critical that executives and investors proactively enforce market discipline.They should demand transparency into funds and leverage and conduct more stress testing that allows mapping out of r

242、isks.Policymakers should recognize that alternative asset managers play multiple roles in relation to other nonbanks,as fiduciaries,competitors,and owners.With efforts already underway to close data gaps to have greater visibility and oversight into these changes,policymakers must be forward-looking

243、 about potential interconnections,especially with the possible expansion of products into less sophisticated investor bases.Further,financial stability is not the only concern,as these changes to market structure also have implications for monetary policy,market integrity,and distributional concerns

244、 around access to investment opportunities.In the best case,nonbanks can support credit expansion withgreater efficiency and safer risk distribution.35Rewiring The Financing Machine|4.A Safer FutureAppendix A:GlossaryBasel III:A set of international banking regulations developed by the Basel Committ

245、ee on Banking Supervision to strengthen regulation,supervision,and risk management within the banking sector.It was introduced in response to the deficiencies in financial regulation revealed by the global financial crisis(GFC).Bilateral lending:Refers to loans made directly to businesses by both ba

246、nks and nonbanks.Bonds:Debt securities issued by companies.Business development companies(BDCs):A type of closed-end investment fund within the private debt sector established to provide capital primarily to small and medium-sized companies and financially distressed businesses.Collateralized loan o

247、bligation(CLO):A structured credit product that pools a collection of loans and issues tranches of securities backed by these loans.CLOs can be categorized into middle market CLOs,which consist of direct loans,and broadly syndicated loan CLOs,whichcontain leveraged loans.Corporate credit market:For

248、this report,we define this market as the sum of outstanding bank loans,bonds,syndicated loans,and private debt to non-financial firms.Derivatives:Financial instruments whose value is derived from the value of an underlying asset,index,or rate.Common types of derivatives include futures,options,and s

249、waps.Direct lending:We define direct lending as a subset of bilateral lending solely originated by nonbanks.Dividend recapitalizations(recaps):Financial transactions in which a private equity sponsored company takes on additional debt to pay the funds shareholders dividends.G7:A group of seven major

250、 advanced economies(Canada,France,Germany,Italy,Japan,the United Kingdom,and the United States)that meet annually to discuss economic policies and coordinate responses to global economic challenges.G20:An intergovernmental forum consisting of 19 countries and the EU formed to address issues of inter

251、national financial stability.High-yield bonds:Higher-risk,higher-yield debt securities,defined as bonds rated BBB-and below.Investment-grade bonds:High-quality bonds with low default risk,defined as bonds rated BBB and above.36Rewiring The Financing Machine|Appendix AInvestment-grade syndicated loan

252、s:High-quality loans issued conjointly by a group of lenders that include both a fixed-term portion and a revolving credit facility.Leveraged loans:While there is no standard definition in the market,leveraged loans are generally higher-risk,fixed-term loans,often to indebted companies.Figures for o

253、utstanding leveraged loans in this report are from the Morningstar LSTA US Leveraged Loan Index.These are senior secured syndicated term loans over$50 million,priced in USD,with at least a 1-year term and 125+bps spread above a base rate.These loans are also often referred to as institutional loans.

254、Loans:Funds lent to borrowers for repayment with interest.Net asset value(NAV)loans:Financial instruments that allow private equity funds to borrow money using the value of their underlying portfolio assets as collateral.Private credit:For this report,we define private credit as financing to non-fin

255、ancial corporate borrowers provided by private credit funds.It is a subset of private debt and includes a variety of strategies,such as direct lending,mezzanine debt,and distressed debt.Most private credit financing is unrated,and borrowers tend to be small to midsized companies.Private debt:While t

256、he market defines private debt in various ways,for the purposes of this report,private debt is any debt extended to non-financial corporations by private credit funds and BDCs.Revolving credit facilities:A line of credit arranged between a financial institution and a business,allowing the business t

257、o access funds up to a pre-established maximum amount when needed.In the context of syndicated loans,the bank usually retains the credit line.Syndicated lending:Refers to loans offered by a group of lenders that conjointly provide funds to a borrower.Synthetic risk transfer(SRT):A financial transact

258、ion in which banks use derivatives like credit-default swaps to transfer credit risk from their balance sheets to other investors,such as credit funds and alternative asset managers.37Rewiring The Financing Machine|Appendix AAppendix B:Endnotes1 Drawing the exact perimeter of“corporate credit”is an

259、art as much as a science.This figure is based on US bank loans,bonds,syndicated loans,and private debt,which sum up to$11.15 trillion in 2023 and are the focus of this paper.There is no comprehensive source for corporate debt,and figures were compiled from various sources.Note that the total debt he

260、ld by non-financial corporations reported by the Federal Reserve in their From-Whom-To-Whom(FWTW)dataset is$17.5 trillion,which includes a variety ofcategories not included in this report.This Fed data does not have separate categories in FWTW for leveraged loans and private debt these might be incl

261、uded within the$9.4trillion of“Miscellaneous Financial Claims.”Excluded categories:mortgage-related debt($1.3 trillion,mostly held by banks),trade credits($3.5 trillion,principally extended by other non-financial businesses)and municipal securities,open market paper,and FDI debt($1.1 trillion total)

262、.Sources:Z.1 Tables Data,“Financial Accounts of the U.S.,”US Federal Reserve,2023;“Annual Global Private Debt Report,”PitchBook,2023;Index Platform,ICE;“Syndicated Loan Portfolios of Financial Institutions,”US Federal Reserve,accessed July 2024;“Morningstar LSTA US Leveraged Loan Index,”Morningstar,

263、2024;“Shared National Credit Program,”USFederal Reserve,2002-2023;Oliver Wyman Forum analysis.2 Definitions of leveraged loans vary widely.In 2013,the FDIC,OCC,and Federal Reserve issued joint guidance suggesting institutions devise their own definitions while suggesting criteria for indebtedness an

264、d use of the funds.The ECB,by contrast,provides a more standardized definition that considers the borrowers leverage ratio and their relationship with private equity funds.This report uses the Morningstar LSTA US Leveraged Loan Index to size the market for leveraged loans and adopts their definition

265、(see glossary p.28).Sources:“Interagency Guidance on Leveraged Lending,”US Federal Reserve,FDIC,OCC,May 2013;“Guidance on leveraged transactions,”ECB,May 2017;“Morningstar Leveraged Loan Indexes Methodology,”Morningstar,July 2024.3“Morningstar LSTA US Leveraged Loan Index,”Morningstar,accessed July

266、2024;Tirupam Goel,“The rise of leveraged loans:a risky resurgence?,”BIS,September 2018.4 Z.1 Tables Data,“Financial Accounts of the US,”US Federal Reserve,2023;“Annual Global Private Debt Report,”PitchBook,2023;Index Platform,ICE;“Morningstar LSTA US Leveraged Loan Index,”Morningstar,2024;“Shared Na

267、tional Credit Program,”US Federal Reserve,2002-2023;“Syndicated Loan Portfolios of Financial Institutions,”USFederal Reserve,June 2024;Oliver Wyman Forum analysis.5“Understanding Collateralized Loan Obligations,”Guggenheim Investments,December 2023;“The U.S.CLO Market White Paper,”LSTA,April 2022.6

268、Huw van Steenis et al.,“Private Credits Net Act,”Oliver Wyman,April 2024.7 Aymeric Bellon,“The Secular Decline in Private Firm Leverage,”NBER,May 2022.8 Jack Bao,Maureen OHara,and Alex Zhou,“The Volcker Rule and Market-Making in Times of Stress,”US Federal Reserve,September 2016.9“The Implications o

269、f the Final Volcker Rule on CLOs,”LSTA,June 2020;Paul Haskel and Robert J.Waldner,“SupremeCourt Preserves the Status Quo That Syndicated Loans Are Not Securities in Kirschner v.JPMorgan Chase,”Crowell,April 2024.10 This phenomenon is true for both stocks and bonds,although more extreme in the case o

270、f stocks,where studies have pointed to a gap of 5,000“missing listings”in the US relative to what would be expected given its advanced economy and developed institutions.See Craig Doidge et al.,“The U.S.listing gap,”Journal of Financial Economics,Volume 123,Issue 3,2017;for decline in US firms issui

271、ng bonds,see Lira Mota and Kerry Siani,“Financially Sophisticated Firms,”October 2023.11 High yields and tightening capital requirement regulations are likely driving increased demand for investment-grade products.Financial collateral,including particular investment-grade securities,can improve a fi

272、nancial entitys risk-weighted assets ratio,in turn alleviating capital requirements.See“Section 2.1-Capital of the Risk Management Manual of Examination Policies,”FDIC,August 2022;Miriam Mukuru,“High Yields Drive Demand For Investment-Grade Bonds,Rate Cuts Likely to Boost Market,”The Wall Street Jou

273、rnal,February 2024.12 Isabelle Lee and Michael Tobin,“Wall Streets E-Trading Boom Adds Fuel to Private-Debt Craze,”Bloomberg LP,May 2024.13 Numerous contemporary news sources cite talent migration from banks to nonbanks during and after the 2008 crisis.DavidEllis,“Brain drain takes toll at Citi and

274、BofA,”CNN,June 2009;James Mackintosh and Chris Hughes,“Hedge funds hit troubled banks with a hiring binge,”Financial Times,July 2008.38Rewiring The Financing Machine|Appendix B14 These post-trade data services include public sources such as FINRAs ORF for OTC equities and TRACE for OTC fixed income,

275、as well as data from numerous private data brokers.“Market Transparency Reporting Tools,”FINRA,accessed July2024.15 For example,satellite imagery of retailers provides evidence of sales beyond company financials.See Frank Partnoy,“StockPicks From Space,”The Atlantic,May 2019.16 In interviews,hedge f

276、und market participants pointed to advancement in order routing in fixed-income trading platforms along with real-time data as critical to multi-asset class trading taking off.With portfolio trading,analysis by Barclays found that type of trading grew from 1%of total investment-grade corporate bond

277、volumes in 2018 to 7%in 2021.More recently,the share could be as high as 10%,with heads of fixed-income electronic platforms noting significant increases in this trading style.See Jeffrey Meli and Zornitsa Todorova,“Portfolio Trading in Corporate Bond Markets,”Barclays,December 2023;and Dan Barnes,“

278、FILS USA:The significance of portfolio trading breaking 10%volume,”The Desk,June 2024.17 Jeffrey Meli,“The equitification of credit,”Financial Times,June 2024;Kevin McPartland,“Understanding Fixed-Income Markets,”Coalition Greenwich,May 2023.18 Hedge fund holdings of leveraged loans are estimated by

279、 multiplying Fed figures for leveraged loan assets of all hedge funds by SEC reported US adviser main office locations in the US(percent of NAV).Z.1 Tables Data,“Financial Accounts of the US,”US Federal Reserve,2023;“Enhanced financial accounts,Hedge Funds,”US Federal Reserve,2012-2022;“Private fund

280、s statistics,”SEC,2012-2022;“US Corporate Bonds Statistics,”SIFMA,September 2024;“Secondary Trading and Settlement Monthly,”LSTA,May 2024.19 Speculative-grade defaults reached only 0.5%for CLOs versus 3.6%for corporate bonds in 2023.While CLOs have been around for a long time,their popularity and ma

281、rket share have significantly increased,so these defaults dont reflect an entire credit cycle at their current scale.Evan M.Gunter and Nick W.Kraemer,“Default,Transition,and Recovery:2023 Annual Global Leveraged Loan CLO Default And Rating Transition Study,”S&P Global,June 2024(this S&P article can

282、be accessed through S&P RatingsDirect).20 Hedge fund holdings of leveraged loans are estimated by dividing US hedge fund leveraged loan assets by total US leveraged loans outstanding.Our estimate includes loans to financial institutions,which,according to SNC reports,comprise 23%of syndicated loan c

283、ommitments in 2023.“Enhanced Financial Accounts:Hedge Funds,”US Federal Reserve,June 2024;“Morningstar LSTA US Leveraged Loan Index,”Morningstar,2024;“Shared National Credit Program Report,”Federal Reserve Board,February 2024.21 Private debt funds use loan covenants frequently due to the generally h

284、igher risk profile of private debt borrowers,see Fang Cai and Sharjil Haque,“Private Credit:Characteristics and Risks,”US Federal Reserve,February 2024.Bonds rarely have maintenance covenants,see GARP,“Covenant Lite and Investor Risk in Leveraged Loans,”Global Association of Risk Professionals,2020.

285、Covenants are typically incurrence-based rather than financial,see David Azarkh and Sean Dougherty,“High Yield vs.Investment Grade Covenants Chart,”LexisNexis,2019.Over 90%of leveraged loan issuance is covenant lite,see Abby Latour,“Covenant-lite deals exceed 90%of leveraged loan issuance,setting ne

286、w high,”S&P Global,October 2021(this S&P article can be accessed through S&P RatingsDirect);Anand Datar,“Making Allocations to Private Credit,”State Street,March 2024.22 While private credit includes many strategies(e.g.,ABL,mezzanine,opportunistic and distressed debt),direct lending is the largest

287、segment.Anand Datar,“Making Allocations to Private Credit,”State Street,March 2024.23 Anand Datar,“Making Allocations to Private Credit,”State Street,March 2024.24 For example,insurers have doubled their allocations to both leveraged loans and CLOs in recent years,which can be estimated to be over$3

288、20 billion.Allocations to CLOs are estimated by multiplying the insurers share of US holdings of foreign CLOs by the total size of the US CLO market.“SHC annual reports,”US Department of the Treasury,2014-2023;“Understanding Collateralized Loan Obligations,”Guggenheim Investments,December 2023.Alloc

289、ations to IG syndicated and leveraged loans rose from$54 billion in 2018 to$122 billion in 2023.Jennifer Johnson,“U.S.Insurers Bank Loan Exposure Rises at a Decelerated Pace in 2023,”NAIC,July 2024.25 Jessica Hamlin,“Why are P.E.firms snatching up asset managers at a record clip?,”PitchBook,July 202

290、3;Bernice Napach,“Trendspotter:Asset Managers Expanding Access to Private Markets,”Think Advisor,November 2021.26“Annual Report,”Office of Financial Research,2023.27 Z.1 Tables Data,“Financial Accounts of the U.S.,”US Federal Reserve,2024.28 Tess Virmani,“The ABCs of BDCs:A Primer on the PC Markets

291、SEC-Registered Funds Part 1,”LSTA,April 2024.29 Shares are calculated using outstanding amounts of corporate and foreign bonds across all sectors.Z.1 Tables Data,“Financial Accounts of the U.S.,”US Federal Reserve,2023.39Rewiring The Financing Machine|Appendix B30 The IMF estimates that 41%of privat

292、e credit borrowers are in IT and 14.5%are in healthcare.“Global Financial Stability Report,”IMF,April 2024;Joern Block et al.,“A Survey of Private Debt Funds,”NBER,January 2023.31 Fang Cai,and Sharjil Haque,“Private Credit:Characteristics and Risks,”US Federal Reserve,February 2023.32“2024 Investmen

293、t Outlook,”Pensions&Investments,February 2024.33“Global Financial Stability Report,”IMF,April 2024.34 Narine Lalafaryan,“Private Credit:A Renaissance in Corporate Finance,”Journal of Corporate Law Studies(forthcoming),March 2024.35 Vitaly M.Bord and Joo A.C.Santos,“The Rise of the Originate-to-Distr

294、ibute Model,”US Federal Reserve,July 2012.36 Narine Lalafaryan,“Private Credit:A Renaissance in Corporate Finance,”Journal of Corporate Law Studies(forthcoming),March 2024.37 Narine Lalafaryan,“Private Credit:A Renaissance in Corporate Finance,”Journal of Corporate Law Studies(forthcoming),March 202

295、4.38 Lira Mota et al.,“Financially Sophisticated Firms,”October 2023.39“Global Debt Monitor,”IIF,accessed August 2024.40 Given the limits of the FSB dataset,Europe is defined as the Euro Area,UK,and Switzerland;Asia is defined as China,Hong Kong,India,Indonesia,Japan,and South Korea.“Global Monitori

296、ng Report on Non-Bank Financial Intermediation,”FSB,December 2023.41“Capital Markets Fact Book,2024,”SIFMA,July 2024.42“Global Debt Report 2024:Bond Markets in a High-Debt Environment,”OECD,March 2024;“World Economic Outlook,”IMF,April 2024.43 Ashok Vir Bhatia,Srobona Mitra,and Anke Weber,“A Capital

297、 Market Union for Europe:Why Its Needed and How to Get There,”IMF,September 2019.44 Magnus Burkl et al.,“The Capital Flywheel,”Oliver Wyman,European Banking Federation,the European Fund and Asset Management Association,and Federation of European Securities Exchanges,May 2024.45“The Rise and Risks of

298、 Private Credit,”IMF,April 2024.46“The Rise and Risks of Private Credit,”IMF,April 2024.47“The Rise and Risks of Private Credit,”IMF,April 2024.48 For more on European CLOs,see Asha Kapengut and Nina Flitman,“Chart Room:New European indices reveal CLO secrets,”Fidelity International,April 2024.49 Hu

299、w van Steenis,“Why Europe Needs A Bolder Plan For Capital Markets,”Oliver Wyman,July 2024.50“Private markets,public risk?Financial stability implications of alternative funding sources,”ECB,May 2024.51 For relative issuance across regions,see Joseph H.Brazil,Richard Lloyd,and Eugene Man,“Late rally

300、softens leveraged loan landing,”White&Case Debt Explorer,February 2024.52 Scott McMunn,“Opportunities and challenges in the EMEA and Asia Pacific loan markets:A conversation with the LMA and APLMA CEOs,”Loan Market Association(LMA),May 2024.53 Emma Russel et al.,“Comparing the European,U.S.and Asian

301、 fund finance markets,”Global Legal Insights,2024.54“Synthetic Securitization Market Volume:2016-2023,”International Association of Credit Portfolio Managers(IACPM),May 2024.55 Fernando Gonzalez and Cristina Triandafil,“The European significant risk transfer securitisation market,”ESRB,2024.56 The F

302、SB category“Captive Financial Institutions and Money Lenders(CFIMLs)”is excluded from all nonbank size calculations.“Global Monitoring Report on Non-Bank Financial Intermediation,”FSB,December 2023;“2023 Capital Markets Fact Book,”SIFMA,July 2023;“Summary of debt securities outstanding,”BIS,accessed

303、 April 2024.57“Global Financial Stability Report:Chapter 2,”IMF,April 2024.58 Evan M.Gunter and Nick W.Kraemer,“Default,Transition,and Recovery:2023 Annual Global Leveraged Loan CLO Default And Rating Transition Study,”S&P Global,June 2024(this S&P article can be accessed through S&P RatingsDirect).

304、40Rewiring The Financing Machine|Appendix B59 Sirio Aramonte and Fernando Avalos,“Structured finance then and now:a comparison of CDOs and CLOs,”BIS,September 2019.60“Synthetic Risk Transfers Reduce U.S.Bank RWA,Boost Alt I.M.Capital Deployment,”Fitch Ratings,May 2024.61 For more on different types

305、of dealers and how they support market liquidity,see Perry Mehrling,“Essential hybridity:A money view of FX,”Journal of Comparative Economics,Volume 41,Issue 2,May 2013.62“Corporate Bond Markets Drivers of Liquidity During COVID-19 Induced Market Stresses”IOSCO,April 2022.63 To translate into the la

306、nguage of dealers:The outside spread will come via alternative asset managers.Long-term investors like pension funds or insurers wont have the risk appetite to buy in times of crisis,but they are ultimately funding these alternative asset managers.See Perry Mehrling,Zoltan Pozsar,James Sweeney,and D

307、aniel H.Neilson,“Bagehot was a Shadow Banker:Shadow Banking,Central Banking,and the Future of Global Finance,”November 2013.64“Corporate Bond Markets Drivers of Liquidity During COVID-19 Induced Market Stresses,”IOSCO,April 2022.65 Mathias S.Kruttli et al.,“Liquidity Provision in a One-Sided Market:

308、The Role of Dealer-Hedge Fund Relations,”SMU Cox School of Business Research,June 2024.66 The minimum period before investors can request fund withdrawal,as specified in fund documents.Based on when withdrawal requests can be made,not when funds are actually paid out.This information is only require

309、d reporting for qualifying hedge funds(at least$1.5 billion in AUM,$500 million in NAV),which accounted for 80%of hedge fund NAV in 2023.“Private Fund Statistics,”SEC,Q3 2023.67 Bond ETFs differ from equity ETFs in pricing and redemption mechanisms,calculating NAV at the bottom bid price instead of

310、the midpoint of the bid-ask and using only part of the portfolio for redemptions instead of replicating benchmarks with precision.See more in John J.Shim and Karamfil Todorov,“ETFs,illiquid assets,and fire sales,”BIS,November 2021;and Ian OBrien Cannon,“4 nuances to know about bond ETFs,”Vanguard,Oc

311、tober 2023.68 Barabara Novick et al.,“Lessons from COVID-19:ETFs as a Source of Stability,”BlackRock,July 2020;“Bond ETFs amid the Coronavirus market shock,”RBC Global Asset Management.69“Division of Investment Management Private Fund Statistics,”SEC,2013-2023.Data based on the minimum period before

312、 investors can request fund withdrawal,as specified in fund documents.Based on when withdrawal requests can be made,not when funds are actually paid out.This information is only required reporting for qualifying hedge funds(at least$1.5 billion in AUM,$500 million in NAV),which accounted for 80%of h

313、edge fund NAV in 2023.70 Thank you to Viral Acharya et al.for inspiring this analysis.Their paper innovatively used the Feds From-Whom-to-Whom(FWTW)data to assess funding relationships within the US.We have expanded upon this analysis,complementing it with known gaps in the FWTW dataset.See Viral V.

314、Acharya,Nicola Cetorelli,and Bruce Tuckman,“Nonbanks Are Growing but Their Growth Is Heavily Supported by Banks,”Federal Reserve Bank of New York,June 2024.71“Global Monitoring Report on Nonbank Financial Intermediation,”FSB,December 2023.72 Ted Berg,Neth Karunamuni,and Daniel Stemp,“A Presentation

315、on Hedge Fund Data,”OFR,March 2024.73“Private Fund Statistics,Q3 2023,”SEC,accessed June 2024.74“Issuer-to-Holder(From-Whom-to-Whom)Data,”US Federal Reserve,accessed June 2024.75 The Fed and SEC publish various datasets that provide a basic understanding of these links including financial accounts,p

316、rivate fund reports,and stress test results but significant gaps remain.This is especially true of hedge funds and private capital firms.Among the principal challenges,hedge funds and private capital firms are obscured within the residual“households”and“rest of the world”categories within Federal Re

317、serve flow-of-funds data.While the SEC publishes some private fund statistics,the financing connections between banks and specific fund types are not public.Many US hedge funds are also domiciled in the Cayman Islands,which makes it difficult to draw the line between domestic and foreign funds.76 Wo

318、rking with nonbank CLO managers rather than securitizing loans off their own balance sheets lets banks avoid retaining risky equity tranches,which post-GFC risk retention regulation would require.This regulation was implemented to better align incentives in the originate-to-distribute model.See“Leve

319、raged Loans and CLOs Good Practices for Consideration,”IOSCO,June 2024;and“Vulnerabilities associated with leveraged loans and collateralised loan obligations,”FSB,December 2019.77 Although highly concentrated within major banks,prime services is a lucrative business,with revenues at the top 30 bank

320、s more than doubling since 2005.Christopher Whittall,“Prime brokerage:the multi-billion dollar cash cow redefining banks trading divisions,”IFR,March 2024.41Rewiring The Financing Machine|Appendix B78 Aldasoro et al.,“Cross-border links between banks and non-bank financial institutions,”BIS,Septembe

321、r 2020;with share of funding to US entities based on“Private Fund Statistics,Q3 2023,”SEC,accessed June 2024;“Issuer-to-Holder(From-Whom-to-Whom)Data,”US Federal Reserve,accessed June 2024;Ted Berg,Neth Karunamuni,and Daniel Stemp,“A Presentation on Hedge Fund Data,”OFR,March 2024;Greg Fayvilevich e

322、t al.,“Subscription Finance:A Primer,”Fitch Ratings,February 2023;Viral V.Acharya,Nicola Cetorelli,and Bruce Tuckman,“Nonbanks Are Growing but Their Growth Is Heavily Supported by Banks,”Federal Reserve Bank of New York,June 2024.79 This is the balance between“elasticity”and“discipline.”Perry Mehrli

323、ng,“Elasticity and Discipline in the Global Swap Network,”Institute for New Economic Thinking,November 2015.80 Banking can be understood as the“strategic management of cash flows,”per Perry Mehrling.81“Crisis and Response:An FDIC History,2008-2013,”FDIC,2017.82“Financial Stability Report,”US Federal

324、 Reserve,May 2023;Charles Cohen et al.,“Fast-Growing$2 Trillion Private Credit Market Warrants Closer Watch,”IMF,April 2024.83“Financial Stability Report,”US Federal Reserve,May 2023.84 James Ashley and Simona Gambarini,“Demographics:The Good,The Bad,And The Ugly,”Goldman Sachs Asset Management Pers

325、pectives,August 2023.85 Scott Carpenter et al.,“2024 Private Markets Outlook:From headwinds to tailwinds,”State Street,April 2024.86 Oliver Wyman Forum,“The New Growth Agenda,”2024.87 Huw van Steenis et al.,“Private Credits Net Act,”Oliver Wyman,April 2024.88 See the interview of the Head of Credit

326、with Robert Armstrong:“Blackstone brought together nearly all of our credit and lending activities into one centralized business unit earlier this year Its now a one-stop shop for borrowers,regardless of the type of financing they need.Short duration,long duration,liquid,illiquid,public or private.A

327、nd so we do that across all sectors,all asset verticals.”Robert Armstrong,“Gilles Dellaert:Were seeing a structural shift,”Financial Times,May 2024.89 Evan M.Gunter,“Credit Trends:Public-To-Private Borrowing Is A Two-Way Street,”S&P Global,May 2024(this S&P article can be accessed through S&P Rating

328、sDirect);Marina Lukattsky,“Banks eye low-rated refinancings to claw back business lost to private credit,”PitchBook,February 2024.90 Huw van Steenis,“The Unintended Consequences Of The Basel Endgame,”Oliver Wyman and Financial Times,January 2024.91“Understanding Collateralized Loan Obligations(CLOs)

329、,”Guggenheim Investments,December 2023.92 CLOs settle similarly to bonds in t+2,while leveraged loans can take over a month to settle at the extreme.To see an example of market practitioner mentioning replacing leveraged loans with CLOs for their increased liquidity,see Tracy Alloway and Joe Weisent

330、hal,“Oaktrees Danielle Poli on the Next Stage of the Credit Cycle,”Bloomberg Odd Lots,September 2024.93 Tess Virmani,“The ABCs of BDCs:A Primer on the PC Markets SEC-Registered Funds,”LSTA,April 2024.94 Brian Moriarty,“Interval Funds:Are They Worth What You Give Up?,”Morningstar,June 2024.95 Brooke

331、Masters,Eric Platt,and Will Schmitt,“Apollo and State Street join forces on public-private credit fund,”Financial Times,September 2024.96 Fang Cai and Sharjil Haque,“Private Credit:Characteristics and Risks,”FEDS Notes,February 2024.97“Financial Stability Report,”US Federal Reserve,April 2024.98“Vul

332、nerabilities associated with leveraged loans and collateralised loan obligations,”FSB,December 2019.99 Madeline Shi,“G.P.s grapple with costly convenience of capital call credit lines,”PitchBook,September 2023100 Thomas Mellor“Lending and Secured Finance 2024,Chapter 14:Financing Your Private Debt P

333、latform,”ICLG,May 2024;Guggenheim Investments,“Understanding Collateralized Loan Obligations,”December 2023;Greg Fayvilevich et al.,“Subscription Finance:A Primer,”Fitch Ratings,February 2023;“Morningstar LSTA US Leveraged Loan Index,”Morningstar,2024;“Quarterly Report on Bank Trading and Derivatives Activities,”OCC,March 2024;“Synthetic Securitization Market Volume:2016-2023,”International Associ