Look Forward | Episode 1: Future of Capital Markets

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(00:00:00)

Andrew Critchlow

Hello. My name is Andy Critchlow. I'm Head of News at S&P Global Commodity Insights, and welcome to the Look Forward podcast from S&P Global.

In today's rapidly shifting markets, success depends on anticipating what's next. The professionals who excel are those who can spot emerging trends before they fully materialize. The Look Forward podcast delivers exactly that, insights to help you prepare for tomorrow's opportunities and challenges. We bring you expert perspectives on macroeconomic trends, capital markets, energy transition and global trade with a sharp focus on what these developments mean for the decisions that will shape your tomorrow.

This podcast connects you with S&P Global's Look Forward Council, bringing cutting-edge research on long-term trends and transformative market shifts. Together, we're committed to providing the forward-looking intelligence you need to navigate uncertainty with confidence.

In today's episode, I sit down with Evan Gunter and Andrew O'Neill, some of the authors of S&P Global's latest Look Forward report to discuss private credit tokenization and the future of capital markets. If you would like to read the report following today's interview, you can find it below in the episode description. Please enjoy.

(00:01:33)

Andrew Critchlow 

Okay. Welcome. So welcome, Evan Gunter and Andrew O'Neill, authors of the Look Forward Journal, Future of Capital Markets. I've read the report, incredibly interesting, some big numbers in there that caught my eye. But just to kick it off, can you explain to us, and I'll go to you first on this, Evan, what are the main drivers behind growth of private credit in recent years?

(00:02:03)

Evan Gunter

Thanks, Andy. When we talk about private credit growing, it's a market that's gone -- it's been growing very swiftly over the last several years. You have about $1.7 trillion in private credit in this market. And this includes invested capital as well as dry powder. It's reaching more borrowers. And in part, it's reaching so many more borrowers because it is bespoke. It's flexible. It works in lots of different kinds of situations.

We used to think about private credit as kind of more suited for smaller middle market borrowers, but that's not the case anymore. We see private credit going to multibillion-dollar transactions. It works on lots of different kinds of situations, including for infrastructure like through asset-based finance, where private credit is going to energy transition and digital infrastructure.

With more borrowers and more structures, there has become a blurring of the lines between some of the funds and some of the securitizations that are taking place in private credit. So in short, some of the rapid growth we're seeing is because it is so flexible and can be brought to bear in lots of different situations.

(00:03:28)

Andrew Critchlow 

And when you refer to private credit, just for the sake of the audience here, do you define that a little bit for us? Are we talking sort of family offices, private wealthy individuals, sovereign wealth funds versus more transparent sources of credit and traditional sources of credit like banks?

(00:03:50)

Evan Gunter

Yes, that's a good distinction. When I'm talking about private credit, I'm -- the root of it comes back from direct lending from alternative asset managers, private credit funds with funding through business development companies and middle market CLOs, sitting down with the borrower, negotiating terms directly and what we call direct lending like a bilateral agreement.

So as you sit down with them, as the lender sits down with the borrower, they're able to work out terms individually. That's what results in a lot of this more bespoke flexible types of debt solutions for private credit. In many cases, it's used for funding leverage buyouts or for funding sponsored companies of private equity, but that's not just the case.

There's also a considerable non-sponsored market. And that's the traditional side of private credit. It's also been expanding out beyond this corporate lending to the infrastructure lending to fund finance, like I was mentioning.

(00:05:06)

Andrew Critchlow 

You mentioned private equity there, and you mentioned in the report as well that there were a record number of exits in 2021. But this has sort of fallen off dramatically in '22 and onwards. And we do hear anecdotally in the market that exiting for private equity is becoming harder. Maybe that's to do with inflation, growing divide between buyers and sellers. How do you see that environment for PEs trying to exit in the next 2 to 3 years?

(00:05:43)

Evan Gunter

The exit environment has -- as you know, it's gotten more difficult since 2021. In part, 2021, there was a lot of liquidity in the market. There's a lot of opportunities for exit. You had a very steep slowdown right after 2021. But for the last couple of years, market participants have been steadily expecting things to get better. So the turnaround has always -- you've always been looking at the turnaround in exits, improvement in the exit market, M&A market, maybe 6 months down the line.

There's a lot of uncertainty right now in the market, and that certainly has been putting a damper on long-term strategic business decisions. So it's hard to tell at this point where the direction of the M&A market is going to go.

(00:06:41)

Andrew Critchlow

But most of that uncertainty, I'm guessing, is macro related, of course. There's a lot of uncertainty around trade tariffs at the moment, of course, the general health of the global economy. It kind of sets the tone in terms of agreeing appropriate valuations, right? 

(00:07:00)

Evan Gunter

Certainly. There's a lot of moving parts with tariffs and trade and global macroeconomic, and forecasts are changing rapidly. It's been an environment where companies are at -- when there's a lot of certainty in the market, it's easier to make large business decisions. When there's more uncertainty, some of these decisions can be more challenging.

(00:07:26)

Andrew Critchlow

If we go into the geography, what sort of regions are you seeing as hotspots at the moment for private credit in particular?

(00:07:38)

Evan Gunter

There is a concentration of private credit within the U.S., but it is a global phenomenon. I mentioned $1.7 trillion in the private credit market globally. A little over $1 trillion of that is for U.S. focused.

Europe is second. Europe also has a sort of mature private credit space. There are some regional differences, but Europe also has a lot of activity, established activity going on. But beyond that, we are seeing a growth of private market funding in other regions as well, including in the Middle East, Asia, including China. India has had some pretty notable large deals recently. So it is a global phenomenon. 

(00:08:31)

Andrew Critchlow

You mentioned the leadership position in the U.S. in this, and you kind of can't talk about that without talking about AI and not just from the perspective that the U.S. has been the driver really globally for the development of AI and a lot of start-ups. A lot of the large tech players, the likes of NVIDIA, obviously, dominating that space. But Andrew, I want to come to you next on this. How do you see these new technologies like AI, tokenization helping investors to navigate the complexities of some of these private credit markets?

(00:09:07)

Andrew O'Neill

Thanks, Andy. And I think one of the pieces that we include in the report is covering the impact of tokenization on financial markets and how some of the trends we're seeing start today may evolve into a broader application across the credit spectrum and with potentially interesting applications in the private credit space in particular.

But just to level set for a second on what tokenization is, it's the representation of an asset on the blockchain. The fundamental problem that, that can help to solve in a financial market context is that when we think about how financial transactions operate today, there is an asset moving from a seller to a buyer through some IT system and record-keeping mechanism. There is a payment for that asset that's going from the buyer to the seller that's going through the traditional banking system, payment wires, correspondent banks, et cetera.

What blockchain enables to do in that context is to actually have the asset and the cash payment for that asset happen on the same ledger on the same system, reducing intermediaries, reducing duplication of records, reducing operational inefficiencies and allowing instant settlement times. So that opens a lot of interesting applications in the financial market space. And the first kind of -- the first seriously beneficial application that we're seeing is really in the collateral operations. 

So in the ability to mobilize collateral quickly, utilizing an asset as collateral today can be operationally difficult even in cases where an asset may be eligible for those kind of operations. And the use cases that we're seeing for the technology initially are really in those assets that are used today as a collateral in financial markets. So that's sovereign bonds.

And interestingly also, we're seeing the growth now of tokenized money market funds. If these were to become eligible as collateral, things like derivatives, that could solve a lot of operational problems in derivative market and really drive the pickup of this technology.

But what we're really seeing today is some quite boring, high-quality liquid assets being put onto this technology. And that's kind of the first phase that we define in the reports over the next 3 years or so, seeing an expansion of those quite boring use cases for that driven primarily by that broad collateral team to enabling that efficient use of collateral, efficient intraday lending operations, for example. As institutions become more -- onboard more with technology, we expect to see some expansion of the more kind of experimental use cases that we're seeing today that will broaden out along credit spectrum, in particular, private credit.

So one element that Evan was mentioning was that as we look at the growth of private credit, we see it become increasingly bespoke. One potential risk there is that you end up with kind of fragmentation of the supply of credit, fragmentation of the lender base, problems in accessing financing coming from that fragmentation.

That's one area that tokenization as a technology may help with in allowing to create pools of liquidity that bring together disintermediated lenders. And so that's where we see another potential significant adoption driver more in a second phase. We don't necessarily see this being an imminent thing. It will require to have some level of embeddedness of the technology already. But -- and so that's where we're looking at more towards the end of this decade, early next decade that becoming a meaningful part of financial markets across a number of different segments and not just the kind of simple and boring things that we're seeing today from a risk perspective.

(00:13:37)

Andrew Critchlow

How are financial regulators approaching this subject? Because, of course, tokenization and private credit markets in themselves, which tend to be a little bit more opaque, have raised some red flags for regulators. Are you seeing any response? 

(00:13:57)

Andrew O'Neill

So there is two parts to that. One is on the tokenization side of things. So there's certainly a differing pace across jurisdictions in terms of progress and adapting regulation to address some of the questions around tokenization and use of blockchain. We're seeing one big tailwinds emerge this year in the U.S., where there's been a lot of uncertainty in the past, particularly in the use of public blockchains. And we're seeing now support from the current administration in taking that direction of -- towards public blockchains.

And the problem that that's really helping to solve is that to date, a lot of these experimentations with blockchains have been done on, say, a bank's own private blockchain and not really allowing for the creation of an open market. And so when we start to think about expanding use cases to lending across institutions, broadening that out to private credit markets, having those have open liquid networks is going to be crucial. Otherwise, there will just be no commercial benefit to this.

And so now that we've -- now we're starting to see institutions in the U.S. pick up on this trend a little more, that could be a key driver of adoption. Again, the private credit thing, we're probably looking more towards end of this decade in our view for meaningful adoption.

But then to come back to your question on other benefits, potentially regulatory benefits that tokenization can bring in the private credit space. There are certainly benefits in terms of transparency of a pool, pool reporting information. If we think about, for example, how we look at loan tapes in the securitization space for -- there will always be a servicer producing information at the end of a certain period. And so a lag between the cutoff date on the data, the time at which that's received either by ourselves or by investors and the time it might take to kind of process, digest that information.

What tokenization allows is to really have some of that information available in real time. So for example, payment delinquencies on loans could be one area. There could be areas around financial covenants, around various business activities that could also be -- could see transparency improved. But again, very early stages for that use case.

(00:16:33) 

Evan Gunter

And Andy, if I can jump in here. You mentioned the opaqueness of private credit. And the way we usually think about it is if you look at the public bond markets and the public financial markets, there are systemic parts of transparency in these public markets because in a public market, you have audited financial statements. You have publicly available pricing of instruments that are traded on markets. And so you get a constant steady stream of data from audited financials, from pricing data, from other types of embedded sources of transparency about the public markets. That's a key difference with the private credit market is in private markets, you don't have systemic transparency.

It's not that it's fully opaque. You do have transparency into some parts of the market, but you don't have a single source of truth and you don't have a single source of information that covers the entirety of the market. There's so many different types of transactions that are taking place, so much customization that's taking place here.

It's largely an illiquid asset type. It's largely considered a buy-and-hold asset. There's not an active secondary market. So you don't get that secondary market pricing information. You don't have audited financials for the private companies. So there's a lot of unknown unknowns in private credit. It's not fully opaque, but the transparency that you have is kind of a slice at a time. If it's tokenized and if private credit is on a blockchain, then that's another slice of information that could be available on it.

(00:18:25)

Andrew O'Neill

I think there's another element to that, which is interesting, which is that what tokenization can enable also is making it easier for asset managers to allocate a small portion of a portfolio to private credit. And so significantly broadening the potential investor base compared to today where you're really looking at only targeting investors that can meet a quite large entry ticket.

(00:19:00) 

Andrew Critchlow

Evan, I'm going to come back to you on the point that we made earlier really about how the current environment is affecting the market to a certain extent. And I'm thinking in terms of the dollar weakness at the moment. I mean are you seeing a trend for more interest for U.S.-based assets as a consequence, they've become cheaper basically.

(00:19:29)

Evan Gunter

There's -- so with the -- after the April 2 tariff and trade announcements, you had a lot of uncertainty and a lot of volatility in the marketplace. During that time, you saw a kind of pullback, sort of a chill come across the broadly syndicated loan markets. Had about 2 weeks, at least in the U.S., where there were no new issues that came to market. There was a thought that started happening a little bit earlier in Europe. So you did start seeing some regional differentiation in response to this initial onset of uncertainty.

Now in times of uncertainty, private credit is kind of viewed as a -- it has a nickname as bear market capital. For a borrower that really needs to get funding, they can often find or private credit might be able to step in and provide funding, but at a cost.

And so when you had the chill in the financial markets in, say, much of April, you did continue to see some considerable deals coming through in the private credit space. There was a lot of -- still a lot of activity that was happening. One of the things that private credit offers is a certainty of execution. So when there's a lot of uncertainty in the market, for instance, with the broadly syndicated deal, the pricing, the terms, the demand for it might change during the course of a long syndication. Private credit offers more certainty and speed of execution, which can enable some deals to get done in more challenging environments.

(00:21:17) 

Andrew Critchlow

And to conclude, I mean, how do you see the growing role of private credit impacting? And this is the big question, impacting the traditional bond market in the next decade?

(00:21:30)

Evan Gunter  

We see this -- we consider it part of a long-term evolution of capital markets. I mean if you look back in the 1980s, you started having the growth of the high-yield bond market. That was followed in the '90s with the growth of the broadly syndicated loan market and the growth of the collateralized loan obligation market. Credit markets have been changing, getting somewhat increasingly private over time. While a high-yield bond is public, broadly syndicated loan is technically a private transaction.

Now with private credit growing as large as it is, it's still a traditional form of lending. So you -- bilateral agreement, the borrower and the lender sit down together, hammer out the terms of a deal. But as it has grown, it's sitting alongside broadly syndicated loans and the speculative grade bond market as a source of funding for leveraged borrowers. So it seems to be -- there's a pendulum that shifts back and forth depending on market conditions. There's a role for public. And private is also increasingly establishing that it has a role to play as well.

(00:22:55)

Andrew Critchlow

If there was one moment that investors, participants in the private credit market, private equity people in this area of finance should be looking at in the next 5 years, what would that moment be?

(00:23:14)

Andrew O'Neill

So if you're looking for a moment really for investors to look out for, I think one of the very interesting developments we've seen this year is first, couple of tokenized private credit funds. And in particular, in May, and we referred to this in the report, we've seen Apollo use their tokenized private credit funds in a decentralized finance lending protocol, allowing investors to kind of take on additional leverage against their shares in that particular fund. 

In this case, the underlying assets are very much traditional loans that are originated off chain. I think for me, a real tipping point will come when we have these funds being created with loans that are already tokenized themselves. So where the whole transaction from borrower to ultimate lender is happening on a blockchain. That is when we will see the most participants gaining utility from use of technology, and we'll see an inflection point in terms of adoption.

And in order for that to happen, we need to have underlying borrowers having demand for that kind of tokenized borrowing. And we think that, that will be driven in some sectors by increasing use cases for digital forms of money, whether that's stablecoins, digital or central bank digital currencies or indeed, digital bank money tokenized deposits.

(00:24:50)

Andrew Critchlow

Interesting. Well, I think that's a great moment to finish on the mass adoption of tokenization in private markets. Thank you, both, Evan Gunter, Andrew O'Neill. Been a fascinating conversation and look forward to catching up soon.

(00:25:09)

Evan Gunter 

Thank you. Great. 

(00:25:10)

Andrew O'Neill

Thank you, Andy. It's been terrific meeting you today.

(00:25:15)

Andrew Critchlow

Thank you. Again, thank you for watching this episode of Look Forward podcast. If you enjoyed this episode, please subscribe to this series on your podcast platform of choice and feel free to leave a comment and review. Thank you again for your time today. We look forward to seeing you next time.