The rise of private debt: navigating valuation challenges

In the aftermath of the global financial crisis of 2008, private debt has emerged as a significant asset class, gaining traction among investors seeking alternative financing sources. This surge in interest underscores a broader transformation within financial markets, where both investors and borrowers are seeking enhanced flexibility and diversification. As the private credit landscape continues to evolve, the importance of robust valuation practices and heightened regulatory oversight becomes increasingly critical, especially in the context of economic fluctuations and changing financial conditions. 

The impact of the 2008 financial crisis

The 2008 financial crisis was a turning point for private debt. The crisis prompted regulators to pressure financial institutions to adopt more cautious lending measures, leading investors to seek alternative sources of financing. While traditional bank lending continues to be a primary source of debt, regulatory changes implemented post-crisis have increased capital requirements, thereby reducing the availability of financing for riskier borrowers. Unlike conventional bank lending, private debt is often preferred despite higher borrowing costs, as providers of this asset class are more accommodating to borrowers, customizing contract terms, introducing covenants, and establishing collateral requirements.¹

Private debt has experienced remarkable growth since then, with fundraising figures illustrating this trend. According to a recent study by Pitchbook published in Q1 2024, private debt fundraising increased from $116.1 billion in 2014 to a peak of $302.1 billion in 2021.² Furthermore, the Alternative Credit Council (ACC), in collaboration with EY Luxembourg in their latest Financing the Economy report, estimates that the global private credit market could reach a staggering $3 trillion, reflecting a robust appetite for non-bank financing solutions.³

Interest rates and valuation methods

The private credit market is significantly influenced by interest rates and inflation, both of which play a crucial role in the valuation of these instruments. Prior to 2022, the economic climate was relatively stable, with interest rates hovering around 0%.⁴ During this period, most financial assets were measured at amortized cost under the International Financial Reporting Standards (IFRS).  IFRS distinguishes between equity and debt instruments, with equity measured at fair value under IFRS 13, while debt instruments can be valued either at fair value or amortized cost, depending on the results of the business model test and cash flow test.⁵

The business model test assesses whether a financial asset is held to collect contractual cash flows, while the cash flow test evaluates whether the contractual terms of the financial assets give rise to cash flows that are solely payments of principal and interest on the outstanding principal amount.⁶ Prior to 2022, the stability of interest rates meant that most financial assets were measured at amortized cost under IFRS, as the intention to sell was not the primary concern.

However, with the rise of inflation in 2022, which reached its highest levels since 1980, the Federal Open Market Committee intervened by increasing the federal funds target rate for the first time since 2018. This led to a rapid escalation of interest rates, reaching 525 basis points by September 2023.⁷ Consequently, private debt instruments became more attractive to investors, generating a need for potential sales and necessitating a shift from amortized cost to fair value assessments. At the same time, there was a growing concern for greater transparency, particularly as rising interest rates heightened the risk of potential losses. This increased scrutiny aimed to ensure that valuations accurately reflected market conditions, and safeguarded investor confidence. 

Transparency and valuation concerns

Despite the significant growth of the private credit market, concerns regarding transparency and asset valuation have emerged. Unlike public markets, where securities are traded regularly and prices are determined transparently, private credit valuations often depend on the discretion of fund managers. This lack of transparency raises questions about the true valuation of assets and the ability of investors to make informed decisions.

One alarming trend is the increase in "payment-in-kind" (PIK) loans, where companies opt to defer interest payments, promising to settle them at the loan's maturity. While this practice does not necessarily indicate financial distress, it raises concerns about the financial health of the companies involved. Furthermore, PIK loans are often valued surprisingly high, with approximately 75% valued at over 95 cents on the dollar by the end of September. This discrepancy raises doubts about the consistency of valuations, especially when compared to similar loans in the public market, which are often valued lower.

Another critical issue is the variance in asset valuations among different fund managers. An article published by Bloomberg provided cases for such variance, citing the example of an e-commerce company, where some managers valued its loans at 65 cents on the dollar, while others assessed them at 84 cents. These discrepancies highlight the lack of standardization in valuation processes and raise questions about the accuracy of estimates provided to investors.⁸

Regulatory focus and future outlook for valuation practices

The increasing attention from regulators underscores the necessity for greater transparency in the private credit market. Between 2022 and 2025, global regulatory bodies have intensified their focus on valuation practices within the private debt market to enhance transparency and mitigate systemic risks. In 2022, the IPEV Guidelines were updated to include specific sections on private debt, providing clearer guidance on how to value these instruments.⁹

The International Organization of Securities Commissions (IOSCO) has also issued reports emphasizing the importance of robust governance and valuation practices to address potential risks associated with private finance. In 2023, IOSCO released a report highlighting the need for enhanced regulatory attention to mitigate risks in money market funds and bond markets, including collateralized loan obligations.¹⁰

Additionally, the Financial Conduct Authority (FCA) has initiated a review to ensure that valuation practices in private markets are robust and transparent. This initiative aims to address concerns about the adequacy of current governance and methodologies, ensuring that asset managers apply rigorous valuation frameworks and provide detailed reporting to protect investors and maintain market integrity.¹¹

In December 2024, the Financial Stability Board (FSB) underscored the rapid growth of non-bank financial intermediaries, such as hedge funds and insurers, which now constitute nearly half of global financial assets. The report emphasizes the need for enhanced monitoring and management of non-bank credit risks, improved counterparty credit risk management in line with Basel Committee on Banking Supervision (BCBS) guidelines, and increased transparency through private disclosures. These measures aim to mitigate systemic risks associated with the expansion of private debt markets.¹²

The BCBS has set a work program and strategic priorities for 2025/26, focusing on Basel III implementation, risk assessment, safeguarding resilience, digitalization, and liquidity. A key area of interest is the Committee's analysis of banks' interconnections with non-bank financial intermediation, which includes private credit markets. This work aims to assess and mitigate risks arising from banks' exposures to non-bank financial entities.¹³

Moreover, the European Securities and Markets Authority (ESMA) has provided guidance on valuation practices for money market funds (MMFs) investing in private debt. In a response to the European Commission in November 2024, ESMA proposed that such MMFs should not use the amortized cost method for asset valuation, regardless of the investor base or the assets held. This proposal aims to prevent potential distortions in the valuation of private debt instruments and ensure a more accurate representation of their market value.¹⁴

At the same time, current macroeconomic conditions, including interest rates, have also impacted private debt valuation practices. As of 28 March 2025, the Federal Reserve's effective federal funds rate stands at 4.33%. This rate reflects the interest at which depository institutions lend balances held at the Federal Reserve to one another overnight. The Federal Reserve has maintained this rate in light of ongoing economic assessments, providing a broader context for evaluating private debt instruments. Elevated interest rates can affect the attractiveness of private debt, introducing volatility that underscores the necessity for rigorous and transparent valuation practices capable of adapting to these dynamic financial conditions.¹⁵

According to the ACC report in collaboration with EY Luxembourg, the majority of private credit managers anticipate expanding their operations in both mature and emerging private credit strategies and markets. Asset-backed lending (ABL), real estate financing, and infrastructure financing now represent a considerable share of the market, together making up 40% of private credit assets under management. The European and Asia-Pacific regions are set for notable growth, fueled by ongoing bank pullbacks, greater borrower awareness, and enhanced regulatory clarity. Furthermore, there is robust investor interest in private credit assets, especially in sectors that provide diversification and alternative return sources. Government initiatives aimed at attracting more investment in public energy and infrastructure projects are likely to create significant opportunities for private credit funds.¹⁶

Conclusion

The private debt market has experienced significant growth, attracting attention from both investors and regulators. However, challenges related to transparency and valuation persist. To protect investors and ensure market stability, it is crucial to enhance transparency and establish standardized valuation methodologies.

As the sector continues to expand, private credit managers must adapt to evolving regulatory expectations while seizing new opportunities in alternative lending. The industry's ability to address valuation challenges and maintain investor confidence will play a crucial role in shaping its future. A collaborative approach among regulators, investors, and fund managers will be essential in ensuring that private credit remains a resilient and trusted asset class in global markets.