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May 19, 2025

Policy Session 1: The Rise of Nonbanks in Credit Markets

In the first policy session of the 2025 conference, participants discussed nonbank financial intermediaries' (NBFIs) potential risk to financial markets, how policymakers might envision a regulatory framework for NBFIs, and the role nonbanks could play for the implementation and transmission of monetary policy. The panel featured Ana Arsov, chief investment officer of Bright Fame Holdings, Nicola Cetorelli, head of financial intermediation at the New Yor Fed, Elisabeth de Fontenay, Karl W. Leo distinguished professor of law at Duke University, and Liz Oakes, external member of the Financial Policy Committee at the Bank of England.

Transcript

Andreas Lehnert: Okay; thank you, everybody. Welcome back to the final session before lunch. So, after David Scharfstein's excellent paper in the last session, in the Q&A part of that, I think we started to get into questions about: What does it all mean to live in a financial system with a much more prominent role for private lending arrangements? And that's what this policy session now is going to explore, and the Atlanta Fed have arranged for really excellent panelists for us. Let me just briefly introduce them in the order in which they'll be speaking, and then we'll turn to them.

So first, Nicola Cetorelli, who's head of the financial and remediation group at the New York Fed's research department, and is a leading thinker on financial stability-related matters. I find his papers to be mandatory reading. Ana Arsov is currently a board member for TD Bank, and she's also the CIO of her family office in Connecticut. She has a career that spans 25 years—I think most recently, co-head of Moody's ratings on private credit related matters, and she built Moody's private credit transactions framework.

Third, we have Elisabeth de Fontenay, who's the Karl W. Leo distinguished professor of law at Duke University, and she's a leading thinker of the consequences of the rise of private credit in a legal framework. And then finally, I think we're very lucky to have Liz Oakes here, who is an external member of the Bank of England's Financial Policy Committee (FPC), with a term that runs through June of 2027. She has a successful and distinguished career in the payments industry—most recently at Mastercard—and she sits on the board of Mangopay, a European payment startup that supports peer-to-peer e-commerce platforms.

So, with that introduction, we'll just go down the panel here; everybody's going to give five minutes (roughly) of remarks, and I'll be monitoring the chat for questions. Nicola?

Nicola Cetorelli: Sure. Thank you, Andreas; and I'm really, really grateful to be here. Thank you to the Atlanta Fed for including me on this panel. I'm a visual person, so I prepared some slides; I'm waiting for them to be put on the monitors . . . or not? There you go; fantastic, thank you.

So, the title gives away my perspective on these developments. It is about the rise of nonbanks in credit markets, and I placed the word "banks" in italics at the beginning of the title—and so I want to stress this important connection between banks and nonbanks in this space. This is one of many versions of the growth of private lenders, different from the one that David was showing before, but the science is the same: really, really considerable growth, especially after the financial crisis.

If you follow the standard narrative about this process, it is that there are certainly some important potential benefits; this growth of private credit should imply a more efficient risk allocation, and basically a complementary statement. It's also the case that it reduces the exposure of banks to high-risk obligors, and so in a way this is good for the taxpayer, from the taxpayer perspective.

And also—and this is the statement that I want to focus on in my few minutes of remarks—with this innovation, it seems like we have been able to engineer, after many decades or centuries, credit provision activity with the absence of liquidity transformation. That's a stylized balance sheet of a PC lender that's basically saying, you have loans on the asset side, a portfolio of loans, and then you are effectively funded with equity (a very small amount of debt), and David had documented that quite nicely, at least for a BDC. But this is true for the system as a whole.

So, this looks very good—too good. So, I'm wondering whether maybe it's too good to be true, and so I just wanted to highlight what might be potential hidden costs, or at least a way to dig a little bit deeper on the way these funds operate. They are providing credit, and so this is intermediation activity, and loans are not static, immutable objects. Borrowers have an expectation that their loans can be renegotiated, that there can be an extension of maturity, that the size of the loan can be increased, that if I have a loan with you, I can come back and actually ask you for some other type of loans that are connected to my business.

I may be in need of contingent liquidity myself, and so you may be asking that of your private lender; and so basically what this means is that if you are a lender in the corporate space, you are naturally in need of managing liquidity risk. That's the point that I wanted to stress. So, how do you do that? One way you can do it is that you can hold liquid buffers—cash—on your balance sheet; but if you are using a business model that is exclusive or largely funded by equity, that liquid buffer is going to be very costly because it's going to have a negative impact on the return on equity of your investors. So, it may not be a good strategy, and in fact David was showing a very small percentage of cash holdings in this space.

There is a lot of conversation about the fact that these funds operate with "dry powder," that there is a lot of capital that is unutilized, that limited partners may have committed and therefore they may be asked to inject in the funds. But really, you cannot deploy capital on demand; and sometimes, again, if you are a lender you will need to satisfy the needs of your borrowers on demand—today, tomorrow, not in two weeks or longer periods of time.

So, what is a possible alternative? This is our conjecture, is that you may buy liquidity services from an institution that can provide them to you. And guess what? Banks are natural providers exactly of contingent liquidity.

Now, anecdotally, that seems to be the case. This is Apollo's own 10-Ks from 2023; you can just focus on the highlighted part. They do recognize that they are exposed to liquidity risk, that they have an important reliance on liquidity facilities from banking institutions, and that if that source of contingent funding were to somehow dry out, it would have material consequences for their business. So, that seems relevant; and so, the point that I wanted to make is that a lot of that growth in the private credit sector needs to be recognized as actually being backed by banking institutions. In the absence of that backing, perhaps we would not be observing this important growth.

Of course, this is a speculative statement. I don't know how to build the counterfactual, so you can believe it or not; but maybe it's worth a conversation later.

There is actually evidence now; finally, we are able to see a little bit better into the private credit segment, from the perspective of banks' loans and credit lines. You're actually seeing a preview of a chart from an article that some of my colleagues at the Board of Governors are going to publish hopefully in a few days or weeks, and I recommend that you read this article because for the first time you can actually see, down at a very granular level, the extent to which banking institutions provide funding to private credit lenders.

And this pattern pretty much mimics the growth in the private credit sector that I was showing in my first chart, and these numbers are pretty big; these loan commitments are about 10 percent of total asset under management of the private credit obligors. The growth has been spectacular, and these funds actually use these credit facilities of banks—so, that's an important point to remark.

Just a quick point here: from my point of view, this is actually a reflection of a broader transformation of the role of banks that we have been observing since the end of the financial crisis. This is work that I have been doing with Viral Acharya and Bruce Tuckman from NYU Stern in a couple of papers; you don't need to squint your eyes to look at that table that we have in our paper, but the point is that it's not just that there is transformation of the role of banks specifically to the corporate lending segment. It is a much broader process that we are observing, with banks effectively going from supporting nonfinancial corporations, to now providing support of nonbank financial institutions.

And you can see this—actually, I like this chart that we have in one of our papers; you can actually see that banks have been shifting their focus. Their business model has been changing, in the sense of basically banking becoming the lender, the provider of liquidity to nonbank lenders.

I think I can go fast on this slide: Why is this happening? I can just free ride on David's excellent presentation earlier on. One possibility is that it is effectively a story of what euphemistically you can call "optimizing on regulatory constraints," and it's just the fact that the cost of equity for banks to engage in this type of lending activity has gone up a lot after the financial crisis because of regulatory and supervisory cost.

And so, this migration to an alternative lender is, in a way, a natural thing to observe. The way they do it is that they manage the liquidity risk associated with that activity from banks, which is the point that I was making.

And so, I just wanted to maybe point your attention to the last bullet, which is, again—the takeaway of our perspective on these developments is that you cannot really look and try to understand the development in this segment in isolation from banks. And so, the point is that it looks like we are observing credit provision in the absence of liquidity risk, but the reality is that that liquidity risk has been shifted on the balance sheet of another set of institutions: the banks.

And so, in a way, you need to be able to look in an integrated fashion at the activities of nonbanks and banks if you really want to have a full understanding of the business model, and of course also of the associated risks; and from that we can speak at length.

Let me conclude with this slide: déjà vu, all over again. In a way, it seems to us—at least, conceptually—we are observing something that historically we have observed at other times, and it's always somewhat associated with banks having to navigate the boundary of regulatory constraints. And one way or another, activities are either found inside the banking system, or they migrate because they become too costly to be done by banks.

But one way or another, contractually or otherwise, risks ultimately return to banks; and so, we see some similarities—for instance, with some of the development that we have observed before the financial crisis. So, in a way, it's history repeating itself (and something that probably we should pay attention to).

I'll stop there.

Lehnert: Thank you, Nicola. Ana?

Ana Arsov: Nicola is a visual person; I'm a standing person, so I'll stand, just to get my steps as well. Thanks for having me at this esteemed panel and conference. I just have to do one legal disclosure: As it was noted earlier, I recently joined TD Bank Group as a board member, and I just want to make sure that everybody's aware that the opinions here are solely mine, and not related to my work at TD.

Actually, a continuation of that is that my views on private credit, and generally banks, have been gained by 25 years of being a risk analyst at large global investment banks—and the last 12 years, at Moody's, where most recently I ran all financial institutions ratings globally (that's roughly around $10 trillion of debt), and additionally was asked to start the first-of-its-kind analytical franchise on the private market; so, my most recent engagement was also, in addition to being head of financial institutions ratings, was to be heading up the rating and research of private credit.

And, how did it start? Typically, you start doing your work before you get the title, so my foray in private credit really started in 2017. And if you look at the chart—actually, that Nicola had—it was very illustrative of the exposure of banks and to private credit, and when that critical point is, if you look at between 2014 and 2017.

So, what was the trigger point? Well, the trigger point was definitely the OCC guidelines on leveraged lending, but there's some other ones that I'll talk about in a second. So, in 2017, at that time I was responsible both for the North American bank ratings but also specialty finance ratings, which is everything nonbank finance and capital markets; and it was obvious that at that time I had only one rating called a BDC, and it was Ares Capital outstanding.

But somehow, the BDC sector became very hot, and everybody was interested in what's happening there; and so, we launched analytical coverage of that sector. And by the time I left Moody's, which was a few months ago, we grew the coverage from one to 32, covering pretty much 95 percent of the assets of the industry. So, that's the growth that happened over the last probably six to seven years.

How did the growth happen? And again, it's the critical point—if you look at that between 2014-2017, leveraged finance guidelines, the Fed guidelines, came afterwards. And then some large asset managers figured out that this kind of activity that we used to do at Goldman Sachs or Credit Suisse or Deutsche Bank, et cetera, is probably more punitive than I think we could have seen on the capital risk calculations and ROE, doing it on a bank's balance sheets. Why don't we move it somewhere else, and actually charge some fees on it?

And I think that's a great business model that has worked today brilliantly for some of these alternative asset managers, and namely some of the biggest funds that were raised at that time is from a fund called Owl Rock that's now called Blue Owl, and subsequently Blackstone, who really changed the nature of the industry.

I'm not going to go into a definition of BDCs, but they ultimately were constructed to really lend to small- and medium-sized enterprises. What happened was, particularly I would say from 2019, 2020—that was when Blackstone raised its signature private credit fund. I like to say Blackstone grew a regional bank in 2 years; it went from zero to 50 in two years, currently it's $73 billion (roughly) in assets under management, and that's just their perpetual, non-publicly traded BDC.

So, why was it attractive? Well, we had several points: a lot of capital, dry powder, being raised; leveraged finance constrained in the bank's balance sheets; and a lot of private equity portfolio companies needing financing. And very timely, during COVID, as we know, the leveraged finance market had a certain hiccup; and particularly, I would say, in 2022 and '23 was relatively shut down because of the significant rate hikes. So, this is what really helped growth of the asset managers, and particularly, I would say, if we look at the public disclosures of the BDC sectors in 2019, rate coverage AUM (assets under management) was $50 billion, but before I left earlier this year it was $300 billion; so that's a 6x increase in less than five years.

Half of the asset base really came from what we talked about earlier: perpetual non-publicly traded BDCs, and those are actually BDCs that are particularly targeted for the retail and wealth management sector, which is something that we can explore later from a risk perspective and systemic risks. So, should we be concerned about all this growth, is the ultimate question why we are here. We know the facts; I think all of us explained and came to the same conclusions, et cetera.

So, when you look at the performance—and I'll just add on some of the points that were noted earlier—when you look at, let's say, leverage in the sector, the BDCs are the transparent part of private credit and leverage; although the maximum leverage did change now to 2x for the industry, it's really muted. It actually was oscillating over the last few years in the higher rate environment between 0.9 to 1.1x leverage. So, leverage at the fund level—not a concern, at least in this more transparent part of the private credit.

On performance; how are nonaccruals? Well, nonaccruals have been very moderate, I would say: 1.7x peak in mid-2024, and actually has come down by the end of 2024 to only 1x. So again, great performance; relatively strong. Profitability—very strong, because the higher the rates, they make obviously nicer spreads.

So, what should be in liquidity risks? We just covered liquidity risk; we'll talk in a second about the exposure to the banks, but liquidity risk does come from the banks—but those are not the financial crisis-type liquidity risk of over margin-type of calls on derivative positions. Here, I'm standing with a visibility of running the structured credit risk at Lehman Brothers during the financial crisis and unwinding $22 billion of derivatives at the Lehman bankruptcy; so, I do know a little bit about transformation of liquidity risk and impact to banks—and definitely we haven't seen those types of proliferation of risks in this private credit space.

So again, liquidity risk—relatively muted. But me, as a risk analyst, I never get satisfied that everything is so rosy, so I said in early 2024, "Why don't we launch a survey of how this liquidity is being provided?" And I certainly agree with what Nicola said; the growth of private credit would have never happened without the assistance of the banks. And we saw earlier—the professor noted—how more profitable for the banks it is, actually, to lend to private credit funds instead of provisioning this riskier lending activities themselves.

So, there are very limited public disclosures. I commend, obviously, the additional disclosures that are coming, as were shown earlier; but in 2024, there was really nothing to tell us how much of this NBFI line that we can see on the bank's reporting is really related to private credit. So, one way to do it is to launch a survey; we launched a survey of 32 of the largest banks active in this market, and that includes $30 trillion of bank assets.

So, what are the key findings of the survey? We found out that the average lending growth to the private credit ecosystem, lending by the banks, increased 18 percent in the period between 2021-2024. That's double-digit growth; us as bank analysts, double-digit growth is always a little bit concerning—something to focus on.

However, that double-digit growth of 18 percent was actually in line with the 19 percent increase in private credit capital fund raising. So again, they're raising the funds, leveraging or getting liquidity for that at the banks; very obvious correlation here in the numbers.

So, what is in our estimate at that time at Moody's, based on the survey? The median exposure of the banking sector—again, the largest 32 banks are active in this—on their balance sheet, we calculate it's roughly around 3 percent of the total loan commitments. Significant, but not a very significant number on aggregate. When you look at it, that 3 percent was actually for banks that are rated single A; if you look at the lower rated cohort, that increased to 5 percent. Not a great distribution of risk, if you think about it. And the global average was around 3.8 percent, with North American banks being higher exposed than other European and Asian peers.

So, in conclusion, these exposures are growing, but they're not highly significant at this time. But another point to note is that, moreover, these exposures are really to SPV secured-type collateral. Our analysis showed that it's roughly 60 percent loan-to-value, so it's very well protected. I would agree: AAA-type, CLO, tranche quality.

So, that's all good, being a bank analyst, in terms of how the banks are protected. But we all believe that, as do the pundits in this world who have covered the industry, that there's a lot of dry power both in the private equity side (a trillion dollars that need to be funded), and private credit will have a meaningful part in funding this, which means that private credit will continue growing.

Today, our estimates at Moody's were that that exposure was around $2 trillion of private credit, with the potential of growing up to $3 trillion over the next couple of years. So, a big part of funding will indeed come from private credit, but also through the banks.

So, should we be concerned? I think whenever there's a high growth, we should pay attention to it; so, my recommendation would be, from a regulatory and supervisory perspective: first and foremost, increase the transparency of what is the exposure of the banking sector—and I would say also the insurance sector—to private credit. And this is a banking conference; we did a similar survey on the insurance industry. I'm happy to talk about that offline, but that's another important (obviously) market for this credit.

So in addition to transparency, I would say that it's considering not all banks had the same type of exposures; we noted that the banks between $100-500 billion actually had a significantly higher growth, and more exposure of their loans, in these recent years to private credit—and I don't believe that some of these banks do have the same risk management standards as the global investment banks, or more sophisticated capital markets bank. Heightened supervision of those risk management practices is something that I would recommend. Thank you.

Lehnert: Thank you; thank you, Ana. Elisabeth?

Elisabeth de Fontenay: Great; thank you. So, I was going to start my remarks differently, but I realized that as we were discussing this, including in several of the earlier discussions, that we never actually defined private credit. And so, I think that's a worthwhile exercise, because it really does frame the risks and advantages that we are talking about.

I define private credit just as commercial loans that are both originated and held by nonbanks, and primarily investment funds—and among those investment funds, primarily closed-end, private investment funds. And this is a market that is hard to value, in terms of size, but it's well north of $2 trillion at this point; and that is a market that's seemingly on all the graphs that we've seen today, but that came out of nowhere. It seems to have shot up, beginning around 2015, mostly, and 2017.

The market, though, of course, we know has been around a long time. There have always been mezzanine debt funds that were originating loans to companies, so what is different about this current iteration of private credit? I would say it's really three things; it's around the size, the scope, and the seniority of these loans that are being made.

So, in terms of size: these private credit funds have become absolutely enormous. They are able to make massive loans to companies that was just not something that could be done by a single investment fund before. In terms of scope, there I think what the market is doing is very interesting, which is: you can think of this as, private credit right now is doing two different things.

So, in terms of the high end of the market, the larger companies—here, private credit seems to be primarily acting as a bit of a substitute for other types of debt, like high-yield bonds and syndicated loans. At the lower end, though, I think it's doing two things: one, it is substituting for just traditional bank lending to smaller companies, but I think it's also accessing borrowers who have not been served before. And so, I think private credit is doing two different things. It is sort of shifting who is holding the pie, in terms of debt financing as a whole, but it is also expanding the pie in terms of reaching additional companies and borrowers.

In terms of the seniority of private credit loans, again: think of companies as having, at the very high-end, very complicated capital structures, with high-yield bonds, syndicated loans, and other types of debt in multiple tranches. You can come in with a single, private credit fund and take all of that out with a single loan. So, what you're seeing is senior secured loans by these private credit funds, and again—you're talking about one or a very small number of lenders, and that is a point that I want to emphasize.

So, there are many ways of thinking about private credit, and most of what we've heard from today focuses on macroprudential concerns: things like, is private credit increasing (or, very potentially, decreasing) the level of systemic risk with lending, what it's doing to bank balance sheets and the business of banking. My focus, and the interest that I have in my research, is more about what private credit has done and is continuing to do to corporate finance and corporate governance, generally.

So, the way I like to think about it is, it's hard for all of us to see because we're living it day to day; but our capital markets and corporate finance, generally, have changed dramatically over the last 40-plus years, and it's changed in a way that's really captured, I think, primarily by two major developments. The first is the shift of capital raising from the public markets to the private markets, and the second is the rise of investment funds, including (in part) as a substitute for banks.

And I think private credit is really the culmination of these two major developments. It is the last big step in those two directions, which is why I think it actually is much more important than we seem to recognize sometimes. So, if I were to tell the story of the transformation of our capital markets over the last four decades as a little bit of a bedtime story, I would do it this way, which is: if you took a large company, randomly—not the very largest, but, again, a large company—if you took that company 40 years ago, it's very likely that that company would be a public company (that is to say, that it's equity would be publicly traded), and its debt might consist of public bonds, and so therefore publicly traded debt (probably also a revolving credit loan from a bank).

But again, what we're really talking about is publicly traded equity, publicly traded debt; and so, we have considerable amounts of mandatory disclosure, considerable amounts of information also generated by trading prices. If you took that same company 20 years ago—same age, same characteristics; 20 years ago—it is very likely that that company would be private equity owned. So, in other words, the equity is now private, and in terms of its financing, it would be financed by a combination of high-yield bonds and syndicated loans. That is not public debt, but it is quasi-public debt; so, there is disclosure from the high-yield bonds, there's trading prices, including in the syndicated loans.

So, you have closely held (and private) equity, and debt that is widely held and very dispersed. If you take that same company today, it is very likely that it is private equity owned and private credit financed. So, now we have "private" on both sides and we have "closely held" on both sides; so, you might have a single private credit fund financing all of the debt again.

Why did all this happen to our capital markets? There are several valid explanations. I think the primary one has to do with the sweeping deregulation of private capital raising over the last four decades. So, essentially what we have done is we have removed both the carrots and the sticks that used to push companies into the public markets, and so what we have at the end of the day, when we are left with many, many firms that are private equity owned and private credit financed, we essentially have firms that have gone dark. What we have to think about is the fact that the information environment in the economy as a whole about these firms has changed dramatically—about firms, and in some cases about entire industries.

And "firms going dark" sounds very bad; it might not be bad. In one sense this allows companies, I think—sort of removed from the scrutiny of the public markets and of regulators and the general public—to operate very efficiently, probably very profitably. The downsides, though, I think, are worth thinking about, and it's something that we don't talk about enough—with, again, private credit as the last step in the move from the public markets to the private markets.

So again, private credit offers some very big advantages; again, we've talked many times today about the better liquidity and maturity matching when you have long-term loans and you have closed-end structures for private investment funds, locked-in capital for a period of, say, 10 years—that is, in general, considered a much better way of financing companies, and a much safer way of doing it. There, I think we do need to mention the fact that there are movements in the other direction—so, private credit ETFs being a very notable one, but attempts to reintroduce liquidity for investors, with these structures that really truly are not liquid and are very closely held.

For borrowers, private credit offers major advantages in the sense that if you are trying to get a loan quickly to do, let's say, a major leveraged buyout, you cannot beat private credit in terms of speed, in terms of the confidentiality of the process, and in terms of the flexibility that you can get in the terms of the financing. And again, as I said, another advantage of private credit is that it has, I believe, expanded access to capital, in particular for the smaller companies.

The disadvantages of private credit that I think are worth at least thinking about are, again, primarily this change in the information environment, generally, about firms: what do we actually know about firms? Regulators and investors will know a lot less in a world in which we are private equity owned and private credit financed, and I think the way to think about it is about capital allocation, valuation, and the impact on investors. This is an overgeneralization, but if I had to characterize it, I would say: What you get in that world is you have no public disclosure, no trading prices, no liquidity, and no documentation—and to these investments for investors, you're going to see very different outcomes. You simply cannot index the private markets; it is not possible to do that.

And so, ultimately what we're going to be doing with investors is making them choose asset managers, and depending on who they choose (and what those investors are invested in), they're going to get wildly different outcomes. The problems with valuation also raise concerns about the potential for exacerbating crises. Is it possible that with private credit, companies will be able to kick the can down the road much longer than they were before? Or will they be much faster at resolving situations of financial distress, because they're no longer dealing with highly complicated structures; you're only dealing with a small number of lenders.

So, I think these are areas in particular where we need to look much more closely, and point the direction for future research. And I'll stop there.

Lehnert: Now, our final panelist, Liz.

Liz Oakes: Thanks, Andreas. This is going to feel like a pivot to a completely different perspective, perhaps, from the UK, in addition to the fact that we use different terminology—so, I think it just does point to the fact that even just baselining on "what are we all talking about?" is really helpful.

So, we talk about market-based finance in a much broader way than just talking narrowly about private credit, partly because we see the interactions between a number of these different market participants. For us, market-based finance has been growing rapidly since before the financial crisis, and I think others have gone into this.

Between the start of the crisis and the end of 2020, NBFIs more than doubled in size, compared to the banking sector growth of around 60 percent. Global NBFI financial debt in 2020 has been estimated at approximately $48 trillion US dollars, or 50 percent of global GDP. So, we look at this from a very macro level, above and beyond just the US.

Specifically in the UK, market-based finance is particularly important in the supply of finance to businesses, and this is primarily why the FPC that I sit on is interested. It accounts for approximately £780 billion pounds sterling, of all lending to UK businesses—56 percent of the total stock of UK corporate debt. Nearly the entire growth of the stock of UK corporate debt since the financial crisis has been driven by an increase in market-based finance.

Conversely, market-based finance helps savers by offering a range of vehicles with different risk profiles through which to invest their cash, including open-ended funds (OEFs) for investing in equity or bond portfolios, and money market funds (MMFs) for placing cash in short-term, lower-risk instruments. In total, investors hold roughly £1.8 trillion sterling in UK-domiciled OEFs, and £230 billion pounds sterling in denominated MMFs.

So, the flip side of this key role of market-based finance in supporting the UK and global economies is that it means disruption can have a significant impact on financial stability and actually on the real economy, which is what we are primarily concerned with. At the Bank of England and on the FPC, our work has been to identify and monitor vulnerabilities in the system of market-based finance, and there are a number of areas that I'd like to highlight.

The liquidity mismatch between the redemption terms and the liquidity of assets held by OEFs and MMFs: this makes them extremely vulnerable to sharp redemptions from investors in stress, and so there is the risk of both runs and contagions across the sector. This could amplify shocks and impact financial stability if investors cannot access cash, and leads to tighter financial conditions. Nonbank leverage creates counterparty risks and can lead to sudden spikes in demand for liquidity, particularly in instances of concentrated and correlated leverage in NBFIs.

For example, in hedge funds' activity in core markets and in liability-driven investment (LDI) funds, where stress crystallized in late 2022 (and I'm sure you're all very aware of what happened in the UK); hedge funds have continued to employ large amounts of leverage in relative value trading strategies, such as the US Treasury cash futures basis trade. In the UK, in the gilt repo market, hedge fund net borrowing rose to around £45 billion pounds in late 2024.

More broadly, hedge funds net repo borrowing—backed by different types of collateral, including US Treasuries—stood close to $1 trillion US dollars at the end of Q2 2024, which is almost twice the size as at the time of the "dash for cash" episode in March 2020. Hedge funds net short positioning in US Treasury futures has reached a new peak of just over $1 trillion. The FPC took action in response to the LDI crisis by recommending to the pensions regulator in the UK to specify minimum levels of resilience for LDI funds and LDI mandates, in which pension scheme trustees can invest.

Now, this may sound like it's a long way from what my other panelists were discussing, but these things are all actually interrelated and interwoven. The notional amount of nonbank investors' over-the-counter derivatives in 2022 has been estimated at almost $90 trillion US dollars. Liquidity demands from margin calls in stress—so, the increases in margin that are unpredictable, or unexpectedly large—can cause liquidity strains on market participants and the financial system.

During the "dash for cash," initial margin requirements at UK CCPs increased by about 31 percent to £58 billion, with a maximum daily increase of £10 billion sterling. And average daily variation margin calls were 5x higher than in the two months prior. We also see insufficient capacity of markets to intermediate in stress—the so-called "jump to illiquidity" risk. Vulnerabilities in NBFIs can be exacerbated by limited dealer intermediation capacity, leading to periods of forced selling of gilts by NBFIs, and self-reinforcing price spirals.

A key challenge in addressing these vulnerabilities is that MBF is a diverse ecosystem with numerous interconnections and interdependencies, with significant data gaps (that I think Elisabeth illustrated very well). Many of these vulnerabilities are opaque, and if they crystallize can cascade through the markets, amplifying market volatility across institutions in the event of shocks, and impacts can span across borders.

So, I want to talk to you a little bit about what we've been doing at the Bank of England to try to identify where these problems lay, and what we are going to do about it. So, the bank has engaged in modeling and testing to identify where these gaps exist, and we've taken some steps. In particular, we ran a system-wide exploratory scenario, or SWES—and first of all, I'd like to thank those of you who participated; I've already met a couple of people who were involved, because the scope of this was much broader than just the UK market participants—which explored what would happen if we injected stress into the financial system and the ecosystem, and the consequences of it flowing through the system. So, this was not a one-day event; this was a much broader activity base.

Fifty-one participating banks, insurers, hedge funds, asset managers, pension funds, and CCPs were provided with a hypothetical 10-day market shock, including a day-by-day account of what was happening in markets, such as rating downgrades. The scenario was a rapid and significant shock to rates and credit spreads, triggering significant losses and margin calls, with margin flowing from NBFIs to banks and central clearing parties. The market shock generated a significant liquidity need for many NBFIs, in the form of margin calls and redemption requests.

The firms then considered the impact of that stress on their firms, and what actions they might take in response. We all learned a huge amount from this. It improved our understanding of the resilience of core markets, and the behaviors of banks and nonbanks during stressed financial market conditions—and how those behaviors play out and interact with each other. For example, the liquidity impact, combined with leverage and risk constraints, as well as investment strategies and other commercial drivers of behavior, led to some NBFIs having to recapitalize and/or deleverage rapidly.

Banks had limited appetite to take on additional risk in some UK core markets. Through de-risking and deleveraging, the system distributed and amplified the impact of the shock, and some core UK markets came under pressure. This provided, for us, further evidence to support existing policy work and future new areas to explore.

I'd like to finish by briefly mentioning another innovative addition to our toolkit in this space, and it refers back probably to the first speech this morning. We have now a contingent repo facility, which widens the direct reach of our liquidity provision to eligible nonbank financial institutions, if we as a central bank judge that the conditions warrant it. It marks a significant step forward in our ability to respond to future episodes of severe gilt market dysfunction that threaten financial stability due to shocks that increase the demand for liquidity from nonbanks, and where liquidity would otherwise struggle to find its way to them.

Having the ability to lend to nonbanks through the contingent nonbank financial institution repo facility—that is the worst acronym I think I've ever heard; I keep trying to get them to change it to something short—in times of severe market stress, means that we are better equipped to maintain financial stability. It opened for applications earlier this year, and we've been encouraging eligible firms to apply.

And to be very clear, that facility is to protect the core of the gilt market; it's not a random thing that nonbank financial institutions just have access to liquidity when they need it. This is a top-down, central bank initiative to protect the gilt market.

I'm going to stop there, and let Andreas continue.

Lehnert: Thank you very much, Liz. So, I'm going to exercise moderator privilege, in a couple of senses; first, I'm going to ask a couple of questions, and then turn to the chat—and, second, my initial question is related directly to my job at the Board, and I'm hoping the panelists can help me look smart for my bosses.

So, I'd like to invite the panelists to imagine that trends continue, that the private credit market grows, continues to be popular, maybe settles into some higher steady state equilibrium. From a macro perspective, as we think about how the financial system flexes in response to various shocks—monetary policy tightening, monetary policy loosening, a subsequent recession, or perhaps broader supply shocks—how would we notice that the system is behaving differently than it has in the past due to the rise of private credit? In other words, what are some potential differences from the traditional Bernanke/Gertler/accelerator-type dynamics that we might expect, in a world of greater private credit?

One could imagine that the system's actually more resilient as a result, simply because so many of these vehicles lack liquidity on demand features, and they are not really redeemable in the face of shocks. So, we'll go down, I think, in the order that we started here, starting with Nicola.

Cetorelli: Sure. I guess maybe related to my take, that I tried to illustrate with my remarks: again, I don't think that there is so much difference between this model and, let's call it a "traditional model" of credit provision through banks. If you are willing to expand, if you will, the purview and the horizon to acknowledge the fact that, again, we're talking about credit provision, it's credit intermediation, it will always involve liquidity transformation, maturity transformation—somebody has to be doing it; somebody has to be doing it.

And so, the difference, again, is this combination of risks are now spread in a broader sense, and on a broader set of entities. And I focused on the role of banks, and so I'm urging—and maybe partly to respond to your question, "what is it that we should be paying attention to," is exactly the extent of this link between the bank and the nonbanks.

But let me go even a step further than that. If I compare—maybe that's the main difference with the traditional model of credit intermediation, one where banks were truly the fundamental institutions at the center of credit provision. Now, you have a system where you have a much broader range of financial institutions that are involved, and they are very, very clearly interconnected to this point. And so, it's not just, again, the private credit lenders, it's also the institutional investors that provide funding to these institutions, it's the broader retail segment that is connected one way or another. And we can go on and on.

So, I think that, to me, is maybe the challenge: that it becomes much harder to actually observe what might be a leading indicator of potential problems in a system that is so much more integrated and has complexified, and so it may be difficult to really fully appreciate potential channels of transmission and amplifications of shocks.

Lehnert: Good. So, I put you down as like a more complex ecosystem where there's potential, various agents who otherwise wouldn't have necessarily been drawn into various relationships; okay.

Ana?

Arsov: Yes; I'll just kind of complement those views, maybe dissect this from a positive and a negative perspective, the proliferation of these funds. And I agree with many of the remarks given earlier. When I used to talk about private credit, I said, "General Electric;" GEC was really the private credit ultimate role model, and then you have so many afterwards. It's not new in any way, it's just that General Electric was funded with commercial paper, and it didn't end up very nicely for the systemic risks out there, and for themselves. This type of funds has learned better ways of provisioning that credit and funding it, to date.

But when you look at it more from macro perspective, which I think was your question; if you look at small- and medium-sized enterprises, roughly 42 percent of GDP or 40 percent of employment—when we focus on such a core part of the US economy, having capital provision from many different sources than just the bank sector, and I just noted in my remarks that particularly sponsored finance, medium-sized enterprises really had trouble refinancing during COVID and shocks of the interest rate hikes of 2021-22.

So, having the permanent capital raised and sitting there to deploy it: yes, it is a more significant price, and spreads widen for private credit relative to BSL loans. But at the end of the day, anybody who wanted to refinance, refinanced. So, that was a benefit to the system.

One now in the negative, which always worried me—and I commend all the PhD researchers out there who look into this—is, did we have a postponement of the default cycle as a result? If you look at where the high-yield default on loans was, anywhere between 3-5 percent; if you include bonds versus loans, that is a moderate default cycle. It, to me, is a little bit unintuitive, as, again, a risk analyst, of 500 basis points increasing rates of highly leveraged entities of north of 6x—and that's if you believe in EBITDA adjustments, that we still have 1 percent on accruals, particularly on the BDCs. Which, again, not the whole private credit system, but a representation of it.

So, one would wonder: How did this happen? When you look at another statistic that, it's out there widely reported, is something called payment-in-kind loans. A lot of these type of high-growth companies do include payment-in-kind loans as an origination, which is, one can say, not a great asset clause, but nevertheless is an asset clause that's being priced and underwritten at that level. But when you look at the transition of payment-in-kind loans over a period of high rates, that was quite significant for many funds as well.

Again, stepping back, one would say, "Well, if we didn't have this additional funding of loans from the broadly syndicated market to be refinanced in private credit and move back, would we have seen a different default cycle, and maybe some of the excesses would have been cleared easily and more beneficial to the system versus potentially masking certain underperformances, and potentially us ending up in a much worse situation at a different time?

So, those are the questions that I'm struggling with, and I would love to see more research on that.

Lehnert: Okay; so, Ana asks the question: Resilience, or zombification? I think we'll find out, in coming years. Elisabeth?

de Fontenay: I had very similar concerns to Ana. I think the way to think about it is, in the syndicated loan market, during the—I hate to bring up bad memories, but—at the beginning of the COVID-19 pandemic you saw a fall in prices right away in that market, and it differed by industry, and so these were very useful signals to everyone, including regulators, about where more help might be needed, and so on. But it was an important signal and a quick reaction, in terms of pricing.

I think with the volatility that we've seen in the markets recently, I have not seen much in the way of any changing marks in private equity and in private credit—and that I view as a bit of a bad sign. I think there is a bit of a myth that there is no volatility in the private markets; of course that's not true, of course the valuations change. It's just a question of whether they report them as having changed, and I think that that is where we'll know if things are really different: if we experience something that we all feel is a major economic shock, and we're not seeing those valuations adjusted in the private markets, then I think that would be a bad sign.

And the second would be, again, what happens in terms of actual financial distress: do we see a surge in either bankruptcies or restructurings out of court, or is it dead silence? If we see dead silence for some period of time, I think that's also a very bad sign.

Lehnert: If I could just stay with you for one second, Elisabeth. When we think about a bank that has a book of just regular commercial loans, those are not mark to market; a bank is not a mark to market vehicle. So, how are these private credit arrangements different? Why would you expect something different from a private credit arrangement than you would from a bank?

de Fontenay: It matters much less if you have truly a closed-end structure; but if you have a situation where investors were giving them the right to come in and out—so, some BDCs, and now increasingly with the wild west that is private credit ETFs—then I think there's a big concern, if we're not adjusting valuations in response to shocks.

Lehnert: Okay. And finally, Liz: thoughts on the macro effects of all of this?

Oakes: Yes; I think it illustrates the fact that we really need to look at this from a macro perspective, and right across the ecosystem—because we can't necessarily see the unintended consequences of some of the things that we see in isolation. One really good example that springs to mind: we've seen a transfer of bulk purchase annuities out of the UK overseas, for example, and those funds are then being reinvested through a long cycle, but through to private credit.

And so, we're starting to see the risk transfer into a more opaque part of the market, and I'm not sure that we're all comfortable with the idea that actually if there was a default in this long chain, the potential for public use of funds to rescue pension holders in the UK, because we transferred all these assets overseas, is not something that the UK taxpayer is going to be particularly happy about. So, there are sometimes quite long, complex chains where we have to try and unpick; and I think we, as a group, we're all going to have to try and figure out: so, what do we put in place? How do we manage these risks? And at a very minimum, can we achieve a bit more transparency?

So, I liked Elisabeth's idea of, we have all these dark companies. I think we have to do a lot of work on valuations, and people actually having credibility with those valuations to start off with. And there'll always be this question of who's allowed access to what data, so I think we, collectively—both the UK and US regulators, in particular—face challenges around data sharing, cooperation cross-border. And this is not just a UK/US problem, but I think it helps all of us to figure out, so how are we going to even start to figure out what the problem looks like if we're not sharing the information?

Lehnert: Yes. The subtitle of this conference is, "How will policy adapt," and I think the UK has actually, as you described in your remarks, taken a lot of actions; you described systemwide exploring, the SWES, and my favorite acronym is SWES FOMO, which I'm hearing a lot about.

But if you think about, of all the things that policymakers have done or contemplated, what's the most urgent, in your view—the most underappreciated policy issue? Liz, I might ask the others that as well here in a second, but just starting with you.

Oakes: I think it's not just a regulatory issue; it's combined with where the markets are going, and just the global economy. I do think we're going to face into a regulatory arbitrage situation that we're seeing with cross-border flight of capital or movement of capital, and so we may have people raising funds in one place and investing them in another just to be able to offset, whether it's taxes or regulatory standards. I think we're going to have to tackle these things together, because otherwise, you'll benefit in one way and we'll suffer in another, and there's not much point in us all getting together in meetings in subsequent years to argue about what happened; it'll be too late.

And then, in the meantime, the market moves super-fast; so, I think for me, the one thing we have to be, it's a bit like trying to fight organized crime. You have to be super agile, and think about, what are the market participants trying to do? They're trying to make money, so how do we actually make that a viable proposition, but without each of us giving away something to the other side?

Lehnert: Good. Well, I'm not going to touch the organized crime metaphor, Liz, but...

Oakes: Don't get me wrong, I'm not alluding that private credit is like organized crime; I'm just saying that we're organized, from a regulatory standpoint—or, we think we're organized—but the market is not necessarily that organized, but behaves in a very different way.

Lehnert: I'm just looking at the chat; Beth Hammack actually raised a question I think Elisabeth and Ana might be able to address: "Do you have concerns about the overlap of private credit sponsors lending to companies that are owned by their PE affiliates?" Beth asks, "Is there a financial stability risk here?"

And one might more broadly say, it does feel like asset managers, sometimes in the form of life insurance companies, private equity sponsors, and then private credit lending platforms, are increasingly linked. So, thoughts on what that might all mean, both for the investors in these funds, the borrowers, and then the system as a whole. Elisabeth, I might start with you on that.

de Fontenay: Yes; I'll take it in sort of backwards order. The insurance in private credit is a risk, and worth looking at more closely because there is some preliminary research that they are taking much more junior positions in their lending than banks are, and so—and particularly if you have concerns about affiliated private credit, and insurance companies, and I think that is something very much worth looking into.

I think for me the most pressing regulatory issue is this major push to get 401k money into private credit. I have lots of questions about that, so if you have truly found a money-making machine, the last thing you want to do is share it; right? And so, the fact that they are so desperate right now to share it suggests that maybe they're excited to earn some extra fees by managing other people's money.

But it also suggests that they might really just be having a hard time offloading these assets and doing anything with these assets, and so that, I think, is the thing I'm mostly worried about.

Lehnert: Ana?

Arsov: On insurance, as I noted earlier, since I oversaw financial institution ratings, first we focused on exposure to the banks, but also we did a survey, sent away to the 40 largest insurance companies in the world. I'm just going to highlight some of the statistics there; this is all in public research.

US insurance companies have the highest exposure to private credit. There is a regulatory difference of treating of securitized assets, particularly, which drives that between Europe and the US, and that's roughly around 16 percent of balance sheets on average—but there's quite a big distribution around that relative to Europe, which is less than 8 percent, and Asia was less than 1 percent.

So, again, there is a key difference between, and the US has definitely grown, and grown the fastest there. So, when you step back and say, "Where is the risk?" Banks are funding it, but they're not really keeping it on a balance sheet. These facilities, they're keeping a balance sheet and, as I said—it's relatively secure, but the ultimate asset does end up, first and foremost, historically in pension funds, who are the biggest investors in private credit, but most recently insurance companies.

The second point is, yes, the vertical integration between insurance companies and alternative asset managers, obviously a pull and a theme being the most known example; but it's actually the KKRs of this world—Blue Owl, and then Blackstone has a little bit of a different strategy. They don't own insurance companies, but they are selling products to a variety, the products that originate to insurance companies; so that's the ultimate, I would say nexus of where private credit ends up, and will continue to grow.

And the insurance companies' balance sheet is really very—and regulation is—relatively simple, because as long as you have an investment-grade rating, there is no difference in an insurance company's balance sheet; if you're a corporate bond versus structured assets as private credit, it's a little bit—there are some nuances there, but it's largely agnostic. So, that's something that certainly should be the subject of more research.

And when you look back about, specifically, the question maybe that Beth asked about—interconnectedness between the sponsor and the private credit fund—I found I was very focused on the issue, and the largest funds comfortably could say that they're not really lending to each other, meaning the private credit fund does not lend to the same private equity fund. There are some exceptions to that, but that's really potentially the smaller funds, not in the largest funds.

And it's really an ecosystem that's been created that avoids the banking system; and if you think about it, you have KKR private credit fund lending to Blackstone, Blackstone lends to Apollo; they also have NAV funds now that also do another set of leverage on top of it. And the banks are, I would say, the temporary funding here rather than the permanent funding—or, more of a revolver funding rather than the ultimate investor.

So that's interesting, and we should think about now more from a regulatory point of view, activity-based versus entity-based regulation; we know that banks that are north of a trillion dollars are globally systemically important banks, and we know what kind of regulation that entails. There are now close to $300 trillion asset managers, who have very different, obviously, types of funding, that maybe does not entail the same regulation; but it's something that the regulators should ask: What's appropriate regulatory framework for a similar type of activity within a different entity?

Lehnert: Ana raises a really interesting point. I'll come back to Liz for just a second on this; both Ana and Elisabeth raised—don't worry, Nicola, I'll come back to you in a second. There's a lot of retirement money that is headed into these structures, or that there are attempts to motivate that; I wonder from a UK, European perspective, whether this fits in with the idea of a broader capital markets union?

One hears about attempts to try to increase mobilization of savings; of course, the UK, I think, has a much longer, and a more successful, tradition of this. But it does feel that a theme of all of this is that asset managers—and ultimately, the long run savings of households, whether through their pension funds or on their own—are being mobilized through these channels, and it does seem like it would be a fairly larger shift in an EU concept, but I think also in the UK as well.

And so, just reactions to that, Liz.

Oakes: Yes; I guess we have some concerns, but at the same time recognize that there is a natural liquidity transformation issue with pensions and insurance investment funds. They're struggling to make the returns, and I think that what we're seeing now is, in a rising interest rate environment, what do they do? Where do they go to get those returns?

It's an interesting challenge, in that from a political standpoint we're facing into, we need growth; we need growth in the EU, we need growth in the UK. How do you fund growth, and how do we deploy assets in a more productive way? So, there are various different thoughts on that; I'm guessing that not everyone is going to agree, but there's definitely a push to get our pension funds investing in more growth-related activity—and actual economy growth-related activity, rather than shuffling money around, as is perceived by the public.

So, where is this going to land? I'm not entirely sure. Some people are very confident that we should pursue those growth ambitions, and other people approaching retirement are probably not that excited about it. The bond market is also probably behaving in a way that they've not seen for quite some time, so it's very difficult to point to the right answer.

Lehnert: So, Sai asked a very related question here: "Does the growth of private funds impact the effectiveness of monetary policy tools?" Some of the largest private credit firms get their funding from, this is the insurance company, potentially further insulating them from capital markets. So, essentially, it's a question, I think, of an issue that we've all thought about, which is: If there's a lot of patient capital that's sitting on the sidelines, not getting engaged, it's not directly affected by changes in the interest rate picture.

Actually, Nicola, this also—Sai didn't ask about this, but a related issue is the Rajan argument that a QE environment has led to a ratchet effect for bank provision of lines of credit. I think, given your work on the provision of lines of credit to nonbank financial institutions in a QT environment, are there potential additional spill-overs or pass-throughs that we might not otherwise have anticipated?

So, I think the narrow question is: Is the rise of this kind of investing going to change the effectiveness of monetary policy? And then as a stretch goal, you could try addressing Raghu's point about the ratchet effect.

Cetorelli: No, I think I would agree on the point of the implication for monetary policy. So, a broader statement is that I don't think we have as clear an understanding of monetary policy transmission in a world as the one that we have been observing over the last 10-15 years, with the rise of these nonbank financial institutions. Very briefly, I have some work on the role of bank loan funds—which are, admittedly, it's a different type of animal, because these are open-ended funds that hold loans on their balance sheet. And without going into the details, the way that investors in these funds react to potential changes in interest rates is in fact sort of the opposite of what you would expect to be the reaction through a traditional bank lending channel.

And so, I think what I'm trying to say is that in a world where you have now different types of institutions with different types of incentives driving their behavior, monetary policy transmission needs to be reassessed.

And so, briefly on the point of Rajan: I think that's absolutely correct. To the extent that there is an important reliance now, speaking about the private credit sector on the liquidity provision of banks, to the extent that tightening of conditions that would affect the ability of banks to provide these types of services, should definitely have the implications that could lead to important amplification—not only amplification, but then again, possibly open the implication for financial stability.

Lehnert: In the sense that there might be a liquidity crisis.

Cetorelli: Which could lead to a credit crunch.

Lehnert: Right. Okay; so, I started asking the panelists what they viewed as the most urgent regulatory priority. Liz made the point that, really, international cooperation is a critical piece of all of this, and I think that is what structures like the FSV are for and are designed to be the kind of place to do that.

But let me just sort of work back along the panelists now, and, Elisabeth, I think you had a very interesting . . . I have to say, reading your papers on this topic is a perspective on this issue of private credit that I hadn't really appreciated before. So, in your view, what's the most urgent thing that policymakers ought to be working on in this space?

de Fontenay: I think it's figuring out how to get disclosure from some of these firms; because right now, again, if they're private equity owned, private credit financed, you're not getting information, you're not getting mandatory disclosure from the company about itself on an ongoing basis, you're not getting mandatory disclosure when the equity is issued, you're not getting mandatory disclosure when the debt is issued, you're not getting trading prices—you're not getting any of that. And I think to the extent that that spreads to a larger section of the economy, then that creates big risks for the economy.

Lehnert: Yes; and again, I'd say: How is that different from bank lending, to just regular old C&I bank loans? There's not a lot of mandatory disclosures—unless the underlying firms are publicly traded, which, in many cases, they aren't.

de Fontenay: Yes. So, for the smallest firms, actually, private credit might mean that we're getting more information than we were in the past, because somebody is kicking the tires. But I think it's that larger, middle market section, and bigger companies, where in fact—at least with syndicated loans, we were getting some information about what was going on, and now we are losing that as well.

Lehnert: And so, I'm going to ask Ana what she thinks is obviously the most urgent regulatory issue; but on this issue of opacity, as you mentioned in your remarks, you conducted this survey—and of course Moody's, I hadn't appreciated this, but even though these loans themselves are not rated, and that's in some sense the whole point; the fact is that to be able to be sold to an insurance company or otherwise moved around in the financial system, they have to get a rating.

So, in a way that many of us are scratching our heads on the outside wondering exactly what the terms of some of these loans are, you actually got to see them. So, maybe we'll just start on the opacity point: What are the big differences that you saw in the terms between a regular loan and some of these private credit arrangements? And then, how do you view this loss of broader market discipline information?

Arsov: Actually, because this is also a topic of interest, definitely, of mine, we got a bunch of internal lawyers to look at credit terms of a broadly syndicated loan and private credit loans, and as a matter of fact, the smaller the loan was, the credit terms at the private credit loans were much more tight than the broadly syndicated loans; so that's a positive. However, the larger the loans were, and the ones that were competing and moving between the broadly syndicated loan market and private credit, actually the terms were extremely similar and almost indistinguishable.

I think somebody made a point that a lot of these loans are negotiated one-to-one; yes, that was the original, smaller, $40-50 million loan commitment. A lot of this $1 to 5 billion most recent trend of loans are actually negotiated with a club, so it's like a club of 12 entities—so, not dissimilar to how the broadly syndicated loan market is. And those, again, have much weaker terms.

So, I would go back now to the supervisory question—and this is not necessarily the remit of the bank regulators here, since the SEC really has oversight of the funds. But again, I'll go back to valuations and why that is important. Elisabeth made that point earlier, but launching an ETF, for example, which is a daily liquidity, without any alignment of how those valuations are for private credit assets among the funds—it's a critical risk.

I hear your point, and since I covered both roles I'm a little bit of a bifurcated personality disorder of banks and nonbanks. I always used to say: As a bank, you would have actually a horizontal review by the OCC to say, "Okay, this is a category one-two-three-four bank." So, I may think it's 3, but the OCC will come back, "I saw it at a neighbor bank; they had it as a four, so why don't you rerate it?" That simply does not exist in the banking system, so that's the key differences. It's okay that you would not necessarily have to know everything about these loans; that's the same as the underlying banks. But is there alignment of how you perform these valuations?

And today, the valuations are done this way: A fund can choose to have two public valuation agents, and private, and they can choose and pick which loans are done by what and frequency of that. So, there's no common denominator, either by the SEC or other market regulators, noting this is how the way the valuations will be done. I think that's a key difference, so I wouldn't necessarily go into market-type structures like the ETFs, which I think it's not prudential to have without that at least baseline being aligned.

Lehnert: Okay; so, just staying on ETFs for just a second, with both of you. You both mentioned the potential growth of ETFs. In principle, an ETF isn't—it's actually like a fairly robust mechanism, in which to let households trade illiquid assets. In some sense, the most illiquid thing is a nonfinancial corporate, and we trade their stocks all the time; we have no idea what's going on under the hood inside the company.

But I think your point is that if there were going to be authorized participants, and there were going to be redemptions, we would need—it's just not really appropriate to have these private credit assets in these baskets, and I wonder if you could be a little bit more granular about the potential issues there?

Elisabeth, do you want to go first on that?

de Fontenay: Sure. I can speak to the first one that was launched; so, this was State Street and Apollo, but Apollo in a very interesting way, which is: it was going to be primarily loans that they originated, but they were going to be the sole source of liquidity—which is to say, they were committing that they would give a quote to buy back these assets, but if that quote is just north of zero that's not really liquidity, and having a single liquidity provider is also not what any of us would characterize as liquidity (and yet, this SEC chose recently just to go ahead and see what happens; now that ETF has a very small portion of private credit). But if it lasts for a while, I assume all of the copycats will come in with increasing percentages of private credit, and if you get to 35 percent or north of that, then I think you really have this problem of we are calling something liquidity that is in fact not liquidity.

Arsov: And I'll just add to that: the differences, and one can say, "Well, the broadly syndicated loan market—that has ETFs." Yes, but the key difference is exactly to the point that Elisabeth made, and I've been making in other conferences, is that the BSL market is traded. It has a standardized documentation, is traded by dozens if not a hundred banks around the world; here the issue was that the one who originates the asset, the asset manager, also would be the one who prices the assets; so, the conflicts of interest can be abundant in this case.

Lehnert: Okay. So, coming back to Nicola: What do you view as the most urgent issue for regulators to address in this broader space?

Cetorelli: The broader space of regulation, some policy—

Lehnert: Yes, exactly; I think you're the person who really has been pushing this idea that the ecosystem itself is changing, and so maybe from an ecosystem perspective rather than focusing on individual institutions.

Cetorelli: It's probably the lowest hanging fruit and the biggest elephant in the room—and I'm not necessarily advocating it; I speak on my own behalf, and not on behalf of my institution—but it's liquidity facilities, to what extent those privileges that are exclusive to banking institutions should be also extended to nonbanks that are now in the business of providing credit. Let's be honest about what it is that they're doing, and so there is liquidity risk; and that liquidity risk, from a social planning perspective, may be addressed by providing backstops.

Of course, it's at the end of the story, historically, for...how long have we had the lender of last resort—130, 140 years or something? I think it goes in a quid pro quo-type of approach, which is what has been applied to banks—again, historically across countries and over time: I give you these privileges, but in return you have to give me some access to what it is that you're doing, which ties with the issue of disclosure and transparency (or lack thereof).

So, I'm not sure exactly how you're going to square that, but especially now that we're talking about this development in the system, where this industry is going to top retail investors—presumably with some form of redemption rights. What do you call an institution that has some form of on-demand liabilities that provide loans? I call it a bank, and so, "no." And then I go to Ana's point: If it is an activity-based regulation then we have to apply, so then we have to call things with the right name.

Lehnert: Good; right. I'm going to try to squeeze one last question in here, because this, Liz, the FPC, the Bank of England, have developed a kind of nonbank lending facility, contingent non-standing facility; it's really focused on the gilt market's operation, but how do you view the potential lending to nonbank-type entities, to support their role in credit creation, and the smooth functioning of a modern economy?

Oakes: Yes; so, I think Nicola hit the nail on the head. We have to figure out how to extend liquidity to these market participants, in the event that they can't access liquidity through the normal channels. And so, it is all about transmission channels and liquidity. We've started with the gilt market, because that's where we saw that it had the most potential to impact financial stability in the UK economy and the core of the UK. But we are then extending that out now to start to look at areas like the corporate debt, the corporate bond market.

There is no way that this can just be contained, so I think the question will then be: What does that look like? How would it operate? Is it a short backstop, similar to the contingent repo facility? And I think that the answer to that is probably that it is, so this is just about emergency lending; this is about access in times of distress. The contingent NBFI repo tool, we see that working as a facility for maybe a week or two weeks at maximum—so, it's not there to fix idiosyncrasies in how people's business models operate.

I think it is just the start of, where do we go with this? But it does raise some really interesting questions about intermediation, and what are the role then of the banks that have reserve accounts? And it's all tied to how we change to a demand-led rather than supply-led balance sheet at the bank. There is a whole raft of different complexities that that sit within this, but I think that the NBFI sector is now so large we have to tackle this head on.

Lehnert: Good. Okay; well, you should feel free to talk to Liz over lunch about your ideas for a good nonbank lending facility. So, one piece of housekeeping: lunch does start now, and you're due back in here at 1:15 promptly for the afternoon sessions.

And so, with that, all that remains is to thank our panelists. So, thank you very much.