Private debt in Asia:
Early stage growth
By Dr. Chris Heine and
Nicholas Brooks, ICG
2
This chapter provides an overview of the evolution of Asia’s private debt market, its major drivers and key
characteristics. It also highlights crucial differences between individual country markets and provides an
assessment of how this dynamic industry is likely to evolve in the coming years.
Market evolution of Asia
The private debt and equity industries in Asia are still in the early stages of development. The buyout industry only
really began in 1999/2000 when a small number of European and US private equity firms identified Asia as a
promising new territory to develop at a time when European and US buyout markets were becoming increasingly
competitive. Leverage finance followed those initial private equity ‘pioneers’ and the industry was built on early
vintages driven by distress in a disorganised marketplace.
During this period, there were a limited number of intermediaries and few trade buyers. The market was
comprised primarily of distressed sellers, selling businesses under the pressure of their lenders or because of
corporate reorganisations. This was particularly prevalent in South Korea and Australia. Those early vintages
were highly successful, benefiting from earnings growth, debt reduction, and also from currency gains and
multiple expansion. This was the foundation that led to the development of Asia’s buyout industry today.
The sub-investment grade debt and mezzanine providers followed the private equity industry and senior direct
debt lending appeared in the market as the banks, particularly international banks with a presence in Asia,
withdrew from Asian mid-market lending as capital constraints and regulation led them to focus more on their
home country territories.
Growth drivers
One of the key underlying drivers of the growth of the private equity and private debt markets in Asia is the
region’s compelling macroeconomic environment. According to the International Monetary Fund (IMF), the region
is home to nearly 60 percent of the world’s population and is responsible for more than 45 percent of the world’s
economic value-add. Developing Asia has been growing at an annual average growth rate of around 8 percent
over the past ten years and, based on IMF forecasts, will continue to grow at 6 percent over the coming decade
(see Figure 1), more than double the growth rate of the rest of the world. Per capita wealth has soared over the
past ten years (see Figure 9.2), with China’s per capita income estimated to have grown nearly five times over the
past ten years. This trend towards greater wealth is projected to continue.
Chart 1: Asia remains fastest growing region in the world
Asia Growth vs the Rest of the World
10
8
6
4
2
0
-2
2010
2011
Developing Asia
2012
2013
World
2014
Euro Area
Source: IMF World Economic Outlook. IMF forecasts 2015-2020.
Private debt in Asia: Early stage growth
2015
2016
EM Europe
2017
2018
EM Latin America
2019
2020
US
3
Chart 2: Asia’s middle class rising
Asia Per Capita GDP (US$)
14,000
40,000
China
India
35,000
12,000
Indonesia
Thailand
30,000
Korea (RHS)
Taiwan (RHS)
25,000
10,000
8,000
20,000
6,000
15,000
4,000
10,000
2,000
5,000
0
0
Source: IMF World Economic Outlook. IMF forecasts 2015-2020.
Nominal US$
As per capita incomes increase and middle classes expand across Asia, the nature of growth has changed, with
higher value-added industry and services-related businesses making up an increasing share of the economic pie
(see Figure 3). This has led to a natural slowing of headline growth rates, but it has also brought exciting new
opportunities for investors as new industries are created and there are successive waves of innovation. In China,
there are still huge potential efficiency gains ahead as private companies gradually take an increasing share of
the economy from the less efficient state-owned sector.
Companies in more developed Asia-Pacific countries, such as Japan, Australia, Singapore, Taiwan and Korea,
have been particularly well positioned to benefit – directly and indirectly – from the rapid transformations taking
place in countries like China, India and Vietnam. ICG believes the market is in a sweet spot for private equity and
debt as local companies increasingly need access to outside capital – particularly those companies in the midmarket, which have grown beyond their original roots but are not yet ready, or do not want to substantially tap into
public markets.
Regional differences
The Asia-Pacific region can be very roughly divided between the ‘more developed’ markets of Japan, South
Korea, Taiwan, Hong Kong, Singapore, Australia and New Zealand and those that are less well developed like
Malaysia, Indonesia, Philippines, Thailand and China. A key strength of the Asian markets for private equity and
private debt investors is that most countries – particularly those in developed Asia – have Western-style laws
governing shareholder protection and the ability to enforce agreements, whether equity or debt. Strong domestic
regulatory frameworks, rapid economic growth and a large and growing number of conglomerates and family
owned businesses in need of finance and/or buyouts to support generational change and growth, point to a
healthy future for the industry.
Private debt in Asia: Early stage growth
4
Chart 3: Transformation of Asia: Services takes off
Services Value-Added as % of GDP
%
50
48
46
44
42
40
38
36
34
32
30
1990199119921993199419951996199719981999200020012002200320042005200620072008200920102011201220132014
China
Developing Asia
Source: World Bank
In the early stages of the development of the industry in Asia, between 2000 to 2006, returns were good with
median returns of 1.8x across the region. 1 Things began to change around 2007/08. It was not just the global
financial crisis of 2008/09 that changed market dynamics. The growth of China as a manufacturing powerhouse
and its increasing openness to the outside world caused investors to substantially increase investment in
businesses involved in taking advantage of China’s low cost manufacturing to export to developed economies.
Growth capital investments led to exits in the public markets and funds poured into China looking for multiple
expansion.
Chart 4: Rising Private Debt Fundraising in Asia-Pacific
6
0.44
Total capital raised (bn)
5
0.83
4
0.1
3
0.04
0.29
4.24
2
1.43
1.84
1.3
0.01
0.1
1
0.83
0.91
0.98
1.16
2011
2012
2013
2014
2015
Senior debt
Unitranche
0
Subordinated / Mezzanine debt
Digressed debt
PDI Research & Analytics
1 According to Preqin data for investments in Australia, Japan, New Zealand, Malaysia, South Korea, Indonesia, Taiwan and Singapore
Private debt in Asia: Early stage growth
5
The period showed that the most successful private equity and private debt investments could be made by
investing in businesses in countries that had their own growing domestic consumption, as the middle classes
increased and services sector industries began to see increasing dynamism and rapid growth. Investments in the
Asia-Pacific economies were far less affected by the global financial crisis than those in the West, including
domestic banks. While headline growth rates in Asia slowed during the global financial crisis period, average
growth in developing Asia still maintained a healthy 6 percent pace. This supported strong deal flow, with ICG
seeing a near trebling of deal flow between September 2008 and September 2012.2 Strong growth and healthy
deal flow made domestic funds and dedicated Asia-Pacific funds increasingly attractive vehicles for investors.
Figure 4 shows the overall rise of the asset class across Asia-Pacific: in 2015 the largest private debt vehicle
since 2011 closed, and aggregate capital raised in the year surpassed the levels reached over the past four
years.
Capital raised for closed-ended private subordinated and mezzanine debt funds increased by over $3 billion
between 2014 and 2015, according to PDI data.
In addition to macro-economic factors, the Asia-Pacific region has a number of attributes, which make it an
attractive investment destination. As many businesses in the region are still held by founding families, there is a
steady flow of transactions as families face succession and generational change issues. In addition, as large
industrial conglomerates wax and wane in their fortunes, they shed non-core businesses and acquire others,
requiring the support of private equity and private debt expertise and funding. Western trade buyers are also
becoming an increasingly important part of the market as they see opportunities to acquire profitable, standalone
businesses in rapidly developing high-growth markets.
Common types of debt
There are three types of private debt transaction prevailing in Asia-Pacific in 2016:
1 Leverage buyouts – where ownership of a business is transferred in a typical leveraged structure and only
existing management roll into the new structure.
2 Capital restructurings – where businesses, often owned by private equity, have not yet fulfilled their business
plan to generate adequate returns for investors and require ‘patient capital’ to replace or augment senior debt
and equity.
3 Minority equity growth capital/shareholder reorganisation – where the shareholders are not PE and have
a requirement for a capital solution to provide liquidity, or an exit, for some shareholders or to take advantage
of a growth opportunity through organic growth or by acquisition which cannot be funded by existing
shareholders and senior debt funding has reached its limits.
The senior debt market in Asia is dominated by local banks, which are generally in good financial shape versus
their peers in the West. These banks tend to focus on their domestic markets and can underwrite higher multiples
against assets they know and like than would otherwise be available.
The subordinated debt market is less clear-cut. The mezzanine and subordinated debt markets in the early years
of private equity in Asia-Pacific were dominated by the large international banks like JP Morgan, UBS and
Deutsche Bank, with the exception of specialist providers like ICG and a small number of other fund managers.
However, due to changing regulations, various crises, including the global financial crisis of 2008/09, and some
large defaults, the senior banks have now largely withdrawn from providing subordinated debt. They prefer to
underwrite more senior debt, access the US Term Loan B market or share subordinated debt business with
specialist fund managers. This move to focus on senior debt is a result of internal credit risk decision making,
driven by profitability and historical loss/provision rates, and by regulatory/capital requirements for higher risk loan
assets. Some of these specialist fund managers have gone from the market as a result of returns, but also due to
issues with sourcing enough volume to deploy capital in a timely fashion. This issue of garnering sufficient
volumes and deploying commitments continues in the current market and has led to some private equity firms
2 ICG data, pan Asia deal data 2000 to 2006.
Private debt in Asia: Early stage growth
6
extending their geographic remit into geographies like Malaysia, Indonesia, Philippines and Vietnam, taking
increased risk for what is hoped will be a higher return.
Investors are increasingly looking for ways in which to participate in both the senior and junior debt markets in
Asia, mirroring their exposures in the US and Europe. Their goal is to be higher up the capital structure, generate
a less volatile return profile, a cash yield and have the ability to deploy funds to take advantage of the region’s
appealing growth rates. More recently, there has been increased interest in distressed debt strategies in Asia,
encouraged by recent transactions like the 2011 Alinta debt transaction, led by TPG, which funded a large
investment in the power generation and distribution company’s debt, leading to a debt for equity swap. Chinese
non-performing loans related to property, mining and commodity companies hit by the cyclical downturn and
distress in the oil and gas sector are all contributing to interest in the sector.
Senior direct lending in Asia is highly dependent on volumes and the local regulatory environment, which vary
country by country. While senior direct lending exposure in Asia can be obtained in Australia through direct
lending funds, including those managed by ICG, it is less prevalent in the other volume territories – like China and
Japan – where local banks tend to dominate the market, providing high leverage multiples at low cost in a
negative interest rate environment. The lack of availability of necessary volumes has meant that Asian LPs are
generally well behind their US and European counterparts in investing in debt strategies as a proportion of their
alternative asset portfolio.
ICG’s approach in Asia-Pacific is to focus on developed economies with predictable legal and tax regimes that
allow for efficient enforcement in the event of default and provide predictable taxation on proceeds and
realisations. ICG invests through its dedicated Asia-Pacific funds into businesses that have track records of
repeatable, sustainable earnings, which generate substantial free cash flow to pay down debt or reinvest in the
business to grow earnings.
Because of its fund mandate, ICG can invest in any of the three investment types described above, providing
more opportunity to deploy capital. ICG often invests in a combination of debt and equity. Debt components with
non-call periods protect the downside and deliver money multiple. Equity exposure through warrants on debt
instruments and/or direct equity co-investment provides equity upside. This combination of debt and equity
exposure is unique, helping to support more predictable returns and less volatility in the fund portfolio.
Given the domestic growth of Asia-Pacific countries, these debt opportunities should have a lower default risk
profile and provide returns to investors of around 7 percent to 9 percent for senior debt and mid-to-high teens for
subordinated debt and mezzanine. However, volumes remain an issue in Asia-Pacific, as does the issue of
geographic shift towards less developed countries by GPs seeking to boost volumes and take higher risk for
higher returns. In our view, it is important for debt investors to try to stick to the more developed debt markets
where enforcement of contracts is strong both for traditional and distressed debt strategies.
Demand for Asia-dedicated private debt and equity exposures should also increase – both from Asia-based and
non-Asia based investors – as the underlying market grows in size and sophistication. Asia senior and
subordinated debt strategies will increasingly form a component of investors’ alternatives asset allocation as a
way to generate yield and return while providing downside protection and introducing geographic diversity into the
portfolio.
Conclusion
To summarise, private debt markets in Asia have developed rapidly over the past 16 years, evolving from being
concentrated in only a few countries with a few intermediaries into much more sophisticated and deep markets
with a growing diversity of investment opportunities and intermediaries. There are still important differences
between countries in the region, meaning that local knowledge and a local presence in each market is critical to
success. Developed Asia remains ahead of developing Asia in terms of regulatory, legal and tax regimes, but
headway is being made across the region. As wealth in Asia continues to rise, the middle class grows and
regulatory regimes continue to improve, private debt and private equity will play an increasingly important role in
funding Asia’s private sector growth.
Private debt in Asia: Early stage growth
7
Dr. Chris Heine is senior managing director and head of equity and mezzanine, Asia-Pacific, at ICG. Chris joined
ICG in November 2006, as the head of Asia-Pacific mezzanine investments and a member of the Investment
Committee. Chris has led the ICG Asia-Pacific team for the last seven years and managed ICG Asia Pacific Fund
I and ICG Asia Pacific Fund II. Prior to joining ICG, Chris was a deputy managing director at CVC Asia Pacific
Limited for seven years where he worked on the origination and execution of buyout transactions in South Korea,
Japan, the Philippines and Singapore. Chris holds a degree in Microbiology and Virology and a PhD in Tumour
Virology from Warwick University.
Nicholas Brooks is head of economics and investment research at ICG. He has over 15 years’ experience as a
global economist and strategist, covering a wide range of markets and asset classes. Prior to joining ICG,
Nicholas was head of research and investment strategy at ETF Securities for over seven years where he built and
managed the institutional research team. Before this he was a senior member of Henderson Global Investors
global strategy and asset allocation team and senior economist on Deutsche Bank’s Global Markets economics
and strategy team. He started his career at Citibank in New York. Nicholas has a BA from Brown University, an
MA from Columbia University and an MSc with distinction from the University of London where he completed work
on a PhD in economics focused on financial fragility, debt cycles and the dynamics of financial crisis.
About ICG
ICG is a specialist asset manager with 28 years’ history in private debt, credit and equity. Our objective is to
generate income and consistently high returns while protecting against investment downside. We seek to achieve
this through our expertise in investing across the capital structure. We combine flexible capital solutions, local
access and insight with an entrepreneurial approach to give us a competitive edge in our markets. We are
committed to innovation and pioneering new strategies where we can deliver value to our investors. ICG has
€22.6 billion of assets under management globally (as at 31 December, 2016), we are listed on the London Stock
Exchange (ticker symbol: ICP), and regulated in the UK by the Financial Conduct Authority (FCA). Intermediate
Capital Group, Inc. is a wholly-owned subsidiary of ICG and is registered as an investment adviser under the US
Investment Advisers Act of 1940. Further information is available at: www.icgam.com.
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Private debt in Asia: Early stage growth