By: Suzanne Craig and Thomas Cavanagh
The collapse of Shield, First Guardian and property developer Bathla has transformed private credit from an investment story into a governance story. Suzanne Craig and Thomas Cavanagh examine ASIC’s emerging enforcement strategy, the growing exposure of AFSL holders and directors, and the implications for D&O and professional indemnity insurers.
Background
For much of the last decade, Australia’s private credit market has been viewed as one of the success stories of the alternative investment sector. Institutional investors, superannuation funds and retail investors alike were attracted by the prospect of enhanced returns, reduced volatility and access to opportunities outside traditional banking.
Recent events, however, have changed the conversation. The collapse of the Shield Master Fund and First Guardian Master Fund have shifted regulatory and litigation attention away from investment performance and towards governance, oversight and accountability. The recent failure of property developer Bathla Group, which predominantly utilised the private credit market to fund its developments, will only advance this shift.
This shift is not merely theoretical. ASIC’s recent enforcement activity demonstrates a broad and deliberate focus on gatekeepers across the investment chain – including advisers, licensees, trustees, research houses and platform providers. The message from the regulator is clear: product governance now presents a greater source of regulatory risk than underlying investment performance.
The governance challenges are compounded by the nature of the asset class itself. Private credit products are inherently difficult to assess. Unlike listed securities, they typically involve limited disclosure, illiquid assets, bespoke lending arrangements and complex valuation methodologies. Once losses crystallise, attention quickly shifts from investment returns to governance processes, risk management frameworks and the adequacy of oversight.
The collapse of Bathla illustrates the point. It highlights the extent to which Australian private credit remains exposed to property development risk and demonstrates how quickly a credit event can become a governance event. Real estate comprises anywhere between 40-60% of the total private credit investment in Australia. With recent downward pressure on property valuations (arising out of recent tax changes and other factors), investors utilising the private credit space will have a keen eye on how responsible entities are managing this risk.
Property development failures increasingly give rise to litigation directed at those involved in product selection, due diligence and oversight – transforming what begins as an investment loss into a question of accountability.
Governance obligations and conflicts of interest
ASIC has repeatedly identified weak governance and poorly managed conflicts of interest as recurring issues within the private credit sector. Governance structures, ownership arrangements and conflict management frameworks are now subject to the same level of regulatory scrutiny as financial performance – and in many cases, attract greater scrutiny.
These concerns carry particular weight given the statutory framework. Chapter 5C of the Corporations Act 2001 (Cth) imposes stringent obligations on responsible entities of registered managed investment schemes. Under sections 601FC and 601FD, responsible entities and their officers must act honestly, exercise the degree of care and diligence that a reasonable person would, act in the best interests of members, and give priority to members’ interests in the event of a conflict.
These duties are especially significant where private credit structures involve related-party transactions and concentrated decision-making authority – such as was the case with the Shield and First Guardian funds.
Director exposure and personal liability
Directors of AFSL holders and responsible entities face increasing personal scrutiny regarding the adequacy of governance frameworks, the supervision of advisers and the robustness of risk management processes. The exposure is particularly acute where directors hold interests in underlying borrowers, developers or related entities, creating potential conflicts that regulators and litigants are now actively pursuing.
Beyond entity-level enforcement and specific obligations of officers of responsible entities under 601FD of the Act, directors of other involved AFSLs face the risk of personal liability for breaches of their general duties under the Corporations Act. Directors will face increased risks of accessorial liability under section 79 of the Corporations Act where they are knowingly involved in breaches by their AFSL entity.
In practice, this means the same underlying facts may support both regulatory proceedings against the entity and claims against individual directors. Again, this will be particularly relevant where the directors are personally associated with the underlying investment vehicles.
Insurance implications for D&O and professional indemnity
Professional indemnity policies are likely to become the primary source of protection for AFSL holders facing allegations concerning product governance, due diligence failures, adviser supervision and conflicts management. For directors, D&O policies will be tested by regulatory investigations and governance-related claims that may proceed in parallel. Insurers should expect an increase in both the frequency and complexity of notifications arising from the private credit sector.
The defining risk in Australia’s private credit market is increasingly governance risk rather than credit risk. For AFSL holders and directors, the key challenge is demonstrating that risks were identified, conflicts managed and investors’ interests placed first. While underlying governance has always been the risk for insurers in this space, ASIC’s renewed focus should be front of mind. ASIC is now more likely than ever to investigate governance failures following investment losses irrespective of whether any claims are made by investors.
About the authors
Suzanne Craig and Thomas Cavanagh are Partners in Wotton Kearney’s Financial Lines practice. Together they advise insurers, AFSL holders, responsible entities, financial institutions and directors on regulatory investigations, professional indemnity claims, D&O liability, financial services disputes and emerging risks across the private credit sector.
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