Private credit in Australia – the regulated "unregulated"

Australia’s private credit market has been the subject of attention given its growing size and significance to Australia’s financial ecosystem. The sector is often described in commentary as “unregulated”. However, there are a range of regulatory obligations that providers of credit in a private market must comply with and regulators are increasingly interested in these.

Key regulatory considerations in respect of the provision of credit include:

• compliance with anti-money laundering and counter-terrorism financing (AML/CTF) obligations;
• registration and reporting with APRA as a “registrable corporation” under the Financial Sector (Collection of Data) Act 2001 (Cth) (FSCODA);
• the impact of Australian financial services licence (AFSL) obligations, particularly in the context of lending through a credit fund; 
• the application of Australia’s consumer protection regimes, which have wide reach and flexible application; and
• the application of foreign investment restrictions which may require the approval of Australia’s Foreign Investment Review Board.

Fund raising activities of private credit lenders may also be regulated in Australia, but these aspects of the regulatory environment are beyond the scope of this note. 

1. Application of AML/CTF obligations to private credit activities

Lending activity is subject to Australia’s AML/CTF regime. This means that any lender within the jurisdictional scope of the Anti-Money Laundering and Counter-Terrorism Financing Act 2006 (Cth) (AML/CTF Act) is required to implement an AML/CTF compliance framework responsive to the money laundering and terrorism financing (ML/TF) risk in its business.  Key obligations under the AML/CTF regime include:

• enrolment with AUSTRAC;
• implementing an AML/CTF Program responsive to ML/TF risks;
• undertaking upfront and ongoing customer due diligence in respect of borrowers;
• reporting to AUSTRAC, including in respect of suspicious matters and annual reports; and
• implementing AML/CTF controls including the appointment of an individual as an AML Compliance Officer.

Common issues faced by private credit providers in complying with the AML/CTF Act

The AML/CTF Act is a risk based one. This means that lenders must put in place controls that are responsive to the ML/TF risk associated with their business. It is not a one size fits all regulatory regime.

In the context of private credit activities, this means understanding the ML/TF risk associated with borrower types, the jurisdictions connected with the lending (including where the funds will be disbursed to), how that lending could facilitate ML/TF and the methods through which the lending is undertaken. The risk profile associated with one lender could be markedly different to another. For example, one lender may engage solely with privately owned Australian companies to fund investment in Australian real estate. Another lender may engage with borrowers located in offshore jurisdictions to fund business operations located out of Australia. Each will have their own risks that need to be managed. 

The importance of understanding ML/TF risk in a business and tailoring controls accordingly has been reflected in AUSTRAC’s enforcement action. This has been particularly focused on appropriate risk assessments being undertaken and a compliance framework being in place that is responsive to that risk. Regulatory action has included a focus on the governance that surrounds the approach to AML/CTF compliance, including board oversight and investment in controls.

In addition, to the extent that a lender is obtaining capital to fund the lending through investors, AML/CTF controls will also apply to the acceptance of the investor’s funds. This means the AML/CTF Program must be responsive to the risks associated with the investors and associated activities as well as the lending arm of the business.

2. APRA’s oversight - registration and reporting and general powers

Entities that are engaged in the provision of finance must register with the Australian Prudential Reporting Authority (APRA) and undertake periodic reporting under FSCODA. The regime applies subject to threshold values of debt being met, generally applying a $50 million threshold.

FSCODA was expanded in 2018 to capture non-bank lenders after APRA identified that the provision of finance by non-bank lenders may materially contribute to risks of instability in the Australian financial system. Periodic reporting requires entities to provide information about their financial position and details about the loans and other information to APRA. FSCODA therefore provides APRA with information on non-bank lending activities, giving transparency and visibility of information to APRA in connection with this sector.

At the same time as the expansion of FSCODA, the Banking Act 1959 (Cth) (Banking Act) was amended to give APRA the power to determine rules raised by non-bank lenders. These provisions of the Banking Act allow APRA to make rules where it considers that one or more non-bank lenders materially contributes to risks of instability in the Australian financial system and that it is necessary, in order to address those risks, to make relevant rules.

Common issues in applying FSCODA to private credit arrangements

FSCODA seems to be an often forgotten regulatory regime. However, potential penalties for non-compliance can be significant. In June 2024, APRA used its enforcement powers to fine Equity Trustees Superannuation Limited $782,500 for failing to report data within the deadlines prescribed by FSCODA.

In the context of private credit activities in Australia, where commentary is often focused on “opaque” lending activities, we expect that enforcement of FSCODA will be an ongoing focus of APRA.

3. Application of AFSL obligations

An AFSL (or an exemption from the requirement to hold an AFSL) is required where a person ‘carries on a financial services business’ in Australia. The AFSL must have the appropriate authorisations for the financial services provided. Generally, financial services are services that are provided in relation to ‘financial products’. These include providing financial product advice in relation to a financial product and dealing by issuing or arranging the issue of a financial product.

The provision of a credit facility is generally not a financial product, and providing loans would generally not require an AFSL or an AFSL exemption unless the lending arrangement is a margin lending facility (or is structured as a debenture or notes offer which is a securities offer or is classified as a derivative).

The AFSL regime is more relevant to credit funds operating in Australia in connection with the offering of the fund interests and managing of the fund’s assets, as fund interests will usually be financial products within the meaning of the Corporations Act. As such, an AFSL (or an exemption) is needed in respect of the issuer of the fund interests and any other party that arranging such issuance (for example if the fund appoints a manager to promote the offering of the fund interests). In addition:

• the credit fund (or its manager or operator) may deal in financial products as part of managing the fund’s assets (either where the assets are financial products, or where the credit fund utilises or implements financial products as part of its management strategy, e.g. uses derivatives to hedge risk or acquires insurance products); and
• if the credit fund is structured as a unit trust and holds financial products, the trustee of that credit fund will be providing custody services, which requires an AFSL or an exemption. 

The operator of the credit fund will need to carefully determine whether the investors in the relevant fund will be wholesale clients or retail clients, within the meaning of the Corporations Act. Offering fund interests to, and operating a fund that is open to, retail clients involves significantly more compliance and regulation, and may require the fund to be registered as a managed investment scheme and the trustee to have a responsible entity  authorisations on its AFSL.

Key AFSL considerations in operating a credit fund

Operators of credit funds need to consider the scope of the financial services and financial products that they expect to provide, together with the expected investor base in the relevant credit fund, to ensure that they either have sufficient AFSL authorisations in place, or can operate under relevant AFSL exemptions. Operators of wholesale credit funds also need robust systems in place for ascertaining the wholesale client status of their investors before providing financial services to them.

4. Consumer protections that may affect private credit arrangements

The provision of credit to consumers is highly regulated in Australia. A licence is required when providing credit regulated under the National Consumer Credit Protection Act 2009 (Cth) (NCCP Act) and associated responsible lending, disclosure and conduct obligations must be met. 

In addition, “consumer” protection regimes will often apply when lending to a small business, even if a licence under the NCCP Act is not required. For example, the unfair contract terms of Australia, under the Australian Securities and Investment Commission Act 2001 (Cth) (ASIC Act) applies to both consumer and small business contracts. The regime has the potential to apply to a particularly broad range of contracts that may not inherently be thought of as entered into with “consumers” or “small businesses”.

Other general obligations under the ASIC Act, including misleading and deceptive conduct and unconscionability provisions, will also apply to the provision of financial services more generally, irrespective of customer type. These legislative standards are often used to pursue conduct in connection with the provision of financial services that do not otherwise require a licence or would otherwise be required to meet prescribed disclosure obligations. Their general, principle-based scope means that the obligations can be adapted to the circumstances that raise risks as sectors and offerings develop.

Common issues faced by private credit providers under consumer protection regimes

Carefully preparing disclosure materials, contractual terms and communications with borrowers is essential when dealing with both individuals and small businesses.  Lenders should carefully consider the circumstances in which they lend to ensure that all relevant consumer and small business protections are taken into account in the design and offering of the credit product.

5. FIRB

Australia’s foreign investment  regime, commonly known as “FIRB ”, regulates the investment activities of ‘foreign persons’ in Australia, The regime is complex and applies broadly to the acquisition of interests in an Australian entity, business or land.

The potential requirement for FIRB approval is an important structuring consideration for private credit transactions, where deals may range from more traditional secured lending transactions to hybrid equity instruments such as warrants and convertible notes. As credit is often provided in time sensitive situations, structuring instruments that can navigate the requirements for FIRB approval is critical.

Key FIRB considerations for private credit funds

Due to the extensive tracing and association rules under the FIRB regime, a large proportion of private credit funds are classified as ‘foreign government investors’ (FGI) and therefore subject to more extensive FIRB approval triggers, including nil monetary thresholds on the acquisition of interests in 10%+ of an Australian entity and Australian land. 

This means that where a private credit fund is classified as an FGI, the following typical actions by the FGI will be subject to FIRB approval, regardless of the value of the asset or the transaction, unless an exemption such as the 'moneylending’ exemption applies:

• being granted security over any Australian land or interests in 10%+ of an Australian entity;
• acquiring an equity interest in 10%+ of an Australian entity, or a lower threshold in certain circumstances. Whether hybrid instruments are covered by FIRB turn on the types of rights conferred by the instrument (including how and when the instrument can be converted to equity).

The ‘moneylending exemption’ is applicable to interests held solely by way of security for a 'money lending agreement’ (or acquired by way of enforcement of a security held solely for the purposes of a money lending agreement). However, there is some complexity to the definition of a money lending agreement, and the related definition ‘moneylending business’ (meaning a business of lending money or otherwise providing financial accommodation). 

Whether a particular lender may utilise the moneylending exemption needs to be considered on a case by case basis, but issues can arise in the private credit space in respect of (among other things):

• the grant of rights over shares (including warrants in respect of shares) in Australian companies in connection with lending arrangements; and
• security granted to secured warrants or other non-loan related instruments.

6. Where to next?

We expect that the lending activities of private credit funds will continue to be a focus of media attention and will likely generate interest from Australia’s regulators. While some of the more prescriptive licensing obligations may not apply outside consumer lending, Australia has a regulatory regime that is flexible and requires general standards of conduct to be met whenever providing financial services. Together with ongoing reporting and AML/CTF requirements, operators of private credit funds, and those looking to enter the market, should continue to ensure that their compliance frameworks are robust and responsive to Australia’s regulatory framework.