Private credit has become a mainstream asset class in Australia, particularly in the current yield-seeking environment. With traditional fixed income struggling to meet investor return expectations, private lending strategies, often promising stable income and downside protection, have attracted significant capital.
But not all private credit is structured the same way. Some funds introduce an additional layer of complexity by lending to related-party borrowers. That’s where the risk conversation gets more serious.
This article explains how related-party lending operates in private credit funds, the risks it creates, and what investors should be asking before committing capital.
What Is Related-Party Lending?
Related-party lending occurs when a private credit fund extends loans to an entity that is connected, directly or indirectly, to the fund manager or its affiliates. This could include subsidiaries, associated businesses, internal property developments, or companies sharing key personnel with the manager.
This doesn’t automatically signal misconduct. But the structure carries inherent tensions that investors should understand.
Consider a straightforward example: a fund manager who also operates a property development firm. The fund lends to that firm’s latest project. The manager collects fees from both sides of the transaction while simultaneously representing investors and maintaining ties to the borrower. That dual position is where objectivity can be compromised.
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Why Related-Party Lending Can Be Problematic
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Conflicts of interest
This is the most significant concern, and often the most understated, in offering documents. When a fund manager sits on both sides of a transaction, representing investors while also having ties to the borrower, the alignment of interests can shift.
Rather than optimising purely for investor outcomes, decisions may begin to favour the stability or success of the related entity. This isn’t always intentional. But the risk is structural, and structural risks have a habit of surfacing at the worst possible time.
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Reduced due diligence standards
Rigorous credit assessment typically involves stress-testing cash flows, scrutinising collateral, and negotiating terms from a position of healthy scepticism.
With related-party borrowers, that scepticism can erode. Familiarity with the business leads to assumptions replacing verification, a subtle shift in mindset that can materially affect credit quality. When due diligence becomes less adversarial, weaknesses tend to go undetected until they become problems.
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Less favourable loan terms for investors
Related-party loans can carry terms that are more accommodating to the borrower than a genuinely arm’s-length transaction would produce. This might manifest as weaker collateral requirements, higher loan-to-value ratios, softer covenants, or reduced enforcement rights.
Individually, these concessions may appear minor. Collectively, they shift the risk profile of the fund in ways that disadvantage investors. There’s also a concentration risk dimension: if a meaningful portion of the portfolio is tied to related entities, underperformance within a single group can have outsized consequences for the broader fund.
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Inadequate transparency
Australian regulations require disclosure of related-party transactions, but the quality and depth of that disclosure varies considerably in practice.
Some funds provide substantive breakdowns: naming borrowers, clearly articulating the nature of the relationship, and explaining how conflicts are managed. Others bury related-party disclosures in dense offering documents with broad, non-specific language.
That ambiguity is itself a risk. Investors cannot price what they cannot see.
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Impact on Investors
These structural risks translate into real-world outcomes. Compromised lending standards increase the likelihood of defaults. Even when loans don’t default outright, performance can lag expectations through restructures, delays, or covenant breaches that erode returns over time.
There is also a confidence dimension. Once an investor begins to question the independence of a fund’s decision-making process, it becomes difficult to evaluate any individual outcome in isolation. Doubt compounds.
In more severe cases, capital loss is not a theoretical concern; it becomes an experienced one.
Regulatory and Governance Considerations
ASIC has clear guidance on conflicts of interest and related-party arrangements: they must be transparent and conducted on arm’s-length terms. Fund managers operating in Australia are required to disclose these relationships and demonstrate that they are managed appropriately.
But regulation sets a baseline. It does not eliminate risk on its own. That is where governance structures become important.
Independent trustees, external investment committees, and formally documented conflict-of-interest policies can each serve as meaningful counterweights. Investors should ask specifically: Can the fund’s independent directors veto a related-party loan? Are external valuations obtained before related-party transactions are approved? If the answers are vague or unavailable, that is itself informative.
Red Flags Worth Watching
A few indicators tend to repeat across problematic structures:
High portfolio concentration in related entities. If a significant portion of the fund’s loans are internally connected, the risk profile is fundamentally different from what a diversified private credit mandate implies.
Absence of independent oversight. Funds where key lending decisions are made by a small group of insiders, without independent review or veto rights, warrant heightened scrutiny.
Opaque disclosure. If the documentation around borrower relationships is vague, simplified beyond usefulness, or difficult to locate within the offering materials, ask why. Transparency is a deliberate choice. So is the absence of it.
What Investors Can Do
Navigating these risks doesn’t mean avoiding private credit altogether; it means being selective about where capital is placed.
Funds with clearly articulated and enforceable conflict-of-interest policies offer a stronger foundation. Independent governance structures with genuine authority over investment decisions, not merely advisory roles, provide meaningful additional protection.
Diversification across unrelated borrowers reduces the impact of any single failure, which matters particularly in less liquid asset classes where exit options are limited.
Most importantly, investors should be willing to ask uncomfortable questions. How a manager responds, the specificity, the openness, and the willingness to be held accountable, often reveal more than the formal disclosures ever will.
Conclusion
Related-party lending in private credit is not inherently impermissible. But it demands a materially higher standard of transparency, governance, and independent oversight than arm’s-length lending. Where those standards are absent or unclear, the risks to investors are real.
For those navigating the Australian private credit landscape, assessing these factors carefully is not optional. It is fundamental to protecting both returns and capital.
If you’re evaluating private credit opportunities and want clarity around structure, governance, and risk, speak with Rixon Capital. Our team works closely with investors to design tailored private credit strategies aligned with their objectives. Visit rixon.capital to start the conversation.
