At the beginning of the year, several providers of private credit funds recorded significant price losses after they began restricting redemptions of fund shares. Just recently, the [Chairman of the Board of Directors of Partners Group](https://www.finews.ch/news/finanzplatz/71829-partners-group-private-equity-private-markets-steffen-meister-finanzplatz-schweiz-warnung) stated that they will implement "gating" for their private credit funds if redemptions exceed certain thresholds. Meanwhile, the [European Central Bank](https://www.ecb.europa.eu/press/financial-stability-publications/fsr/special/html/ecb.fsrart202605_04~3f2135af91.en.html) is warning of a risk of contagion to the financial system in connection with private credit products, as banks are increasingly granting loans to such funds. What happens if the private credit market runs into trouble? How can investors prepare for this? And what do investment advisors and managers of private credit investments need to keep in mind? ### What is "private credit"? "Private credit," sometimes also called "private debt," refers to loans provided outside the banking system and capital markets. They are granted directly to companies or for the financing of specific projects by private investors such as private equity firms, insurance companies, or funds. Thus, private credit solutions offer an alternative source of financing, particularly for small and medium-sized enterprises without access to capital markets. Financing via private credit is currently especially widespread among AI companies. This form of lending is particularly popular with borrowers because, unlike traditional bank loans, it offers them a high degree of flexibility and rapid financial support. Investors, for their part, benefit from returns that are usually significantly higher. ### Private Credit Funds Private credit instruments can take various forms. Specialized investment companies may, for example, establish investment funds in which they pool capital contributed by various investors. They invest either directly in companies and projects or, via a fund-of-funds structure, in target funds that in turn invest in companies. In Switzerland, these funds are generally subject to the Collective Investment Schemes Act ("CISA"). For a long time, private credit funds raised their capital primarily through institutional investors. They were often structured as closed-ended funds. To make the investment accessible to a broader audience, private credit providers have begun in recent years to structure the funds in such a way that they are also accessible to private investors. As a result, private credit instruments have become attractive investment opportunities, particularly for family offices and in asset management mandates. In the case of open-ended funds, investors generally have the right under the CISA to redeem their shares at net asset value at the expense of the collective assets. This means that they can generally withdraw their funds from the fund at any time. However, fund providers have various options for restricting these rights: 1. Restriction of the right to terminate at any time Termination dates are also permitted for open-ended funds. Pursuant to Art. 79 CISA in con-junction with Art. 109 of the Collective Investment Schemes Ordinance ("CISO"), Swiss funds must allow for redemption at least on a quarterly basis. Consequently, unless a fund is traded on a stock exchange and is liquid, an investor can only liquidate their investment after a certain delay. Pursuant to Art. 66 CISA, investors in real estate funds may request the redemption of their units at the end of a financial year, subject to a notice period of twelve months. Art. 67 CISA therefore requires, as a protective measure, that fund management companies ensure that Swiss open-ended real estate fund units are regularly traded via a bank or a securities dealer, on a stock exchange, or over the counter. 2. Gating In the case of private credit funds, the underlying loans are generally not readily tradable due to a lack of access to capital markets. If there is an increase in redemption requests during a negative market environment, the fund may face financial difficulties due to liquidity shortages. To counteract this, funds are increasingly relying on "gating" mechanisms. These mechanisms permit a pro-rata reduction of redemption applications upon reaching a specific percentage or threshold of the fund's assets on a specific valuation day. The conditions for "gating" must be set forth in the fund regulations. These protective measures are applied only under exceptional circumstances and only if they are in the interest of the remaining investors. If "gating" is implemented, this must be reported immediately to the fund’s audit firm and, if the fund is subject to FINMA, to FINMA. Investors must also be informed in a suitable manner. 3. Deferral of Redemptions In addition to "gating," the fund regulations may also provide, among other things, that redemptions may be temporarily and exceptionally deferred not only on a pro-rata basis but in full. Unlike "gating," such a deferral does not occur upon reaching specific thresholds, but rather in the event of certain emergency scenarios, including political, economic, military, or monetary emergencies, or in the event of the redemption of a large number of fund units and the resulting significant impairment of the interests of the remaining investors. This safeguard is intended to prevent emergency sales from lowering the value of the shares held by the remaining investors in the fund. In extreme cases, therefore, an investor may have to wait many years before receiving a redemption. ### What risks do private credit investments pose to investors? Following the 2008 financial crisis, banks came under stricter regulation, which led them to increasingly withdraw from riskier credit segments. Private credit providers have filled this gap. However, these providers are subject to less stringent oversight than banks. Paradoxically, stricter banking regulations have therefore actually increased the risks for investors in the private credit segment. The private credit market is currently under criticism, in part due to its popularity among AI companies. In particular, there are questions about whether loans for the construction of AI computing and data centers will generate a return on investment. More pessimistic voices are even talking about an AI bubble. If private credit funds run into trouble, the main risk for investors is that they will not be able to exit their investments, or at least not in a timely manner. While investors in open-ended funds generally have the right to redeem their units, as just explained, this right can be significantly restricted in practice. Consequently, investors risk a total loss of their investments. ### What should investors do? An investment in private credit instruments should be carefully considered. While higher returns are on the horizon, so are higher risks. Such an investment is therefore not suitable for all investors. Investors should first assess whether and what issuer risks they are assuming. Is the private credit instrument a structured product or a fund? If it is a structured product, the key questions are who the issuer is and what collateral is in place. If it is a fund, investors must be aware of the options available to fund providers to prevent or delay the redemption of fund units. We therefore recommend thoroughly reviewing the documentation for both new and existing investments. ### What risks do private credit investments pose for investment advisors and fund managers? From the perspective of private credit investment providers, the primary concern is the risk of payment difficulties or insolvency among the borrowing companies. These companies have long benefited from low interest rates and competition among lenders. Rising interest rates have caused financing costs to increase significantly, which is increasingly leading to financial difficulties for the borrowing companies. This, in turn, often results in reduced distributions to investors in private credit funds. The redemption restrictions mentioned at the outset - which certain private credit providers have implemented due to the financial difficulties of the companies they support - have already led to lawsuits by investors in some cases. For investment advisors and fund managers, the key question in light of a potential crisis is how they can minimize the risks of litigation related to private credit investments. ### What should investment advisors and managers of private credit investments do? Risk Disclosure Investment advisors are subject to strict duties of care and conduct when advising their clients. In the lawsuits already filed in connection with the redemption restrictions, it was argued, among other things, that investors suffered losses due to false or misleading information, particularly regarding the risks. Investment advisors who recommend private credit investments to their clients must therefore provide them with appropriate advice. This includes comprehensive risk disclosure. As part of this disclosure, investors in private credit funds should be explicitly informed that while open-ended funds generally allow for the redemption of fund shares at any time, there are various mechanisms in place to restrict this right. Consequently, investors face the risk that they will be unable to exit the private credit investment, or that doing so will be difficult. Due Diligence Review In the lawsuits filed against private credit providers, some were also accused of failing to adequately vet the borrowing companies. Material risks associated with the borrowing companies must generally be disclosed appropriately and in full. Accordingly, fund managers must conduct a suitable due diligence review of the companies financed by the fund. Investments in financially opaque companies should be avoided. In addition, managers should ensure that they do not invest too heavily in single, high-risk sectors or affiliated companies. If such investments are made, this must be fully disclosed to investors, and the associated risks must be explained. Calculation of Net Asset Value and Fees The precise calculation of the net asset value ("NAV") can also lead to disputes. Since private credit investments are not traded on the secondary market, the managers of such funds have considerable discretion in valuing the investments. Such valuations are often not reviewed in a timely manner. This problem is exacerbated by the fact that the calculation of the NAV can influence the fees charged by fund managers, which may give rise to conflicts of interest. To prevent disputes, it is advisable to perform the calculations regularly and according to a transparent, comprehensible methodology. The NAV must accurately reflect the portfolio values. This should be reviewed regularly. The basis for calculating the fees earned by investment advisors or managers must also be disclosed. Any conflicts of interest must be prevented to the extent possible and communicated to clients. Inability to Pay and Insolvency of Borrowing Companies Even the best due diligence conducted by fund managers on borrowing companies cannot entirely rule out their subsequent insolvency or bankruptcy. In addition to risk disclosure, it is therefore recommended that fund managers promptly engage restructuring or insolvency attorneys at the first signs of payment difficulties and proactively assess options for action and possible scenarios. This also involves assessing the risk of legal challenges should a company continue to make repayments to individual lenders while it is already in financial distress. As a fund provider, it is essential to avoid making repayments to fund investors, as the fund could subsequently face claims for reimbursement from the company’s bankruptcy liquidator. Experience shows that it is often more cost-effective to prepare proactively than to react during a crisis. Our [Banking](https://www.vischer.com/services/banking-and-finance) and [Insolvency Law](https://www.vischer.com/services/restructuring-and-insolvency) team is happy to assist you with a comprehensive review of potential measures, their development and implementation, as well as any other questions you may have. The content is provided for informational purposes only and does not constitute investment advice, financial analysis, or a solicitation to buy or sell financial instruments. **Authors**: Jana Essebier, Ria Gurtner

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