According to Financial Times News, UBS chair Colm Kelleher warned at the Hong Kong Monetary Authority’s Global Financial Leaders’ Investment Summit that insurers are creating “looming systemic risk” through ratings arbitrage on private credit assets. Speaking on Tuesday, Kelleher specifically criticized US insurers for engaging in practices similar to those seen with subprime loans before the 2008 financial crisis, noting that smaller rating agencies are providing “private letter ratings” visible only to issuers and select investors. The warning comes as the Bank for International Settlements last month indicated that ratings on private credit assets held by US insurers might be inflated, raising concerns about potential fire sales during financial stress. Recent bankruptcies of subprime automotive lender Tricolor and car parts company First Brands have intensified scrutiny of these opaque practices in the rapidly growing private credit industry.
Dangerous Parallels to Pre-Crisis Behavior
What makes Kelleher’s warning particularly alarming is how closely it mirrors the conditions that preceded the 2008 global financial crisis. The fundamental mechanism remains unchanged: financial institutions seeking higher yields while maintaining regulatory compliance turn to complex instruments with questionable underlying quality. The shift from publicly traded securities to private credit arrangements represents an evolution in form rather than substance. When Kelleher states “in 2007 subprime was all about rating agency arbitrage,” he’s identifying the same core vulnerability—the gaming of regulatory capital requirements through creative ratings rather than genuine risk assessment.
The Structural Weaknesses in Private Credit
The private credit market’s explosive growth to over $1.7 trillion creates systemic vulnerabilities that extend far beyond insurance balance sheets. Unlike publicly traded corporate bonds with daily pricing and transparent liquidity, private credit instruments often lack standardized valuation methodologies. This opacity becomes particularly dangerous during stress periods when multiple institutions might simultaneously attempt to exit positions, discovering there’s no functioning secondary market. The Bank for International Settlements warning about potential fire sales highlights how illiquidity can transform individual portfolio problems into system-wide contagion.
Regulatory Gaps and Supervisory Failures
Current regulatory frameworks appear fundamentally unprepared for the private credit boom. The proliferation of “private letter ratings” creates information asymmetries where regulators cannot adequately assess aggregate exposures or concentration risks. When smaller rating agencies capture market share by providing favorable assessments, it represents a classic race to the bottom in credit quality standards. The situation echoes the SEC’s struggles with mortgage-backed securities before 2008, where regulatory frameworks failed to keep pace with financial innovation. The fundamental question remains whether regulators can effectively monitor risks they cannot see.
Why Insurers Are Particularly Vulnerable
Insurance companies represent a uniquely dangerous vector for systemic risk due to their combination of long-duration liabilities and regulatory capital requirements. The search for yield in a low-interest-rate environment has pushed insurers toward private credit as traditional fixed income returns diminished. However, the mismatch between insurers’ need for liquidity to meet policyholder claims and the inherent illiquidity of private credit creates a ticking time bomb. When claims surge during economic downturns—exactly when private credit markets typically freeze—insurers may face impossible choices between regulatory capital breaches and fire sales of illiquid assets.
Beyond Insurance: Contagion Pathways
The systemic risk extends well beyond the insurance sector through multiple transmission channels. Pension funds, endowments, and other institutional investors have similarly increased private credit allocations. Banking sector exposure comes both through direct lending and through financing arrangements with private credit funds. The interconnectedness means that stress in insurance portfolios could rapidly spread through collateral calls, margin requirements, and counterparty risk. The real economy would feel the impact through reduced credit availability exactly when businesses most need financing during economic contractions.
What Effective Regulation Would Require
Addressing this systemic threat requires more than incremental adjustments to existing frameworks. Regulators need authority to access all ratings—including private letter ratings—and mandate standardized disclosure of valuation methodologies. Capital requirements must better reflect the liquidity risk embedded in private credit holdings, potentially through stress testing that includes simultaneous liquidity and credit events. Most importantly, regulators must overcome the political pressure for “faster economic growth” that Kelleher identified as conflicting with effective oversight. The lessons from 2008 about the dangers of regulatory arbitrage appear to have been forgotten precisely when they’re most needed.
