Feb 01, 2024 ESG

The road ahead for direct lending

Supporting transformation and sustainability ambition

Michael Verhoeven

Michael Verhoeven

Product Specialist
Maria Milina

Maria Milina

Research Analyst
Michael Lewis

Michael Lewis

Head of Research, ESG
  • The size of the private debt market globally is expected to grow to an all-time high of US$2.8 trillion by 2028 with direct lending constituting roughly half of the total debt market
  • Direct lending offers financing opportunities for the European transformation, such as in the digital transformation, where small- and medium-sized enterprises play an important role
  • From a geographical perspective, Benelux and the Nordics are catching up with the traditional direct lending core markets of the UK, France, and Germany
  • Geopolitical risk and muted economic growth have meant the sector focus for direct lending has been skewed towards non-cyclical sectors with technology and healthcare dominating the deal pipeline. A pick-up in lending to consumer facing sectors is now beginning to emerge
  • We expect margins in direct lending to follow the repricings seen in the liquid market implying further tightening ahead . The driving force behind a more aggressive pricing strategy is the demand for deals that is anticipated to far exceed supply
  • Sustainability linked loans have also become a route to support sustainability ambition among lenders and borrowers. These introduce certain KPIs such as carbon emisison reduction or energy efficiency targets to the borrowing costs of the loan
  • Efforts are underway to improve sustainability data collection, monitoring and verification which should introduce more transparency into the sustainability linked loan market where issuance has dropped significantly since its 2021 peak


The direct lending market has witnessed strong growth over recent years. In this article, we outline our assessment for the year ahead. We show how the direct lending market is evolving into an important financing vehicle to support the transformation of small- and medium-sized enterprises across multiple sectors of the European economy.

This paper is organised in three sections: the first examines the size and market opportunities for the direct lending with a particular focus on sector deals. The second section explores the prospects direct lending can provide for the European transformation, highlighting the leadership of the Nordic region when it comes to the renewable energy and digital transformation.

The final section assesses the characteristics of the sustainability loan market which offers the possibility that direct lending strategies can deliver real world sustainability outcomes such as greenhouse gas emission reduction. We also highlight the challenges with tracking and verifying company performance against specific key performance indicators that need to be addressed to support the long-term growth prospects for this market.

1 / Market size and outlook

According to industry estimates[1], the size of the private debt market globally is expected to grow to an all-time high of US$2.8 trillion by 2028. In terms of composition, direct lending constitutes approximately half of the global private debt market with the remainder of the market made up with instruments such as distressed and mezzanine debt.

Market activity

Direct lending demand is driven primarily by private equity. In the past few months, the private equity landscape has been confronted with several challenges. Geopolitical instability, political uncertainty, and a gloomy economic outlook have all affected valuations of companies and their ripple effects are still being felt[2]. Exits take longer as a greater valuation discrepancy persists, and market sentiment remains muted. While it is true that private equity is experiencing a trying period, funds are still able to allocate and have found creative ways to generate liquidity and performance in periods of market stress[3].

Although returns for private credit can currently yield more than private equity according to some sources, the mutual dependency warrants a more differentiated perspective on the state of private markets rather than a simple snapshot[4]. The uptick in activity in the fourth quarter of last year can serve as a positive sign of more deals to come, which should translate into more deals on the private credit side. Calls that private equity is not as relevant as before and that private credit is going to play a larger role seem premature and, given their relationship, misplaced. The recognition of private credit as an attractive asset class does not have to precipitate a reevaluation of private equity’s value. The asset classes are intertwined and rely on one another to differing degrees and should be examined accordingly. Private credit certainly does not have to shy away from any comparisons with other credit instruments given its attractive return and enduring value amid turbulent markets.

Sectors bias towards non-cyclicals

The trend that non-cyclical sectors are still in vogue has intensified in the European direct lending landscape. Hence, securing funds for other sectors has become even more challenging, for example, sectors that are consumer facing[5]. Chemicals have also been affected by a more cautious approach of lenders who are prioritizing stable businesses[5]. However, looking ahead, DWS analysis indicates that although non-cyclical sectors are still dominating the deal pipeline, change is afoot and more deals are being set up or struck in the consumer sector.

Sector agnostic perspective on the market may play out in General Partners favor to ensure that the best relative value is the driving force behind sourcing and structuring deals, instead of blindly following the trend of defensive features. However, geographical differences apply, high margins and the selective approach are making direct lenders look expensive. Meanwhile, banks are staging a comeback, especially in the lower mid-market, trying to claw back some of the market share they have lost in recent years[6]. As a result, sector diversification and fending off competition from banks can be strong arguments for re-assessing the credit worthiness of sectors and their associated risks. Nimble private debt lenders may salvage this momentum to lend to strong businesses in ‘weaker’ sectors. The speed and flexibility of private debt gives lenders more options to explore more cyclical sectors, because pre-cautionary measures can be taken, and tailor-made agreements can be fashioned at ease.

Caution in an uncertain macroeconomic backdrop is understandable and prudent. However, it should not lead to presumptive assumptions about business models operating in ‘riskier’ sectors, as each deal depends on the individual nature of the business and the deal structure. Factors such as market position, business model within the value chain, quality of management and strength of cash-flow profile should be considered first. Other key aspects for the risk assessment are sponsor commitment, leverage levels and the strength of covenants.


More topics

Discover more

1. Preqin, Future of Alternatives 2028 Report

2. LCD, European bond issuance slumps to post-GFC October low amid rate volatility, November 2023

3. EY, Private Equity Pulse: key takeaways from Q4 2023, January 2024

4. BNN Bloomberg, Private Credit Is Giving Investors Better Returns Than Private Equity, December 2023

5. LCD (November 2023). Higher interest costs to keep default rates elevated, rating agencies agree

6. LCD (December 2023). European direct lenders target popular sectors, opening door for banks

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