Private credit - non-bank lenders that provide loans directly to businesses outside of public markets - has been warned to lift its standards or face more stringent regulation by the outgoing chair of the Australian Securities and Investments Commission, Joe Longo.
As he released a roadmap detailing how the watchdog plans to boost investment in the nation's public and private markets, Mr Longo said ASIC has already witnessed several missteps and failures in the opaque sector.
"If we fail to address the risks building in this sector, we could very well see our own 'Minsky moment' in Australia with a market collapse," he told the National Press Club on Wednesday.
"In times of prosperity when money flows freely, no one worries about liquidity. However it's the first thing everyone will miss in a crisis."
A "Minsky moment" refers to a sudden collapse in asset values after a long period of prosperity lulls investors into underestimating financial risks.
Private credit funds are estimated to have grown by more than 500 per cent in the past decade.
ASIC says there are positives to the growth of private markets, such as increasing the availability of "patient", long-term capital.
But while some participants demonstrated strong practices, ASIC also witnessed many examples of poor practices that risked eroding confidence in the sector and hindered its development.
"We need to see a significant uplift in practices and if the sector can't get this right, law reform may be required - introducing new, mandatory obligations to lift standards and address poor consumer outcomes," Mr Longo said.
"More rules would not be my first choice, however, if poor practices undermine the integrity of this sector as it grows we may be left with no other option."
Coinciding with the growth of private credit is a decline in companies pursuing initial public offerings on the stock market.
Mr Longo says private companies were making the most of "regulatory arbitrage", shying away from public listings to reduce the need for onerous reporting requirements, which public company directors argue are making their jobs increasingly difficult.
Australia needed to seriously think about where to draw the line between public and private companies, and even consider introducing a tiered system for reporting requirements based on company size.
"Why is it that a small cap biotech with less than $10 million in turnover has the same remuneration reporting requirements as our largest mining company, BHP, with a turnover of $80 billion?" Mr Longo asked.
"Or have more corporate reporting requirements than the operator of Sydney Airport, a company with over $2 billion in turnover, which is critical to growth and prosperity, and which millions of Australians are invested in through their superannuation?
"Is this really the right balance?"
The regulator will also increase its scrutiny on troubled stock exchange operator ASX.
The value of equity raised in public listings has fallen by 82 per cent in the past decade, with ASIC saying a lack of confidence in the share market operator was a significant factor.
ASIC in October gave the green light to US-based market operator Cboe to provide listing competition to the Australian Securities Exchange by allowing an alternative exchange.
But Cboe threw a spanner in the works at the weekend when it announced it was putting its Australian arm up for sale.
ASIC vowed to work closely with Cboe through the sale process to find a suitable buyer.
The Australian Banking Association, the Association of Superannuation Funds of Australia and the Financial Services Council welcomed ASIC's continuing work to strengthen oversight of private markets.
