Exclusive Op-Ed for Fixed Income News Australia by Andy Armstrong, Co-Head of Whole Loans and Capital Markets at Challenger Investment Management
In structured finance, vehicles are designed to be bankruptcy remote. Structural separation protecting investor capital from the fortunes of an originator is what securitisation is. But there is an important corollary: while legal structures should be remote, due diligence never should be.
Data tapes, eligibility criteria, and covenant reporting are necessary, but not sufficient. Truly effective diligence requires proximity. Walking the floor of an originator’s office. Sitting across the table from the people making lending decisions. Understanding not just what the numbers say, but whether the culture, the business model, and the motivations behind them hold up under scrutiny.
The recent cases involving MFS Investment Management and Tricolor Auto Group are a timely reminder that even well-established diligence frameworks must be continually tested, challenged, and upgraded to reflect new risks. They are also a useful prompt to step back and ask what good diligence actually looks like.
The Underlying Issue
The MFS and Tricolor cases both involved the double pledging of assets. Loans or receivables already pledged to one funding vehicle were simultaneously pledged to another, inflating the apparent value of collateral pools. The mechanism was simple and, in hindsight, detectable.
The consequences for investors were material and the reputational impact on the broader private credit market significant, prompting legitimate questions about the controls framework underpinning warehouse and securitised lending.
However, double pledging was a symptom, not the root cause. The underlying issue in both cases was the lender itself: its motivations, the way it was running the business, the types of borrowers it was attracting, and the commercial pressures it was operating under. A data tape will not reveal those things. Understanding who you are really lending alongside, and what is driving their behaviour, requires the kind of diligence that cannot be done remotely. It demands direct engagement with the originator’s people, processes, and culture.
An Industry Coming Together
The industry’s response has been constructive and collaborative. The ASF in Australia, AFME in Europe, and the SFA in the United States have each mobilised working groups to review existing frameworks and develop enhanced best practice. In Australia, the ASF is producing guidance that is descriptive rather than prescriptive, recognising that effective controls must be adapted to different asset classes and originator models.
The collective view is encouraging: this is a market committed to learning from recent events, retesting its assumptions, and upgrading its diligence practices. It is also a recognition that diligence is not static. What constituted best practice three years ago may no longer be sufficient today.
An important insight from these discussions is that neither annual financial statement audits nor the traditional trustee and custodian framework are designed to detect deliberate fraud. A controls-based approach, embedded in a purpose-built AuP engagement, is the more effective tool, and one the industry is now moving to adopt more broadly.
What Good Diligence Looks Like
In our experience, the strongest diligence frameworks share a small set of common features.
The first is genuine independence. Credit assessment is most effective when it sits in a governance layer separate from the investment team, a dedicated second line of defence reporting to a Chief Risk Officer rather than to the people originating the deal. When findings reach the investment committee unfiltered, and separately from the investment proposal, the credit assessment maintains its independence and impartiality.
The second is depth born of repetition. Onsite loan file reviews, cyber assessments, and regulatory and operational diligence conducted across dozens of lending platforms build something no data tape can: pattern recognition. It sharpens the sense of what good practice looks like in practice, not just on paper, and it means operational weaknesses can often be spotted before they become problems.
None of this is novel. It is simply what diligence looks like when it stays close to the business it is assessing.
Where Diligence Goes Further
In response to recent events, five areas stand out where diligence has been going further. None are new ideas. Each reflects a recentering of best practice rather than any single firm’s playbook. There is also value in the expertise of specialist third-party due diligence providers, especially those with international experience across Australia, New Zealand, and Europe which can bring a perspective shaped by dozens of originator reviews.
First, whole-of-book reconciliation. This looks beyond any individual trusts an investor is directly exposed to. The most direct defence against double pledging is obtaining the lender’s complete data tapes across all funding vehicles and systematically checking for duplicate loan identifiers, borrowers, and security addresses at the population level, not just the sample.
Second, ongoing independent title verification. Loan identifiers are spot-checked against the relevant titles registry on a random, unannounced basis. Done on-site, or via live screen-share with the originator’s systems, it keeps diligence close to the business rather than remote from it.
Third, independent AML and PEP screening. Rather than relying solely on an originator’s internal compliance processes, politically exposed persons and sanctions screening can be verified independently.
Fourth, system-level controls. Informed by emerging best practice from the UK, this examines how loans are tagged and segregated across funding vehicles, who has access to change loan ownership attributes, and whether those access rights are regularly reviewed. It takes diligence beyond data outputs to the integrity of the system itself.
Fifth, settlement and cash flow audit. Understanding how originators interact with their solicitors; how settlement cash is moved, tracing payments from borrowers through collections accounts to note; understanding who their auditors are, and the scope of those audit engagements completes the picture. It is the full operational chain, not just the loan file, that keeps diligence genuinely close to the business.
Staying Close
Private credit continues to grow, and diligence frameworks need to grow with it, not just in response to events, but as a matter of ongoing discipline.
Bankruptcy remote structures are what our industry does well. The harder task is making sure due diligence never becomes remote as well.
