Takeaways From The 11th Annual Global Fund Finance Symposium – Finance and Banking

Marion Steward


United States:

Takeaways From The 11th Annual Global Fund Finance Symposium


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On February 16-18, 2022, the Fund Finance Association reconvened
for its 11th Annual Global Fund Finance Symposium
in Miami where market participants gathered to discuss the latest
developments in global fund finance and to consider the outlook for
the industry in 2022 and beyond. Below is a summary of our key
takeaways from the conference.

  • Market Update — The year 2021 saw a
    record level of fund financing activity. The pace of fundraising on
    the sponsor side accelerated in 2021 and, with it, interest in fund
    financing solutions. Subscription facilities have become essential
    working capital products used by an ever-increasing number of
    private funds from their initial formation through and sometimes
    beyond their investment periods. Conference participants expect
    deal volume to continue to increase in 2022, particularly in
    subscription lines and NAV facilities. Fund structures are become
    increasingly complex, including from greater use of alternative
    investment vehicles, co-investment funds, “side pockets”
    for certain categories of investments (e.g., distressed), warehouse
    vehicles and series limited partnerships.In light of this
    complexity, sponsors and their legal counsel should seek to ensure
    that the fund’s organizational documents provide sufficient
    flexibility to obtain appropriate financing for these structures at
    the outset to avoid having to go back to investors for
    amendments.

  • Effect of COVID-19 — The global pandemic
    gave the fund finance industry a chance to prove its resilience and
    flexibility. Conference participants agreed that, while some
    borrowers had difficulty obtaining funding at the start of the
    pandemic in early 2020, most lenders were able to deliver flexible
    and creative solutions to their borrowers’ liquidity needs,
    including temporary upsizes to existing facilities, the addition of
    qualified borrowers and NAV and hybrid facilities. By the end of
    2021, the fund finance market exceeded its pre-pandemic level and
    continues to grow with new entrants and more complex financing
    structures. On the lender side, competition has increased since the
    start of the pandemic, resulting in lower margins, higher advance
    rates and riskier structures, forcing lenders to consider what
    products they should focus on to set themselves apart.

  • Alternative Lenders — Alternative
    financing sources, such as private credit funds and insurance
    companies, have demonstrated enormous interest in acting as lenders
    in fund financing transactions. Since they generally require a
    higher return than banks and have more flexible risk appetites,
    alternative credit providers will likely find their niche in more
    bespoke structures, including NAV and preferred equity facilities,
    rather than subscription lines. For sponsors, the entry of
    alternative lenders into the fund finance space brings both
    opportunities and risks.Sponsors should bear in mind the
    implications of sharing confidential information (such as the
    identities of LPs) with alternative lenders and should ensure that
    the loan documents provide sufficient notice and consent rights
    with respect to potential assignments and participations by
    lenders.

  • “Fund Finance 2.0”
    Conference participants discussed the evolution of the fund finance
    market from its origin in simple “bridge” subscription
    facilities to today’s variety of dynamic, solution-focused
    products. Several factors have driven the growth of non-traditional
    fund finance products, including the financing challenges created
    by the pandemic, increasing familiarity and comfort with fund
    financing on the part of sponsors and investors, greater complexity
    of fund investment structures and the entry of alternative
    financing sources. While many traditional lenders have been slow in
    offering these products, one panelist expects that, once these
    lenders gain confidence in their long-term durability, the growth
    will be exponential rather than linear. Some of these structure
    include:

    • Rated note feeders— This structure was
      designed to enable sponsors to raise capital from insurance
      companies in the form of rated notes (typically pay-in-kind) that
      are treated more favorably, as compared to equity investments,
      under capital requirement regulations applicable to insurance
      companies. A fund’s subscription facility must allow inclusion
      of the insurance companies’ commitments to purchase the rated
      notes in the borrowing base similarly to equity capital
      commitments. For lenders, these structures may carry some risk
      since the enforceability of the insurance companies’ note
      commitments in the event of a bankruptcy of the fund may be unclear
      or untested in the relevant jurisdiction. These risks may be
      mitigated by incorporating an investor’s note commitment into
      the fund’s partnership agreement or other organizational
      documents. As a result, it is crucial for fund managers to engage
      with subscription facility lenders early on in the process to
      ensure that an investor’s note commitments will be included in
      the borrowing base, including in circumstances in which the note
      commitment may convert into equity.

    • Hybrid facilities— Under hybrid
      facilities, borrowing capacity is based on both investor’s
      uncalled commitments and the fund’s net asset value (NAV),
      theoretically extending the term of the facility from “cradle
      to grave.” Despite their attractiveness to sponsors, many
      lenders struggle to provide these facilities given the bifurcated
      collateral packages, which are typically covered by separate credit
      review processes and underwriting teams. However, lenders that can
      successfully coordinate these teams internally are able to provide
      a flexible financing product that is well suited to every stage of
      a fund’s life cycle.

    • NAV facilities— The use of NAV
      facilities, which were traditionally utilized primarily by
      secondary funds, took off during the pandemic.  New to the
      product, private equity buyout funds began to use NAV facilities to
      provide liquidity to struggling portfolio companies in legacy
      funds, as well as to fund add-on acquisitions and even
      distributions. With a limited number of assets, these
      “concentrated NAVs” are often too risky for commercial
      banks and thus have been provided primarily by alternative lenders.
      In the secondaries market, the use of NAV facilities also
      skyrocketed in 2021, with these facilities still provided primarily
      by commercial banks and requiring a minimum level of
      diversification in the portfolio. With the growth of secondary
      funds sizes, lenders are being asked to write bigger checks,
      requiring banks to rely more heavily on syndication, including to
      insurance companies that have been entering the space in increasing
      numbers. Secondaries’ NAV facilities are also seeing greater
      interest from LPs and family offices that started to look into
      these facilities as a way to leverage their own portfolios.

    • Preferred equity— Typically used as an
      alternative to a NAV facility, preferred equity may be issued at
      the fund or aggregator level. While preferred equity (unlike debt)
      does not have a fixed maturity or require regular cash interest,
      investors may obtain a preferred dividend “ratchet”
      and/or the right to force a sale if the preferred equity is not
      redeemed within a certain period. Preferred holders are entitled to
      receive a percentage of future distributions (e.g., when the fund
      sells an underlying portfolio investment) in accordance with a
      waterfall set out in the preferred equity documentation. Although
      more expensive, preferred equity may be preferable to debt given
      the longer horizon, PIK dividends and fewer restrictive covenants
      as compared to debt.

    • GP financing— GP financing, i.e.,
      financing secured by the GP’s capital and carried interests in
      the underlying funds, is used by GPs to get liquidity without
      selling their GP stake. Although panelists agreed that this type of
      financing is still very much in its early stages, at least one
      panelist made the bold prediction that the volume of GP financing
      transactions will surpass the volume of GP stakes deals in the near
      future.


  • Single/Separate Managed Accounts (SMA) Funds
    — SMA funds (also known as “funds of one”) are
    becoming increasingly common as GPs seek to build relationships
    with large institutional investors, who are attracted to SMAs for
    their greater input into investment decision-making and tax or
    regulatory advantages (as compared to commingled vehicles). To
    mitigate the risk associated with relying on a single
    investor’s commitment, subscription lenders conduct greater due
    diligence and require enhanced documentation from investors, such
    as investor letters that give the lender contractual privity with
    the investor. Lenders also run lien searches to ensure that the
    investor’s limited partnership interest is not back-levered and
    tighten events of default and investor transfer restrictions in the
    loan documentation. Having been pressure-tested during the
    pandemic, the SMA and “fund of one” sub-line seem to be
    here to stay.

  • Effect of Fraud Cases — As Ropes &
    Gray has previously discussed, the potential for fraud in fund
    finance transaction brought to light by the Abraaj and
    JES Global cases has ultimately had limited impact on the
    subscription finance segment. One lender-side participant at the
    conference mentioned attempting to run a more intensive due
    diligence process on an existing sponsor client after JES,
    only to be emphatically rebuffed by the sponsor. On the other hand,
    lenders are conducting more intensive diligence on new
    fund sponsors than they had historically, including verification of
    the identities of LPs and obtaining confirmation from LPs of their
    specific fund commitments. Notably, lenders report that LPs have
    been constructive in cooperating with this process, presumably
    because they have a shared interest in minimizing LP default risk.
    Ultimately, while panelists noted that while fraud will always
    remain a risk, actual instances have been exceedingly rare and the
    risk remains highly remote, particularly for established
    sponsors.

  • ESG — Both sustainability-linked and
    “green” use of proceeds facilities have accelerated in
    Europe in the past two years though, even there, there is not yet a
    wholesale shift in incorporating these into fund financings. In the
    U.S., while these products are far less common, investors are
    certainly focused on ESG considerations. Nevertheless, as one
    panelist remarked, ESG-related finance is still in its “first
    inning” and investors and LPs remain focused on a fund’s
    ESG strategy and mission broadly rather than how that strategy
    plays into fund-level financing specifically. The risk of
    “greenwashing” remains a concern, especially as there is
    still no market standard for setting or measuring KPIs. However,
    panelists were optimistic that achieving such standardization is
    only a matter of time and that, as more comps come to market and
    participants as a whole become smarter on this topic, investors
    will embrace the advantage of potential savings in funds’ costs
    of capital. (For additional information on Ropes & Gray’s
    ESG practice generally, and sustainability-linked debt
    specifically, please refer to our ESG practice homepage and our podcast on ESG-linked debt.)

  • LIBOR Transition — In the fourth quarter
    of 2021 and continuing into early 2022, lenders have been
    accelerating the process of transitioning their portfolios from
    LIBOR to alternative rates. While most lenders have adopted CME
    Term SOFR as the fallback, some lenders continue to explore various
    “credit-sensitive” rates or, in some cases, simply the
    “prime rate”.With the widespread transition to Term SOFR,
    the main point of contention has been whether to add a credit
    spread adjustment (CSA) on top of the margin. While the syndicated
    market has been increasingly adopting a no-CSA approach, lenders
    under bilateral and privately placed facilities have sought to
    maintain a CSA, whether tiered (as contemplated by the original
    ARRC “hardwired” fallback provisions) or flat.One
    panelist noted that, without a CSA, lenders may seek to limit
    borrowings to a one-month interest period while, if there is a CSA,
    they are more likely to be comfortable with one-, three-, or
    six-month periods. The lack of market consensus on spread
    adjustments creates complexities for asset-liability matching,
    particularly for credit funds whose assets and liabilities may use
    different benchmarks, or use the same benchmark but with spread
    adjustments. While the market is expected to move toward a
    consensus during 2022, the current lack of consistency is causing
    enormous frustration on the part of sponsors.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.

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