Beyond subscription lines: fund financing trends spreading across the Atlantic
18 Sep 2019
Zoë Hallam, senior counsel and funds finance specialist in the Guernsey team of Walkers, highlights developments in fund financing
Image: Shutterstock
When we talk about “fund financing”, discussions tend to focus on subscription line facilities—the traditional “capital call” facility is the original cast member in an industry which has evolved and grown substantially over the last 15 to 20 years.
Data today suggests 90 percent or more of European closed-ended funds currently being established will intend to use a subscription line. This is a credit facility provided to predominantly closed-ended funds, including private investment funds, which is secured on the fund’s ongoing rights to call for, and receive, capital from its investors—whether for short-term equity bridge financing, liquidity and cash flow management, or for other reasons.
Based on Q1 2019 figures released by the Guernsey Financial Services Commission, and applying the same growth across all four quarters, Guernsey could see 64 new closed-ended funds launching this year, 57 of which should be looking to put in place a capital call facility. As fund size grows, so too does facility size, and at a typical 35 percent loan-to-value we have seen revolving facilities in the global market in excess of $3 billion in recent years.
Beyond subscription lines, however, there is a range of other finance products being offered to funds (both closed and open-ended) by an increasingly diverse lender base. A net asset value, or asset-backed, facility will come into play when a fund has called down capital to make investments and can provide security for its borrowings over those assets, the holding vehicles for those assets or the income stream arising from those assets. Given that a fund may need a subscription line and a NAV facility, we now see several lenders offering a “hybrid” facility—taking security over capital call rights and, as uncalled commitments decrease and assets under management increase, taking security over the fund’s underlying investments. This is a useful solution for those funds looking for a long-term facility from launch through to end of life.
And this market encompasses more than just fund borrowers. General partners are expected to have “skin in the game” and to make their commitment in cash, rather than through a waiver of their management fee, so there are opportunities for lenders to provide funding at the general partner level, security for which might be taken by way of an assignment of the general partner’s right to receive the management fee and/or security over the account into which it is paid. Similarly, fund managers are increasingly looking to provide key employees with co-investment plan opportunities, whether by way of incentive or as part of the fund’s succession planning strategy. The employee’s investment into the fund can be leveraged and its limited partnership interest in the fund secured in favour of the bank or other financial institution. We have seen numerous such transactions in the US market for a number of the large private equity houses and the trend looks to be spreading into Europe.
The fund finance market has traditionally been a relatively small and relationship-driven sector. Low-interest rates and the perceived low credit risk of the products, among other factors, has resulted in rapid growth. The number and type of leverage counterparties available to funds and other borrowers in the market are at an all-time high, with the result that lenders will be vying to launch new products and structure innovative collateral arrangements. While competition among banks and alternative lenders (such as debt funds) increases, we have also noted the emerging presence recently of debt advisers into this sector, with approximately 10 active participants in the European market.
We will wait to see what impact this has on the industry, but it is clear that for Guernsey funds looking for leverage, the market is looking favourable.
Data today suggests 90 percent or more of European closed-ended funds currently being established will intend to use a subscription line. This is a credit facility provided to predominantly closed-ended funds, including private investment funds, which is secured on the fund’s ongoing rights to call for, and receive, capital from its investors—whether for short-term equity bridge financing, liquidity and cash flow management, or for other reasons.
Based on Q1 2019 figures released by the Guernsey Financial Services Commission, and applying the same growth across all four quarters, Guernsey could see 64 new closed-ended funds launching this year, 57 of which should be looking to put in place a capital call facility. As fund size grows, so too does facility size, and at a typical 35 percent loan-to-value we have seen revolving facilities in the global market in excess of $3 billion in recent years.
Beyond subscription lines, however, there is a range of other finance products being offered to funds (both closed and open-ended) by an increasingly diverse lender base. A net asset value, or asset-backed, facility will come into play when a fund has called down capital to make investments and can provide security for its borrowings over those assets, the holding vehicles for those assets or the income stream arising from those assets. Given that a fund may need a subscription line and a NAV facility, we now see several lenders offering a “hybrid” facility—taking security over capital call rights and, as uncalled commitments decrease and assets under management increase, taking security over the fund’s underlying investments. This is a useful solution for those funds looking for a long-term facility from launch through to end of life.
And this market encompasses more than just fund borrowers. General partners are expected to have “skin in the game” and to make their commitment in cash, rather than through a waiver of their management fee, so there are opportunities for lenders to provide funding at the general partner level, security for which might be taken by way of an assignment of the general partner’s right to receive the management fee and/or security over the account into which it is paid. Similarly, fund managers are increasingly looking to provide key employees with co-investment plan opportunities, whether by way of incentive or as part of the fund’s succession planning strategy. The employee’s investment into the fund can be leveraged and its limited partnership interest in the fund secured in favour of the bank or other financial institution. We have seen numerous such transactions in the US market for a number of the large private equity houses and the trend looks to be spreading into Europe.
The fund finance market has traditionally been a relatively small and relationship-driven sector. Low-interest rates and the perceived low credit risk of the products, among other factors, has resulted in rapid growth. The number and type of leverage counterparties available to funds and other borrowers in the market are at an all-time high, with the result that lenders will be vying to launch new products and structure innovative collateral arrangements. While competition among banks and alternative lenders (such as debt funds) increases, we have also noted the emerging presence recently of debt advisers into this sector, with approximately 10 active participants in the European market.
We will wait to see what impact this has on the industry, but it is clear that for Guernsey funds looking for leverage, the market is looking favourable.
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