Our Thoughts on the 13th Annual Global Fund Finance Symposium

Introduction

The Fontainebleau Hotel in Miami Beach was the venue for the 13th Annual Global Fund Finance Symposium, organised by the Fund Finance Association (FFA), from 26-29 February 2024. The symposium was a huge success, attracting almost 2000 delegates and more than 130 sponsors from the global fund finance community. The agenda covered a wide range of topics, from current trends and legal developments to industry forecasts and best practices.

The symposium was an excellent opportunity for attendees to learn, network and reconnect with peers and experts in the field. Our global Fund Finance team was delighted to attend and support the symposium as Gold and Wi-Fi sponsors. Associate Robin Gibb shared his insights on the Rated Note Feeders panel, and I was honoured to deliver the symposium’s opening remarks.

Our team has summarised some of the key takeaways from the amazing panel discussions that we attended.

PANEL: Post-Regional Banking Crisis Market Update

• The initial reactions from the bank failures were from limited partners looking to move money out of the banks and concerns whether their money would be FDIC insured.
• Currently, the market feels very settled and healthy. The middle market managers continued to be underserved and many regional banks are looking to expand their business whereas others may be looking for higher deposits. Many new lenders are coming into the space but very much with the same approach and key personnel.
• Mixed approach on 100% uncommitted vs committed facilities. The lenders offering 100% uncommitted facilities have been able to get their client comfortable, noting that all requests have been fulfilled. Other lenders have been offering a combination of both committed and uncommitted given that there is not a significant difference in capital charge so uncommitted is not preferred by the general partners.
• The regional banks do not have the ability to commit to large facilities, therefore their strong suit is their creativity, as such deepening the relationship between the general partner and the lender.
• Also depending on the SMA, the general partner would prefer to work with the regional banks as they can have more open discussions on the strategy and borrowing base.
• Subscription line facilities continue to have significant benefit due to its ability to access quick liquidity of cash and that doesn’t seem to be decreasing the near future.
• Non-bank lenders could be disrupters in the market given their cash flow. It will be interesting to see how this will play out with tighter restrictions coming into play. Especially if lenders are looking for 30-40% cash deposits, that it’s simply not feasible for the general partners. The idea of the subscription lines is to be cheap quick cash.
• Regional banks have and will absolutely continue to have a vital role to assist with SMAs and providing unique borrowing base if they continue to engage with the general partners and understand their needs and provide a credit facility based on that understanding.

Lessons Learned from the Regional Banking Crisis

• Communication was key with the general partners and understanding their liquidity needs.
• In addition to the lender’s relationship with the general partners, they were concerned about their own personnel; it’s all about the relationship at every stage. Those relationships were vital during the crisis as everyone was working together to find a way through and gather the little information that was readily available.
• Generally, there was a significant amount of uncertainty around the payment mechanics and whether borrowing requests would be fulfilled. It important to note that every borrowing request was honoured in full.
• Going forward, the market may see a shift from the long-standing relationship with particular lenders to a diversity of lenders and financing providers including opening accounts across many institutions.
• Overall, the subscription lines continue to be a safe product with the support of credit committees.  The industry was not impaired from this event and the well-established relationships enabled the market to stabilise and not overreact.

PANEL: Subscription Finance Hot Topics

• The panel discussed a broad range of topics but a key message throughout was that in a difficult fundraising market, there is an ever-increasing focus by the banks on proactively engaging with borrower at an early stage and working closely with the borrower to ensure there is open communication on borrowing requirements throughout the lifecycle of the fund. This is coupled with getting all relevant parties engaged at an early stage to ensure constitutional documents allow for both borrowing during the fund’s life, but also symmetrically across the various vehicles in the fund structure.
• A slightly more challenging environment means selecting the right lender and right loan size is key. Borrowers should borrow for the reality of what they need, rather than the maximum loan available based on investor commitments. If a fund is not going to fully utilise the loan, there is no need to pay unnecessary undrawn commitment fees.
• Looking through the fund cycle, the panellists turned to NAVs replacing subscription facilities and noted that there is more acceptance by investors of NAV facilities that are utilised by the fund to fulfil the same cash flow management requirements for which the subscription facility was taken out. Investors are seeing the NAV as a similar facility backed by different security. That said the market has not shied away from showing its concerns where the NAV line is being used for increasing fund leverage or for paying distributions to LPs rather than simply smoothing down capital call frequency as might be done with a subscription facility.
• The panel also discussed the use of ratings of subscription facilities and this currently being a bit of a one size fits all approach. It is hoped that this will move to a more specialised model but the slow move to ratings is allowing for comfort in the market. It should not become the baseline for credit analysis and reliance by the banks on the health of a fund but rather the panellists felt that the ratings add colour and help with syndication but should not be deal critical.

Rated Note Feeders and Collateralised Fund Obligations

• Having set the scene as to the use of rated note feeders and CFOs, the panellists discussed the challenges for private equity fundraising in 2023 and solutions offered by accessing insurance capital but set against the stage of the past two years’ worth of changes in the insurance regulatory landscape.
• There was agreement that rated note feeders are currently predominantly a US-based product for US insurance investors but there is usage in Bermuda, Korea and Mexico, among other jurisdictions. For Europe, differing regulatory regimes do not currently present a requirement for a rated note feeder form of insurance investor structuring.
• The mechanics, capital return waterfalls and structuring of rated note feeders and CFOs were discussed, with the backdrop of ratings agency analysis of the product ever present. The correlations with structured finance products, such as CLOs, were drawn and the use of technology from such products being applied to CFOs with rated note feeder and NAV facility elements also being included.
• With the rating agencies having increased their focus on these products over the past 12-18 months, the panel agreed that this has increased the weight behind this product, especially in terms of establishing the more debt-like features. That said, the increased popularity in the product is meaning insurance investors are having more choice in where to put their capital leading to competition between fund managers.
• There was agreement that with continued education and familiarity with these products in the market, acceptance by regulatory bodies, and careful consideration of the structuring and governing documents, the future looks positive for the rated note feeders and CFOs.

PANEL: NAV Lending to Buyout Funds (Fund Level, Back-Leverage, LBO)

• NAV lending was once again a hot topic at this year’s conference. A few core themes emerged, both at this panel and beyond. Firstly, there is a diverse use-case for NAVs. This includes optimising the overall capital structure, debt financing for strategic add-ons, investor liquidity – to name a few. There is no one-size-fits-all.
• Likewise, there is no one-size-fits-all in terms of what a typical NAV deal looks like. Panellists discussed the unsecured / secured dichotomy which is emerging in the market – and that is probably as black and white as it gets right now. Outside of this, it is diverse and multifaceted, and it isn’t possible to categorise with any precision.
• Another key theme is the development and increasing maturity of the market. As the nomenclature becomes better established, one panellist thought that this could help to decode some of the complexities that may be a turnoff for some LPs. The sub line space was cited as a good example of this in action.
• Another is the need for investor buy-in. We were told by one of the panellists that ILPA are nearing the release of its guidance on NAV loans – which we expect will cover transparency and investor education. While some of these themes were debated by the panel, there was broad agreement that there are benefits to educating LPs in this space, particularly against the backdrop of recent press coverage.
• Finally, it’s worth bearing in mind (particularly as lawyers) that there’s a world beyond the LPA; yes, what the LPA says is important and will determine whether the NAV financing is permitted, but it’s not the end of the matter – it’s important to bear in mind the broader investor relationship and commercial context.

PANEL: NAV Lending to Credit Funds

This was a fascinating panel which complemented the buy-out session discussed above. The panellists discussed a number of themes and use-cases for NAV financings in the private credit space. The key differentiators (vs. buy-out) emerged as follows:

• Unlike in the buy-out space, there is pressure to refresh the portfolio and this can lead to different dynamics for the fund and lender, and different drivers within the documentation. Similarly, the diversity of the assets (vs. concentrated private equity) is another key distinguisher.

• Investors will be expecting credit funds to incur leverage as part of their investment strategy, so may be more willing to accept NAV financings alongside other types of debt (vs. private equity investors who may not necessarily expect their investor to be encumbered at that level).
• NAVs in a private credit context sit within the existing capital structure which will invariably already utilise leverage through tried and tested methods that are very well-established in the market.
• The panellists struck a positive tone for the use-case of NAVs in the context of credit funds. Managers are now utilising this product as and when it suits, based on the particular fund’s needs, asset-base and capital structure. We should expect more to come.

PANEL: Fund Finance Market Updates, ESG & Macro Developments

• An interesting and relevant discussion on ESG and macro developments. The panel first discussed how the industry has evolved in the last 10 years. There has been a distinct movement from mere subscription line facilities to private credit, CLO tranche investing, NAVs and hybrids.
• Various macro-economic developments have driven alternative lenders into fund finance. For example, the challenging interest rate environment and the large influx of capital into insurers and pension plans, which has given them the opportunity to look at different options to deploy capital. In addition, the huge surge in private credit into the industry – borrowers are getting bigger and more sophisticated.
• In the last 12 months, the regional banking crisis has impacted pricing, but the industry showed great resiliency. 25% of the market disappeared overnight, but most of it came back very quickly through consolidation and employee movements. The market is showing it is now a little more competitive of late. We’re not fully healed from the regional banking crisis, but we are getting there, and as capital markets come back, that will help relieve the pressure on the sub-line product.
• ESG was a hot topic in 2023 but that chatter has quietened down a little. This has a lot to do with backlash in the US. Despite this, a focus on sustainability is still alive and demand for ESG data is continues to be high.
• The EU is still ahead in its focus on sustainability. 80% of the EU GPs view ESG and sustainability-linked loans as having a positive impact on fund returns, this is in comparison to only 41% in the US.  The LSTA has an SLL working group to provide guidance specific to fund finance transactions coming out late March. However, expensive, and cumbersome reporting requirements continue to provide a roadblock to efficient implementation of ESG initiatives into the industry.

Keynote

This was an entertaining and interesting discussion with the CFO of Blackstone. In a mere 40 minutes, topics covered topics included the broader macro-economic outlook and the rise of private credit. He also took the audience through various aspects of the Blackstone business and what has made it one of the largest and most durable companies in the world, such as the various risks to the business, how they manage bank relationships and how important their people are to their organisation – people, culture and reputation are critical assets that Blackstone zealously protects.

PANEL: Global Market Update: Perspectives from Outside the US

• There was consensus among the panellists that the fundraising environment is not as difficult as portrayed and is more buoyant than perceived. Further, current market conditions mean that LPs can see how good the investment manager is and the quality of their investments. Panellists noted there is a lot of fundraising in certain sectors, especially healthcare, tech, private credit and infra, which are perceived to be protected from inflation.
• Lenders’ view is that they are seeing prolonged fundraising periods. Lenders are seeing more extensions and an uptick in bespoke solutions. Also seeing the evolution of NAV as liquidity support. Given the longer time frames, there was a view that lenders need to work closely with the GPs. The main change lenders are seeing is the growth of other products and the need to adapt.
• Consensus from the audience and panellist was that the rise of non-bank lenders is not a threat to banks, it’s a positive development. Banks will not be able to cope with the size of the fund finance market, and the supply-demand gap is attractive for non-bank lenders. Given that banks are working through capital regulation changes, the additional capacity needed in the broader market will help with the demand from GPs. This is seen as an opportunity overall.
• One difference noted is in Asia, where non-bank lenders are not active. It was seen to be an opportunity given the pool of assets in the Asian market. Pricing has gone down in Asia, especially with the rise of new entrants. Lenders’ view regions coming in with cheap pricing as part of the globalisation of the fund finance market, in that there are specific pricing structures between different markets. GPs would like more relationship banks for the level of service and stability they need, especially after regional bank crisis. There are a handful of Asian bank lenders who see opportunities and are happy to deploy capital.
• The panellists discussed China, the rise of India, and the business district of Gujarat International Finance Tec-City (GIFT City) in India, which is India’s offshore investment hub. From a fund finance perspective, lenders are lending into GIFT City structures. In Japan, there are big ownership changes of businesses. China funds are doing well. Investors are looking at Thailand, Vietnam is strong in the infrastructure space. Challenges that were noted are the upcoming US elections, the recent Taiwan elections, the collapse of China Evergrande and the impact on the Asian real estate market. Panellists believe it will be lumpy year for Asia.
• One panellist noted a rise of Middle Eastern investors in Asia. They were seeing more SMAs and some Islamic fund financing with regional banks that offer this product. There is a belief that there will be a rise of Sharia law compliant fund finance in Asia.
• The panellists then discussed the rise in NAV. One panellist mused about how, with the rise of NAV and non-bank lenders, there is a tension between the borrower fund sharing information on their underlying assets to essentially a competitor, the credit funds of one firm to the PE fund of another. Are there information barriers in place? It was noted that this isn’t an issue with a bank lender. This is one of the main reasons there aren’t non-bank lenders in Asia – there is a level of mistrust. Overall, insurance capital was seen as less problematic. There was a belief that there will be a continued rise in the use of NAV technology to fund through different cycles to return capital back to investors, to provide leverage and liquidity support. Overall, NAV financing will help attract scale.
• To conclude, the panellists’ predictions for next year was that they expect a flight to quality, both on the GP and lender side. With the regional bank crisis, GPs are more thoughtful about their lenders, who they want to trust, have a long-term relationship, and with banks and lenders that can execute with certainty. From a European perspective, challenge will be new regulations, which have a large impact on capital for bank lenders. Finally, there was a reminder that Asia is not just China and it’s a region that should be seen not as a challenge but an opportunity.

PANEL: Legal Update

• Discussions on the legal update panel addressed various topics, including a recap and experience sharing exercise on last year’s banking crisis and local jurisdictions recent hot topics.
• The consensus among the panellists, across all represented jurisdictions, was that the standard finance documents have been updated and supplemented to anticipate and address concerns and issues resulting from circumstances similar to those that the industry faced last year (to name a few, without limitation, the inclusion of receivership appointment within the definition of Debtor Relief Laws or the reallocation of obligations from defaulting lender(s)), but that, regardless of how relevant and adequate such adjustments may be, the related contractual mechanism (notably the defaulting lenders related provisions) were expected to be of limited use and help as the Federal Deposit Insurance Company would in the end overrule these and lead the process. This would for instance be the case when it comes to disclosure requirements.
• It was also noted that negotiation of documentation terms would focus on similar concerns and issues regardless of whether the lender role would be played by traditional credit institutional or non-bank lenders.
• Panellists’ views, across jurisdictions, were that the scope of diligence and required formalities in case of an assignment of a lender’s rights and obligations would be rather limited. In the US, while updating the UCC filings is not seen as a strict requirement, it was noted that filing updated contact information would, from a practical perspective, be of best practice to ensure that any search conducted on the UCC would return accurate results and circumvent any issue or delays in the context of notices being served to account banks.
• A few favourable trends were noted, such as (i) the recent removal of the Cayman Islands from the EU AML black list, (ii) the lighter approach taken in various jurisdictions on the topic of the notification of capital call security to investors (the panellists noted that service of such notices through investor portals or as part of quarterly reports was increasingly accepted, a trend confirmed by 83% of the attendance) or (iii) the absence of requirements to repeat notification in case of the assignment of a lender’s or secured party’s rights and obligations.
• The foregoing was subject to certain reservations in case of a change of security agent. On this topic, it was noted that in the Cayman Islands, nothing in case law suggests the need to update or repeat formalities in such circumstances. There was a consensus that such formality nevertheless has informational value, on which lenders are typically focused. The very issue that is meant to be addressed relates to the perceived risks that investors would refrain from funding otherwise, while from a sponsor perspective, such risk is admittedly fairly remote given the waiver of defences provided for in the fund documentations. Such formality shouldn’t, in any case, be linked to an Event of Default absent legal requirements. In Luxembourg, an assignment of a lender’s rights and obligation to a new lender would not trigger the need to repeat any perfection formality. The answer would be different however in the case of the appointment of a successor security agent. Notification of the replacement to the local account bank would then be necessary to avoid undue delays in case the successor security agent serves enforcement notice.  The audience were reminded that under Luxembourg law, notification to investors is not a perfection requirement, but that, by operation of applicable legal provisions, the assigned debtor (the investor) may validly discharge its obligations in the hands of the chargor (the fund, borrower) until it is made aware of the granting of the security in favour of the lender. Such nuance explaining why the service of a notice of pledge over capital commitments to investors is deemed to be required.
• Another recent trend is the reluctance from certain Luxembourg branches of foreign credit institutions from waiving the security interest that may exist in their favour by operation of their terms and conditions. Such entities, often acting as depositary, would typically take security over accounts opened in their books. The reluctance to waive such security interests and instead demand subordination in ranking causes issues under Luxembourg law, where creditors will typically expect first ranking security to be granted in their favour and the absence of any other lien or encumbrance. The issue is particularly delicate as the consent by a first ranking beneficiary to the creation of a security interest of subsequent ranking over the same assets is a condition to the valid creation of such security interest. The panellists were hopeful that such Lux branches of foreign credit institutions will soon revert to the well-established market approach and consent to the waiver, allowing for the setting up of a valid and enforceable first ranking security in favour of lenders.
• The recent reform of the Luxembourg bankruptcy legal framework was finally discussed, and in particular the fact that under the new regime, the early termination or modification of debt obligations (including acceleration thereof) may be rendered impossible if a Luxembourg based debtor has applied to reorganisation. The consensus among legal practitioners is that financial collateral arrangements (such as the pledges over capital commitments or collateral accounts) remain insolvency remote and enforceable despite such proceedings being initiated. It is therefore advisable to ensure that the contractually agreed trigger event allowing enforcement of such local security interests is not conditioned to prior acceleration of the secured obligations. Where such position is not commercially acceptable, the local security documents should include an additional event of default not otherwise include in the main financing agreement and corresponding to the occurrence of any insolvency event affecting the Luxembourg based debtor.
• As a conclusion, it appears that the market quickly adapted to the post crisis environment and to any recent change to the local legal frameworks, so that there already exists on the market widely accepted legal fixes and mechanism circumventing any related concerns and challenges.

PANEL: The Rise of Non-Bank Lenders in Fund Finance

• A very insightful panel discussion where the key takeaways were that there are a lot of opportunities for non-bank lenders in what is accepted as an ever-broadening market with new product lines being established all the time.  With the increasing regulatory pressures on banks, this has opened the doors to new entrants, in particular those from the insurance sector, and indeed, as one panellist said, with the market being so big, you need everybody so there is clearly space for everyone.
• What is interesting to note is the potential for non-bank lenders at finding ways to work with the banks and how this marriage of relationships can in fact add value from the sponsor perspective. Given the sponsor concerns centre around quantum of capital, certainty of execution and who they are partnering with, if a non-bank lender can deliver on these criteria, with their increased appetite for risk, the future for non-bank lenders looks bright.

PANEL: FX & Interest Rate Risk Considerations for Fund Managers

• The panel focused on the impact of higher rates and a rising USD, hedging interest rate risk and liquidity management. Foreign exchange and interest rate hedging has increased due to several factors, including private credit growth and rate changes. Basel III and potential increases in regulatory capital needs have also had an impact.
• There has also been a major evolution in the way fund managers view banks resulting in increased activity in interest hedging, direct lending swaps and length of time to close deals.

PANEL: Private Credit

• Private credit is an asset class defined by non-bank lending. Prior to the global financial crisis, there was direct lending, but it was not significant. Growth has been driven by the increase in lenders and the large amount of capital looking to be allocated.
• Dry powder in the private equity community is four times larger than the private debt community. Currently, there are 200,000 middle market companies and only 10% use alternative financing so there is quite a bit of opportunity.

PANEL: Secondaries and Continuation Fund Market Update

• 2023 was a record year for secondary fund raising with more than US$100 billion in deals and the market reaching more than US$500 billion.  The secondary market was established about 30 years ago but really picked up steam following the global financial crisis. In the last ten years, it has morphed into its own asset class and continuation funds are often used as a portfolio management tool to free up liquidity.  The main difference between continuation funds and commingled funds is that continuation funds are more concentrated and there is no blind pool risk.
• Transactions can be LP-led or GP-led. An LP-led transaction is where LP sells on secondary market and a GP-led transaction involves the GP wanting to move assets to new vehicle. Usually, there is a lead investor. The syndicate comes in which are the smaller groups of investors.
• With respect to continuation funds, there were many deals happening in the lower rate environment. Now that we are in a high-rate environment, we have seen one of the lowest levels of buyouts.
• Despite the current high interest rates, there seems to be no downturn in deal volume. Similarly, regardless of rates and bank failures, there has been no impact on demand with respect to large transactions.  This is largely due to buyers sharpening their underwriting and more participation from non-bank lenders.

Investor Panel

• The credit space has merged massively. Growth has been significant, and we are seeing investors actively allocating to private credit as a diversifier and income source.
• Investments have largely been in senior first lean type credit but there is a focus across the entire credit spectrum including structured credit and the full range of private credit with the goal of achieving up to a 10% return target. This has been a means of generating long term equity returns with much less risk and volatility.
• Most investors are bullish on real estate private credit as banks have pulled back on direct property lending. As a result, alternative lenders are filling the gap.