Sessions

Evolution of Fund Finance

• There is an imbalance in supply and demand in the fund finance market. On the demand side, infrastructure funds are doing better than regular funds and exits are slowing. GPs are looking for increased liquidity and different types of financing.
• Pricing continues to be an issue. NAV financing is becoming particularly expensive and timeframes between deal origination and completion are getting longer.
• GPs are looking for reliability. They are looking to maintain relationships with the same lenders, but also expect the lenders to adapt to current market conditions.
• GPs are closely tailoring the size of their credit facilities in an effort to reduce margin and unused fee costs.
• Although demand for subscription lines is high, banks are increasingly selective due to balance sheet constraints.

Legal Update: Implications of Defaulting Lenders

• Legislation and regulations designed to promote bank stabilisation have allowed regulators to respond quickly to the recent banking crisis. The trend has generally been towards bank stabilisation and sale rather than liquidation of distressed institutions.
• Defaulting lender provisions, introduced through Loan Market Association (LMA) and Loan Syndications and Trading Association (LSTA) syndicated forms of documentation, provide a set of rights to borrowers under the loan documentation to respond to a scenario where a lender becomes insolvent or unable to fund. While present in many deal documents, defaulting lender provisions have not been widely tested in practice.
• Bank regulations are effective, but we are in the ‘interesting but untested’ space when it comes to seeing the contractual defaulting lender provisions play out in practice and how they will interact with the regulatory obligations of all stakeholders.
• The diversity of relationships, and the need to be prepared, emerged as a key theme. Sponsors are now seeking to diversify relationships with their bankers and their account banks following recent events.

NAV 1.0: Diversified Collateral and Debt Underlying

• At its core, ‘NAV’ refers to any facility that relies on the net asset value of the fund’s assets for repayment. Broadly speaking, the three principal NAV facilities seen in the market are NAV facilities to PE funds, NAV facilities to credit or debt funds and NAV facilities to secondary funds.
• Secondary funds primarily focus on three factors with respect to portfolios: asset quality, diversity, and liquidity.
• Some credit funds take on leverage using an asset-backed lending facility. ABL facilities have similar characteristics to NAV facilities.
• As fund raising generally becomes tougher, asset exits begin to slow and the need to distribute to investors becomes more urgent, NAV facilities provide a perfect liquidity solution to PE and other funds.
• NAV facilities can also be used for funds to make follow-on investments outside of the investment period, therefore providing funds with an additional source of liquidity.
• The recent bank failures have motivated funds to spread their banking relationships even further.

NAV 2.0: Concentrated Collateral and Equity

• The common understanding is that NAV deals with fewer than five portfolio assets are deemed to be ‘concentrated’ whilst those with more than ten portfolio assets are considered ‘diversified’.
• Concentrated NAV deals are usually smaller bespoke facilities, often bilateral.
• Structural considerations include whether the transaction is permitted by the LPA, whether there is financial indebtedness in the investment vehicles below, and the sources of fund cash flow.
• Funds sometimes use two loan tranches - a term loan tranche for distributions and a revolving loan tranche for working capital.
• Third-party valuations have become an increasingly focused upon feature of NAVs given the current volatility in the markets.

Non-Bank Lenders – Current Status and What is Needed for More Growth

• In recent years, an increasing number of non-bank lenders have entered the fund finance market, often offering more innovative approaches to subscription line facilities than traditional banks.
• The growing prominence of NAV structures calls for more standardisation of fund documents. Fund documentation drafted to allow for a traditional subscription line may not allow for a NAV line.
• Increasing the number of non-bank lenders in the fund finance space is not the sole answer to the liquidity challenge. Fund finance is typically a relationship product and the role of traditional banks in the market is well-established. However, having both traditional and non-bank lenders supporting the market will facilitate growth immensely.

Structuring and Managing Risk in 2023

• The risk environment is much different now than it was this time last year, and it continues to change.
• Interest rate hedging was a prominent theme among the panellists. Those who hedged their long-term exposure benefitted significantly given the recent interest rate hikes. The panel encouraged market participants to consider their hedging strategy in detail.
• The need for liquidity remains. U.S. lenders have pulled back and Japanese, Australian and Asia-based lenders are filling supply gaps.
• Lenders are being strategic in deploying their limited capital. The panel agreed that regardless of the changing interest rate environment and supply constraints, they couldn’t think of a deal that didn’t get done because of pricing.
• LPs are more selective in the funds they allocate to and are asking more questions about sponsors’ investment management and debt repayment practices, which the panel agreed is a positive sign of a well-functioning maturing market.

Evolution of ESG in Fund Finance - Recent Developments and What's Next?

• The use of ESG-linked facilities in the fund finance market has seen slower growth in the past year.
• ESG-linked facilities remain more common in the market than green ‘use of proceeds’facilities, and Europe is considered the global leader for ESG-linked facilities.
• GPs must still weigh whether ESG-linked facilities provide sufficient pricing or fundraising benefits against the costs associated with the negotiation of ESG provisions and the collection and verification of ESG data.
• The introduction of the LMA Draft Provisions for Sustainability Linked Loans has increased efficiency in establishing ESG-linked facilities and reduced negotiation time. Increasingly in Europe, LPs are also looking for alignment of ESG principles when investing in a fund. These factors are pushing growth in the market.
• The regulatory landscape in Europe is set to (i) introduce more stringent ESG reporting requirements and (ii) incentivise sustainable finance. This is expected to further drive growth in ESG linked facilities in the coming years. 

Ratings, Capital Relief Structures and Risk Transfer

• The increased demand for rated sub-lines has led some rating agencies to prepare specific methodologies for such facilities. Part of the increased demand has resulted from the growth of private capital markets.
• The key rating drivers for sub-lines are: (i) manager identity, (ii) LP quality, (iii) structural features (existing leverage at fund level, default obligations provisions on LPs, covenants, etc.), and (iv) potential diversification of LPs. External factors, such as the fact that last year was difficult for the markets, will usually be taken into account.
• Significant Risk Transfer (SRT) or ‘risk sharing’ is a form of capital relief that allows banks to free up credit lines and regulatory capital.
• Confidentiality is the greatest concern for funds when using rating agencies.
• Private and public ratings follow similar methodologies; private ratings can only be shared with specifically defined persons.
• SRTs are mostly prevalent in corporate and SME financing transactions, whilst they are still a small part of fund financing transactions. However, the entrance of SRTs into sub-line and NAV facilities seems to herald a significant growth in the use or SRTs in fund finance.

Innovation and New Structures

• Recently, the market has seen a supply gap due to some larger players, including certain U.S. banks, pulling out of the fund finance market.
• Reduced asset level market activity means that the demand for GP financing has increased as fund managers are receiving  carry interests from the realisation of existing investments more slowly.
• Fund raising and M&A activities have been slow, and whilst larger sponsors remain less affected, small and mid-size sponsors are finding it more difficult to secure commitments from lenders.
• Rated facilities will become more common as they allow insurance companies to participate in credit facilities. Increased insurance company involvement as lenders will bring in new structures and capital.

Key Trends in NAV and Subline Financings

• GPs are looking for certainty in subscription line financing to maintain liquidity for as long as possible within the investment period.
• The pricing gap between recourse-light and fully secured NAV facilities has widened recently, with GPs typically seeing the gap at around 2%-3%. GPs are increasingly opting to trade flexibility for lower pricing.
• GPs are looking to implement NAV facilities earlier in the fund cycle due to difficulty in accessing appropriate subscription line financing. Relying on extending subscription line facilities with the risk of having to refinance is increasingly a concern for GPs, whilst NAV financing typically offers a longer term solution.
• The NAV market remains more active in Europe, although there are still a limited number of NAV lenders. Due to higher levels of ‘NAV window-shopping’ execution risk has increased, and GPs are looking for lenders who are committed to the NAV market in the long term.
• Funds' constitutional documents are increasingly being drafted to accommodate NAV financings, although GPs are still seeing push-back from LPs.