The evolution of fund finance – from the exceptional to the expected

From modest beginnings as overdraft facilities to the full spectrum of complex products available today, a panel of experts led by our co-head of fund finance, Richard Fletcher, discussed the evolution of fund finance at the 2022 Fund Finance European Symposium in London on 28 June. Panellists were Mark Alexander-Dann from ANZ; Aleksandra Cison from Citi Private Bank; Iain Millar from Appleby; and Kate Sinclair from Simpson Thacher & Bartlett LLP. 

The session progressed from the initial benefits funds found in bridge facilities, giving them speedy access to money for investments and smoothing out capital calls, to lenders reacting to demand for increasingly sophisticated financing transactions and the entrance of alternative debt funders. 

Participants covered the following ground.

• Where once investors questioned leverage at any level due to concerns ranging from debt falsely inflating return figures to interest on debt being a drag on returns, now investors expect to see leverage in fund structures. More sophisticated LPs want to use facilities for joint ventures and separately managed accounts and encourage GPs to set these up.
• Larger funds entering the market has led to a homogenisation of terms and security structures in more straightforward facilities, but an increasing complexity of different products have also developed.
• GP support / co-invest / management fee facilities, secured by the GP profit share or management fee stream, have evolved to be available for fund operating expenses, bridging employee contributions, and even acquisitions. These facilities can be complex to put in place and administer, but can strengthen relationships between lenders and funds and provide opportunities for lenders to provide different types of debt. Having started out as term facilities with short availability periods, there is now more demand for revolving or delayed draw type facilities.
• Lenders can support both closed and open-ended funds as they move along their lifespan, in the former case by providing liquidity to distribute to investors in advance of an asset sale, and in the latter by providing sub line structures split into two tranches, one backed by investor commitments and the other asset backed.
• Searches for alternative liquidity sources have increased the popularity of rated feeders, often targeted at the insurance companies, who benefit from better regulatory capital treatment for debt commitments rather than equity commitments. Two common structures are:
  • a feeder is set up which issues debt and equity in strips, with the debt having a preferred return ahead of the equity; and
  • a more synthetic structure where a feeder is set up to invest in the main fund using ordinary LP commitments, such LP commitments being funded using notes or loans issued into the market, which have different returns depending on where they rank. 
• These structures require early engagement with lenders regarding how these commitments will be treated for subscription line / borrowing base purposes. 
• Investors are demanding more reporting on ESG matters, and Loan Market Association (LMA) standard sustainability linked loans are popular, along with “ESG linked” loans which may not meet all of the LMA standards. Participants had seen loans where any increase in premiums linked to not meeting ESG key performance indicators were required to be donated to charity, to avoid the moral issues connected with profiting from this failure.

As one participant remarked, complexity was the theme of the afternoon, with further advanced innovations expected on the horizon.