European Union: Fund Finance Laws And Regulations 2022 | England & Wales

1 Summary

What makes a fund finance transaction “English”?

There are a number of features of a fund finance transaction that can give it a significant nexus to England & Wales, including:

• the facility agreement being governed by English law;
• a lender or the arranger being incorporated in, operating from, or leading the transaction from England & Wales;
• the fund manager or fund vehicle being formed, incorporated in or operating from England & Wales (usually as an English limited partnership);
• one or more investors being domiciled in England & Wales; or
• particularly in the case of net asset value (NAV)-based facilities, the assets being located in England & Wales.

In practice, it is the first two of these factors that most clearly define a fund finance transaction as “English”, and it is the market of transactions with those two features that this chapter is chiefly focused on.  However, these transactions are rarely domestic in nature.  The location of the fund manager and investors varies significantly from transaction to transaction, and the fund vehicles used in these transactions are often domiciled in other jurisdictions, as explained in more detail below.  Fund financiers operating from other jurisdictions (such as continental Europe and Asia) also use English law to govern some of their facilities, and so commentary below on English contractual matters is also potentially relevant to fund finance transactions that are not, in other respects, strictly “English”.

When and why did the English fund finance market develop?

Outside North America, England & Wales is the most mature fund finance market, having its genesis in the early 2000s.  The main drivers for its initial development were:

• a growing need and desire for fund-level liquidity from (principally) private equity managers; and
• the close relationship between the small group of financial institutions that first began to provide these types of products and the end-user private equity managers (sometimes in an investor capacity), giving them access to fund-level information essential for the assessment of the credit quality of the collateral underpinning the financing.

While many very large transactions were being carried out at this time (generally bilaterally), the size of the market was comparatively small as a result of:

• a limited number of financial institutions offering this type of product and offering it as a relationship-enhancing product in conjunction with more traditional credit lines, such as portfolio company leverage; and
• a limited number of fund managers being considered an appropriate user of this type of financing – typically top-quartile European and global private markets managers with high-quality, diversified investor bases and underlying assets, and proven track records.

How has the English fund finance market faired in a second year of global uncertainty?

In the previous edition, this chapter discussed the upsurge in fund finance activity during 2020 even though it was a year quite unlike any other.  This year, despite continued global uncertainty and with limitations on movement creating growing issues for almost every business sector, the fund finance market in England has continued to build on its rapid development in 2020, with our team in London experiencing a year even busier than 2020.  Products have continued to develop, general partners (GPs) have continued to look for increasingly innovative liquidity solutions, the profile of participating lenders has changed further and – despite saying in last year's edition that 2020 was “one of the busiest, most technically and commercially varied (and challenging) years ever” – as 2021 draws to conclusion, it is clear that 2020 has nothing on 2021!  We have advised on a multitude of subscription, umbrella, hybrid, GP, co-invest, back-levered, NAV and pref. financings (and just about everything in between), allowing us to observe and participate in the evolution that 2021 has brought.  We have been involved in some of the largest subscription facilities to come to the market and some of the most structured and complex NAV-based financings.

The main drivers of growth in the fund finance market in England have traditionally been:

• an increasing number of financial institutions, insurance companies and asset managers with capital to deploy looking to these products to deliver attractive risk-adjusted returns and, in the case of financial institutions, to facilitate a wider and deeper relationship with private markets fund managers;
• the attractiveness of the “low default” record of these transactions with only one notable European exception in 2018 in respect of the Abraaj Group's demise;
• as the products have become better understood and more widely used and recognised, a greater willingness and appetite to make these products available to managers across all asset classes, sizes and jurisdictions across Europe (including Germany, Spain and Italy) where English law generally remains the governing law of the financing;
• an increase in the prevalence of different types of fund finance products as alluded to above, including an increase in the number of GP/exec. financings, umbrella and co-invest facilities and separately managed account (SMA) financings and the continued development of the “PRAV facility”; and
• the desire of fund managers to use fund finance products to facilitate the use of their dry powder capital as efficiently as possible, with an intelligent use of fund finance facilities providing a competitive edge.

Looking at these drivers, it becomes clear why the fund finance market has again outperformed itself in 2021.  In the English and European markets at least, the Abraaj situation led to a recalibration of lending terms during 2018 and 2019 to tighten certain central commercial provisions and protections (such as timing for the delivery of investor notices, the impact of senior management fraud and the impact of management company-level insolvency), placing the subscription line documentation in a good place leading into 2020/2021.  2020 was one of the most dynamic and defining years for product growth and evolution in fund financing and 2021 has seen the products continue to develop, with the rise in NAV financing observed in 2020 now being fully entrenched as part of the liquidity armoury of GPs.  Some key observations regarding the development of the market over 2021 are as follows:

• Market players.  Prior to 2020, the subscription credit market had experienced exponential growth, with swathes of new bank lenders coming to market.  In 2020, we saw a number of these institutions pull back either partly or in full from this market.  A number of the traditional bank players that featured less in 2020 are now well and truly back in the market and banks that stepped in to plug the gap in 2020 have capitalised on their increased market profile in 2021.  The interest from non-bank lenders for various fund finance products that we saw in 2020 has continued to grow and entirely non-bank syndicates (as opposed to non-bank bilateral lends or small clubs, which were already the case in 2020 and before) have even emerged.  The sweet spot for non-bank lenders appears to remain NAV and preferred equity lines (and other similarly motivated structured products) where returns are higher than for subscription facilities, but non-bank lenders also have a growing presence in the subscription line market with new and innovative solutions to the timing issues that revolving capital call facilities present non-bank lenders being developed.
• Developments in subscription facilities.  As mentioned above, 2018 and 2019 saw a period of adjustment of the terms under subscription facilities in light of the Abraaj situation and so it is, perhaps, not surprising that terms under subscription facilities have not changed greatly across 2020/2021 to address the impact of the economic uncertainty arising from the pandemic and other world events.  The noticeable shift upwards in pricing, particularly during the first and second quarters of 2020, has now largely reversed.
• ESG.  The ESG market has become much more established during 2021 from its foundations in 2020.  The market now seems to have reached a level of understanding with respect to ESG metrics and mechanics, and 2021 has seen ESG feature in a large proportion of deals with certain banks stepping forward into a role of ESG Co-ordinator or Agent, to represent the lenders in negotiations to agree suitable key performance indicators and reporting given the underlying business.
• Developments in NAV and hybrid products.  In a similar vein, 2021 has seen the NAV product circumnavigate a seemingly unending combination of structures and asset classes, with lenders of varying types showing appetite to participate in some of the most cutting-edge structures in the market.  There has also been a continued upsurge in interest from managers who see NAV financing as a means of increasing liquidity and facilitating returns to investors and, based on our experience, there was as much time spent by lenders and funds evaluating and executing on NAV trades in 2021 as subscription line facilities (though that is not to say the deal volumes matched).
• “PRAV facilities”.  In last year's edition, we commented at length on “PRAV facilities”, which, as the name suggests, feature elements of both NAV and pref. financings.  This year, we have devoted a whole chapter to this topic as it has become so important to the market and so refer you to that for further details as to how the market has developed.
• GP and co-invest financings.  GP financings, which, at least in the first half of 2020, seemed to have slowed, returned to more normal levels this year.  The main developments in the GP/co-invest market in 2021 have been the continued trend toward programmes that covered all (or nearly all) fund vintages of a manager under a single credit agreement, with optionality for executives from all participating vintages to join the programme and with flexibility for older funds to drop out of the programme and new funds to come in.  The trend toward an increased market share for private wealth banks has also continued to grow.
• Single account financings.  We reported last year that the second and third quarters of 2020 saw an increase in the number of single account financings from the levels of previous years and this has continued, perhaps to a slightly lesser extent, in 2021.  Given the increased prevalence of these deals over recent years, as managers have looked to meet the needs of investors that want to deploy their investment through a segregated account, and as lenders have become increasingly comfortable with the concentration issues that arise on these deals, this increase in deal numbers may well have occurred anyway.  But, at a time when the logistics of raising capital for new funds remains impeded by lockdowns and travel restrictions for a second year, SMAs continue to provide a useful solution both for managers keen to maintain and grow fee revenue, and for investors looking to deploy capital with managers that may be delayed in their usual fundraising programmes.  The trend toward “near-SMA” deals we saw in 2020 (i.e. deals with two or three investors, not strictly a single-asset deal but having a sufficient lack of investor diversity for similar principals to apply) has continued in 2021, with many of these deals involving continuation vehicles or vehicles to bring increased liquidity into structures involving mature funds in the later stages of their investment and divestment cycle.  We have continued to see an increased focus on not just investor letters (creating a direct relationship between the lender and the investor), but on lenders tracking through the investor holding company structure and requiring this comfort to come from the money vehicle behind the investor (where the investor on record is a special purpose vehicle).

2 Subscription finance structures

In the past, and it is still true today, subscription credit facilities advanced against diversified limited partner pools have been and continue to be the most prevalent product in the English fund finance market.  The product has developed over time to become far more sophisticated, both because of the natural development and deepening of the market and because managers are increasingly looking to their subscription credit line to do more and more things.  Gone are the days when there was a straightforward revolving credit line; subscription facilities now allow for letters of credit, bilateral ancillary facilities, swing-lines, portfolio-level borrowings, separate feeder and parallel-level borrowings, secured hedging and umbrella arrangements for commonly managed funds – to name just a few of the features that managers now expect to see.  As subscription facilities retain such a prominent position in the market, it is worth looking at some of the key areas of development:

• Secured or unsecured.  Prior to the global financial crisis, many subscription line facilities in the English market were provided on an unsecured, uncommitted basis with a security power of attorney often being the only piece of (quasi-) security taken by the lenders.  The rationale for this was:
  • the market at this point comprised only very high-quality, experienced private markets managers with whom lenders had close institutional relationships;
  • importantly, the terms of the facilities precluded any other indebtedness within any fund vehicle sitting between the lender and the lender's ultimate source of repayment, i.e. the contractually committed and uncalled capital of the investors and very often, the underlying assets of the fund as well;
  • these facilities were niche bespoke products at that time and, whilst the fund documentation expressly contemplated the fund having the power to borrow, the security package that is now widely accepted as a staple part of these transactions was often not expressly contemplated;
  • these transactions were accompanied by a legal opinion from the fund's counsel confirming that the lender's claims under the finance documents ranked ahead of the claims of the investors (being the only other potential “creditors” of the fund); and
  • utilisation of these facilities was largely short term, so the periods during which lenders were on risk was generally less than one year.

As the market has grown and developed, with the funds using fund finance products no longer having these relationships or features, so the emphasis on security has become greater, such that we now rarely see unsecured lines. 

We have also seen an acceptance by sponsors (and a raised awareness of lenders as to the importance) of properly perfecting security prior to the first utilisation of the facility.  Investor notices are now rarely provided any length of time after closing and, in all but a couple of deals in 2021, we have seen evidence of delivery of investor notices required, if not on the closing date then as a condition to the initial drawdown.  We have also seen a trend toward the more formal agreements with English account banks that we were previously more accustomed to seeing where the account bank was in a continental jurisdiction such as Luxembourg or in the US (where there would be a deposit account control agreement).

• Committed versus uncommitted.  Historically, many subscription line facilities were structured on an uncommitted basis, enabling lenders to benefit from favourable regulatory capital treatment under UK regulation.  Private markets managers using these facilities had done so on a regular basis for many years and took comfort from their experience with the lenders providing uncommitted facilities over this time that they would not be withdrawn without serious cause.  The size of these facilities ran into the hundreds of millions, if not billions, and the savings made by private markets managers on commitment fees were considerable, particularly given that, historically, these facilities tended not to be heavily drawn.  We still see a number of uncommitted transactions (or transactions with an uncommitted element) in the English market, but as the market has opened up to new entrants, some managers have become less confident with uncommitted lines and many banks now do not have the ability to provide uncommitted lines.
• Side letters.  As a result of fund finance facilities becoming better understood and more widely used across the private markets, the use of debt by fund managers has become a focal point for investors when negotiating the limited partnership agreement and side letters and we are seeing side letter arrangements become more bespoke and detailed (and longer), including with respect to provisions that relate to, restrict and otherwise impact on a manager's use of subscription lines.  We are increasingly seeing restrictions around who can serve drawdown notices on investors and restrictions on the amount that can be called from investors by lenders providing subscription lines, including some provisions that may seem innocuous but that may have a material impact on a lender's recovery.  There is also an increasing trend to include requirements for the delivery of information to investors together with a capital call notice, which raises practical questions as to how a lender will be able to obtain and deliver such information in an enforcement scenario.  Another aspect of side letters that we have seen gain increased prominence in 2021 are investor requirements with respect to ESG, which can have a bearing on the investor's obligation to fund capital calls (or the amount that can be called), and so are relevant to all facilities and not just those that are ESG facility agreements.

3 Fund domicile in English law fund financings

Guernsey, Jersey, Ireland and Luxembourg continue to be the most popular when it comes to fund domiciliation in English law fund financings, and based on our 2021 dealbook, Luxembourg would seem to be the most prevalent of those four.

Comparatively few English fund finance transactions involve English-domiciled funds.  This is at least in part because, until relatively recently (2017), the law governing English limited partnerships was antiquated, with the key statutes, the English Limited Partnership Act 1907 and the Partnership Act 1890, having changed little since they were originally introduced.

The introduction of English “private fund limited partnerships” in 2017, in respect of which some of the traditional rules, restrictions and administrative burdens that previously applied to all English limited partnerships and their limited partners no longer applied, does not appear to have resulted in any material increase in the number of funds choosing to domicile in England & Wales over the past 12 months (or four years), perhaps because English limited partnerships still do not provide all of the advantages of limited partnerships in some other jurisdictions.

With the use of Luxembourg, Ireland and the Channel Island jurisdictions, we have seen an increasing number of different types of vehicles being used as fundraising vehicles – particularly corporate structures – which can present challenges in terms of putting a subscription or hybrid line in place.  The challenges depend on the structure, jurisdiction and terms of the fund documents, but include addressing and providing the lender with control over any additional steps that need to be taken in order to complete the call-down process on investors.

4 Looking back and looking forward

At the time of writing this chapter, we look back at a year in which a new president of the United States was sworn in, COVID-19 vaccinations were launched, the UK left the EU, and we all continued to adjust to the trying business and personal circumstances brought about by the continuing pandemic. 

We also look back, as this is a fund finance publication, on what is a truly remarkable year for the fund finance market in Europe.  It was a year that started at what seemed full throttle at the beginning of January and then the pace only increased from that level throughout the year.  The combined impact of a sizeable increase in the NAV/pref. deal volumes and products combined with a truly buoyant subscription line market would have made for a record-breaking year, but added to that was the need to remediate a seemingly endless book of existing transactions for changes to LIBOR, leaving the market and its participants counting down to 31 December.

And what will the new year bring?

The fund finance market in England has thrived throughout 2020 and 2021.  The trend toward more sophisticated and structured product offerings that started in 2020 has been eclipsed by an even busier and more innovative 2021. 

The market seems primed for a move of the more sophisticated “borrower-friendly” NAV and PRAV products, which have been largely the preserve of the larger sponsors, into the mid- and smaller-sized fund market and although there have been some mid-market deals on those types of terms, it will be interesting to see whether lender appetite remains the same – expect these deals to see an increased role for non-bank lenders. 

Overall, the outlook for 2022 remains optimistic.  Fundraising in 2021 has been exceptional again and the pipeline for 2022 seems abundant in all fund finance product types.  Dare we say it, 2022 will be even busier than 2021…

Originally Published by Global Legal Insights

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