A flexible approach to fund finance

RBS International has a funds banking team that supports more than 300 fund manager and fund administrator customers from offices in the UK, Guernsey, Jersey and Luxembourg. Private Equity International talks to Mike Lewis, head of funds banking, London, and head of private equity at RBS International, about the challenges facing private equity firms and how fund finance can help address them. Hot topics include subscription credit lines and Brexit.

What is your view of today’s backdrop for private equity?

2017 was a strong year for private equity fundraising. We have to go back to the mid-2000s, before the financial crisis, to see this level of activity and this degree of positive sentiment, so it’s an exciting time for the industry. Because of this, there has been a re-emergence of mega funds in the pan-European space – funds securing  multi billions of capital commitments from investors.

There has been a flight to quality: investors have their preferred fund houses, and are keen to re-invest with those teams. Looking at this another way, whilst there is a positive fundraising environment this is not to say it’s easy. Investors are not throwing money at any fund that launches: they’re being quite discerning about which ones they back.

Are individual banks able to lend enough to meet the credit requirements of these new funds?

Particularly with the larger funds, we are seeing increasingly significant credit requirements, necessitating more multi-bank club arrangements. We’re one of the more significant banks in terms of arranging these facilities and individual hold levels: how much we’re prepared to lend to a single fund. But at the same time we’re increasingly looking at ways of being more capital-efficient – balancing meeting our clients increasing needs, growing our business and being smarter in our capital deployment.

A hot topic at the moment is the issue of subscription credit lines. Private equity funds have always used them, but these credit lines have grown bigger. Why is this?

Subscription credit lines provide real benefits in terms of flexibility, pace and efficiency. Administrators and limited partners can benefit from a more structured/predictable capital call scheduling.

Credit lines can also be used to make funds more nimble. If a fund wants to make a rapid-fire acquisition, it can deploy capital immediately without having to wait two or three weeks for limited partners to come up with the money.

But some limited partners don’t like the trend towards larger credit lines.

They may be worried about the transparency of performance metrics. In the early stages of the fund, calling on large credit facilities, rather than on limited partners, can distort the internal rate of return of funds.

This makes it more challenging to compare fund performance – funds that don’t use credit facilities so much may have a lower IRR because of this, particularly in the early years. Nevertheless, because of IRR considerations, it’s all the more important for funds to be totally transparent about what they’re doing.

If funds are going to use credit lines, how do you think they should go about this?

One of the first steps is to ensure that the fund’s legal framework enables the use of credit lines. Hence, it is important to discuss this with the fund structuring lawyers at the earliest opportunity. This will enable them to factor in the intention of using a credit facility when drafting the limited partnership agreement, which may need to deliver the improved transparency that some investors would welcome. This might include areas such as utilisation levels of any credit facility, how the facility is being used, what the commercial terms are, fund returns including and excluding the impact of the facility, and so on.

All stakeholders also need to carefully consider the risks involved. One example is investor liquidity: if there were a systemic event that hit the banking industry, as in 2008, then the largest, most prevalent, limited partners could potentially be called on to repay credit facilities across a range of funds at a range of banks. Common use of substantial credit lines could mean a larger sudden cash call on dominant limited partners.

EXIT STRATEGIES

Are you worried about the effect of Brexit on your business?

Brexit is an uncertainty for everyone. But, as a banking provider with offices in four key fund structuring hubs for private equity – Jersey, Guernsey, the UK and Luxembourg – we’re confident that, whatever the outcome, we can continue to provide a consistent service to our clients. It’s conceivable that in the future, in order to access the EU market after Brexit, fund managers will set up new funds in Luxembourg, or other European cities, rather than the UK. A number of our clients have already boosted their operations in Luxembourg, which has been very good at creating a regulatory environment that appeals to private equity funds and their administrators.

If credit lines are going to be used increasingly by funds to conduct their business, how should the banks adapt?

We need to be innovative about what we offer. For example, many funds may find a use in accordion facilities, where the credit facility is expanded at the client’s request like the musical instrument from which it takes its name. This type of facility takes the form of a predetermined framework written into the credit agreement that provides the ability for us to efficiently increase credit lines at short notice, when needs arise.

The fund has to balance the cost saving against the lack of a formal commitment up front. For example, a client might have a £100 million ($139 million; €113 million) facility that enables it to complete typical deals, but the opportunity may come up to make a particularly large acquisition, say £200 million, which may have a sell down element to co-investors, necessitating  borrowing an extra £100 million from the bank.

Accordion facilities can be very cost-efficient: the fund may not want to pay high non-utilisation fees for a larger facility, but at the same time it wants the flexibility to borrow more when necessary, accepting that it is not a committed increase.

What do you think will happen with subscription credit lines in the future?

The market in credit lines is much more buoyant than I’ve seen for many years, to the point where I think it’s becoming the norm. We’ll have to see whether the current debate about the pros and cons of credit lines changes anything, but I think for now the attitude among general partners is very much: “If we don’t have one, are we going to be at a competitive disadvantage?”

Do you think you might extend your presence within the EU?

For many fund administrators, there is no stark choice between one location and another. It’s common practice for administrators to be multi-jurisdictional. An increasing number of our clients have presence in multiple locations where we have offices, and the most ambitious have presence in all four. If we’re everywhere they are, they can get a consistent service. Clients have historically said: “We really value the RBS International business model in the Channel Islands. Please provide us with a common platform and similar processes in Luxembourg and London.” We’ve responded to that.

What else do funds want from their banks, aside from funding?

Some of our competitors just offer credit facilities to funds, but we have a full-service offering. For example, we also have strong operational banking capabilities through our multi-currency platform and foreign exchange services.

THE NEED FOR CLARITY

EQT, with almost €40 billion of capital raised across 25 funds and portfolio companies throughout Europe, Asia and the US, has used subscription credit lines for many of its funds in the past. Magnus Lindberg, the head of Treasury at EQT, says transparency is crucial: “Our experience is that such credit facilities have a broad variety of benefits, and a key aspect is a transparent communication and understanding between the different stakeholders. Throughout our relationship with RBS International, their banking team has demonstrated an in-depth understanding of EQT’s requirements and they have structured and delivered solutions that best fit EQT’s needs.”

What kind of expertise do you have in forex hedging?

The customer may come along and say: “I have this particular problem with my foreign exchange exposure. How can I mitigate that risk?” Our markets team may then present a series of structures for the client to consider from their perspective. For example, a funds general partner/advisor may receive management fees in euros when their overheads are primarily in sterling if their main office is in London. They may want to reduce the risk that, because of a fall in the euro, the value of their overheads rises relative to their management fee.

What benefits are there for private equity funds in using a full-service bank?

The depth of the relationship brings benefits. Connectivity between our various specialists and our one team approach enables us to meet more of our clients’ needs through better understanding and strong delivery.

Do fund administrators also like using one bank?

There’s very much an efficiency angle for them. This is enhanced by our electronic banking platform, eQ. By the middle of this year we’ll have made a multi-million pound investment upgrading this platform to make it future-proof and enhance its functionality, increasing the range of browser and device compatibility as well as ease of use.

Some fund administrators worry that although their bank is there for them today, it might not be there for them tomorrow. How can you reassure them?

We’ve been active in this market without interruption before, during and after the crisis, and we’ve committed over 75 funds banking professionals to this part of our business. Many of us have over 10 years of experience in this specialist sector. For example, I’ve worked in each of our four offices involved in funds since 2007. We’re here for the long term.

This article was sponsored by RBS International and first appeared in the March edition of Private Equity International.