ILPA Principles 3.0: Choi on what’s new and what’s controversial

The guidelines for best practice incorporate several key issues for limited partners, including GP-led secondaries, subscription credit lines and co-investments.

Jennifer Choi

The Institutional Limited Partners Association has released the third iteration of guidance on best practice. ILPA Principles 3.0: Fostering Transparency, Governance and Alignment of Interests for General and Limited Partners incorporate several key issues for limited partners.

The new Principles expand, refine and update the previous version. The current edition is 44 pages, compared with the 24-page version published in January 2011. The latest edition also addressing new topics, such as GP-led secondaries transactions, the use of subscription lines of credit .

“Because this is such a dynamic industry, we knew that there were a number of things that simply weren’t addressed in prior editions because they weren’t factors at the time,” says Jennifer Choi, managing director of industry affairs and lead developer of the Principles 3.0 guidance.

“For example, we weren’t a regulated industry, so talking about the impact of regulation takes on a different lens today than it might have eight or nine years ago. Subscription lines were not a factor, and GP-led secondaries had an entirely different connotation than they do today.”

The Principles, which were first published in September 2009, are now used by a range of industry participants.

ILPA will not be seeking official endorsements for the document in the way it did with the previous versions. However, the organisation will be “encouraging industry-wide adoption of its tenets through supporting guidelines, templates and model documents”, it said in a press release.

One reason for this, says Choi, is that many of the ideas in the Principles, such as standardised reporting, are now widely accepted as standard practice, and so endorsement does not provide any significant additional benefit.

Choi says that 10 years ago ILPA sought endorsements in order to build a critical mass of support within the industry for the ideas it was promoting. However, “over time we found it was sometimes being conflated with this notion of compliance. Compliance implies some sort of an assurance mechanism, that someone has gone in and examined documents, practices, behaviours against a standard, and that’s not the case for the Principles.”

Any document of this nature will attract strong opinions. Choi singles out two recommendations that she thinks may not be well received: that the industry move to a gross-of-tax clawback model; and that the preferred return should be calculated when capital is invested, rather than called from LPs, in order to mitigate the effects of a subscription credit line.

The first version of the Principles stated that clawback amounts should be gross of taxes paid. However, this was switched to a net-of-tax recommendation for version 2.0 following feedback from GPs.

“With that we began to hear about the very high rates that were being applied in computing the tax,” Choi says. This prompted the decision to revert to a gross-of-tax model which, she adds, is “really challenging to achieve”.

“Because it hits people in their wallets, so to speak, we anticipate there will be views about that recommendation.”

Choi says she has “yet to hear of any GP supportive” of calculating the preferred return from the time a financing facility is drawn rather than the date the capital is ultimately called. However, she says: “I think they do understand that there’s a need to mitigate what might be behaviour-altering effects of the use of these facilities”, particularly when amounts are outstanding beyond a year.

In an effort not to tie regulatory recommendations to any particular jurisdiction, the Principles focus on transparency and disclosure, including looking at which regulatory entities the fund is subject to and if there are regulatory changes that affect the operations of the fund.

The guidance states that GPs, on request, should provide LPs with “full access to the results of any regulatory investigation or examination”.

“That is not a market norm today,” says Choi.

She says the one thing ILPA wants the market to take away from the new Principles is: “We can do better.”

“We can establish a better starting point, and we can be better aligned as an industry and within our individual partnerships.”