Fund managers must be much more open with investors on the use of subscription credit lines and their impact on fund performance, while investors should be proactive in seeking information, according to the Institutional Limited Partner Association.
In its nine-point guidance on the increased deployment of credit lines, published on Tuesday, the LP representative body said their use should “accrue to the benefit of the LP,” adding investors and managers should be clear on their expectations regarding use of subscription credit lines.
It states partnership agreements should set out reasonable thresholds for the use of credit lines, such as establishing a maximum percentage of all uncalled capital, the number of days it should remain outstanding and the longest period of time for which such lines can be used.
“Managers are encouraged to include the firm’s official policy on credit lines as part of the due diligence packet provided to LPs, including the intended use of proceeds from current or future utilization of such lines, and how the impact will be disclosed to LPs,” the guidance said.
Where credit lines are used, the ILPA said GPs should provide detailed disclosure of the status of the facility as part of its quarterly reports. This should include the current use of the proceeds from credit lines – ie, whether they are used solely to bridge capital calls or for other purposes such as accelerated distributions – and the net IRR with and without the credit facility, among other data.
Fund managers should also disclose details of the terms of the line itself to LPs, tell them which assets are being used to service the line, the name and contact information of the lender and provide a description of the loan covenants.
“Terms of the line itself that may introduce additional risk, eg, payable on demand, lender discretion over management decisions or exposure beyond unfunded commitments, syndication among multiple lenders, cross-default provisions [should also be disclosed],” the ILPA recommended.
The guidance advises which matters should be factored into terms and conditions. These include aligning hurdle rates with the date on which the credit facility is drawn, rather than when capital is ultimately called from the LPs in the waterfall provision, and ensuring that reporting on details in the underlying portfolio doesn’t lag the execution of a deal due to credit facilities delaying capital calls.
Investors should also take responsibility for ensuring they are informed about a manager’s use of credit lines, the guidance said.
“During due diligence of a prospective manager, LPs should request that managers provide the impact of lines of credit on track record, ie, levered and unlevered IRRs, as well as any tax impact,” the ILPA said.
It also recommended LPs take into account the potential impact of these lines on quartile rankings when evaluating relative benchmarked performance of a manager, and adding a discussion item on the use of credit lines to any LPAC meeting agendas.
“LPs should also consider that all commercially available peer benchmark providers are very likely to include both the returns of funds with credit facilities and those without,” the guidance said.
The ILPA said it will update the document to reflect member feedback and new market conditions, and the guidance will be included in the 2018 ILPA Principles.