RBS International has a specialist funds banking team that supports more than 500 fund manager and fund administrator customers from offices in the UK, Jersey, Guernsey and Isle of Man. The team provides a range of banking solutions to help firms manage their operational, funding and FX risks.
As it prepares to open a Luxembourg office, we talk to its newly appointed head of funds Peter Brown about how banks can help private equity firms deal with their complex financing needs.
Tell me about some of the major challenges facing private equity firms at present.
One of the biggest challenges is finding a reasonable return on your investment. On the one hand, asset prices are very high because of strong competition: these days, there are a lot of private equity investors, and corporates, with lots of money, all of them seeking to put it to work. This has raised the price paid for quality assets.
On the other hand, returns may not be very high in the coming years. Corporate earnings growth is relatively sluggish because GDP growth is low in many continental European economies. Private equity investors customarily have investment returns higher than underlying earnings growth, of course, as they invest a lot of time and intellectual capital to drive efficiencies and growth, as well as leveraging the assets they buy.
However, general partners are increasingly prepared to take on similar levels of leverage to that in 2005-7 to fund these increased enterprise valuations. Banks and other institutional investors have a much better awareness of their costs of capital and are arguably pricing risk more appropriately. Given the potential economic headwinds across continental Europe we could start to see more credit stress, as inflation, and hence interest rates, start to pick up. This could impact returns too.
How can banks help funds to deal with these issues?
Clients are increasingly using fund finance as a form of competitive advantage. Faced with the possibility of lower returns and with a more crowded marketplace, they are trying to make themselves more popular with investors both by increasing returns to them and by making life easier for them.
Funds bankers help with this by allowing private equity funds to rely on them more for their cash management needs. Limited partners are generally relatively highly credit rated. This creates an opportunity: banks can provide funding against investor commitments, to enable funds to buy assets while bothering investors less frequently than in the past with requests for cash.
What funds would like to do these days is to say: ‘We’d rather not go to investors for a year.’ To do that, they might need to borrow 20 or 25 percent of the fund’s value, rather than the 10 or 15 percent of the past. This not only reduces the bureaucratic burden for investors; it also boosts their annualised returns, since their money is tied up for less time.
What other kinds of financing are available?
Funds can reduce the amount of time that investor money is tied up by even more through hybrid schemes that allow a change from investor-backed loans to loans backed by the assets acquired by the fund.
It is hard to generalise about the form this might take because it is highly bespoke. However, it might take the form of flipping: switching wholesale from investor-backed loans to asset-backed loans when a certain trigger point is reached. This could be when 70 percent of the fund is invested, for example. There might, alternatively, be a blended approach, where the change is made gradually.
These solutions could make LPs more enthusiastic about investing in the private equity manager’s next fund as an asset-backed credit facility may allow funds to return some cash to investors early thus enhancing returns and supporting the next round of fundraising.
So far we have dealt with important long-term trends. What about forthcoming events?
One forthcoming event of striking importance is Brexit – though in fact the consequences of Brexit are already hitting private equity funds. Two particular problems spring to mind immediately.
One is sterling volatility, which began immediately after the Brexit referendum result in June. Currency volatility can have a significant impact, both positive and negative, on fund level returns. Many managers are also considering the impact of sterling volatility on returns at the general partner level in terms of their management fee currency versus that of their cost base. These considerations are all the more important in an era when it is much more difficult to get a good return, for the reasons we have already discussed.
Will firms have to relocate?
Brexit will impact individual firms in different ways, depending upon the extent they are EU or non-EU focused. UK managers may find they are unable to access the EU investor market unless some form of passporting or equivalence regime is agreed. Fund managers may well stay outside the block, but many back-office services will have to be within the EU – most likely in Luxembourg, which is a huge centre for fund domiciles. In some cases the private equity firms have back-office teams in Luxembourg. In other cases they are outsourcing this to fund administrators.
How can RBS International's funds banking team help firms address these problems posed by Brexit?
Clients have shown heightened interest in managing FX risk since the Brexit referendum. A number of funds amended their FX strategy immediately following the result, using a variety of hedging tools. RBS can help with both FX hedging strategy creation and trade execution. RBS International’s new Luxembourg office is largely a response to the continuing migration of funds’ back office operations to the Duchy.
This trend had already begun long before the Brexit referendum, though the prospect of Brexit is speeding up the pace. This office will be able to do much more than the bank’s previous Luxembourg operations: moving beyond just cash management into lending, working both with private equity managers’ back office people and with the fund administrators.
Are there other ways in which funds bankers can make life easier for fund managers through enhancing services?
Clients are increasingly dealing with core banking services online. We are investing in our eQ electronic banking platform in 2017 to enhance functionality and make it quicker and easier for clients to do their banking. The customer due diligence requirements for onboarding, where the new client is taken on by the bank, can be quite onerous for funds.
Banks that can make this process as painless as possible will have a competitive advantage. The opportunity is to automate much of this, so that accounts can be opened much more quickly. I don’t think any bank is there quite yet, but we are focused on how we can improve this through future upgrades to our eQ electronic banking platform to help ease this burden.
We have concentrated so far on talking about the funds. What about the people behind them?
There are a lot of ways to offer a wider range of services for the individuals who manage funds. One of the biggest challenges that established private equity firms may have is how to enable the senior people to stand aside so that the next generation can come through. It is very expensive to buy out a group of senior people – you’re looking at a buyout deal. We can fund that.
We also see demand from partners in the firm looking for individual or collective financing to help them raise the money they need to co-invest in funds.
So you believe that your funds team is just part of the RBS solution?
Very much so. Banks need to focus ever more on providing an end-to-end service, incorporating setting up funds, the investment stage, the harvesting stage, managing the wealth created for the partners, and enabling the next generation of partners to buy them out. RBS International can tap into the expertise of people both inside and outside the funds team. For example we work closely with the RBS Leveraged Finance team who support key funds clients at the asset level.
Peter Brown has more than 25 years’ experience in corporate and institutional banking, and most recently headed up the RBS Financial Institutions Group in the UK, which included the RBS funds banking business in London. Prior to that, he was one of the founding members of the RBS mid-market leveraged finance business, delivering buyout transactions alongside key private equity sponsors.
BANKING ON A DEAL
So how can a bank help smooth the process to ensure a deal goes through on time? Mid Europa Partners, one of Central and Eastern Europe’s most successful private equity firms, uses RBS International for bridge financing so that it can complete deals in a timely manner, says Manish Mittal, partner and chief operating officer.
“We need to provide investors with 10 business days’ notice for any capital drawdown, and as we do not always have visibility on when a transaction will complete, such a facility with RBS International provides us with assurance that we can complete the transaction smoothly.”
RBS International always works with Mid Europa to provide a solution. “We contractually need to give the bank 48 hours’ notice on the facility. If we can give them a heads-up, saying: ‘it might not be 48 hours. Can it be 24?’ they will work with us to find a solution, even if it’s not specifically catered for within our normal arrangements.”
Another example: “Let’s say we’ve just initiated a drawdown notice to our investors, but we need the money prior to or on the exact date when drawdown is supposed to occur. You can’t guarantee when you’ll get the money on the due date. But if we said to them: ‘Can we exceed our capital call facility for a few days in advance of receiving the money?’ I’m sure they’d work with us to find a solution.”
Mid Europa is used to exacting deal deadlines. It retained its Firm of the Year in CEE title in the 2016 PEI Awards after being involved in some of Eastern Europe’s biggest deals last year, including the Allegro deal in October, in which Mid Europa teamed up with Cinven and Permira to buy ‘the eBay of Poland’ for $3.25 billion.
Summing up what he wants from his funds banker – and what he gets from RBS International – Mittal says: “RBS International proactively works with us to ensure any funding gaps are resolved such that matters progress smoothly and transactions complete on time.”
This article is sponsored by RBS International. It appeared in the Fund & Deal Finance Special published with the March 2017 edition of Private Equity International