When the US Securities and Exchange Commission conducts its routine examinations of private fund managers, it now eyes subscription credit lines as well as the more traditional areas of concern, sources familiar with the organisation tell Private Equity International.
The SEC is particularly focusing on the disclosure and transparency surrounding the facilities, according to several sources. The regulator declined to comment.
“When it comes to the usage [of] credit lines, [the SEC] looks at it just as it looks into any other conflict of interest issues,” says one of the sources.
Norm Champ, previously the director of the division of investment management at the SEC and now a partner at Kirkland & Ellis, acknowledges he has seen the SEC look at this aspect in routine exams of private fund advisors, albeit in a limited way. “We haven't see a huge focus yet, but it's certainly something on their radar screen,” he says.
The SEC is in no way interested in curtailing the use of credit lines for private fund managers, sources say. Its interest is likely to focus squarely on transparency, especially how performance is calculated and communicated to investors.
Also taking an interest is LP lobby group the Institutional Limited Partners Association. It has been asking its members, which represent nearly half of the capital committed to private equity globally, about the use of fund finance. And the SEC is interested in its findings, according to a source.
The feedback so far has “focused on reasonable thresholds around terms and days outstanding”, says Jennifer Choi, managing director for industry affairs at the association, referring to the length of time that a line of credit might be left before being 'cleaned down'. LP members have “broadly supported recommendations for additional disclosures,” she says.
Investor opinion on the value of this sort of fund finance is mixed, according to Choi. “For LPs with a positive view of these lines, they see the practical benefits in terms of smoothing cashflow, or the appeal of higher reported IRRs,” she says.
“There are others who care about absolute return, ie, multiples on invested capital, more so than IRR, and wo feel there is a cost and some amount of risk associated with these lines,” she adds. “They may be more inclined to think that the use of these facilities has gotten out of hand, and would like to see the use of these lines reined in, but not necessarily eliminated.”
ILPA is working on recommendations to include in its Private Equity Principles document – which is intended to improve communication and alignment between LPs and GPs – in an update at the end of the second quarter.
The recommendations are likely to cover maturities, number of days outstanding and transparency on performance reporting. It is also likely to call for GPs to report both their current and prospective LP returns on a levered and unlevered basis.