The increased use of subscription credit lines by GPs is one of our main concerns today.
Credit lines are very useful and make a lot of sense to manage short-term cashflows and to ease the life of both LPs and GPs, as long as you use it as a working capital tool to avoid doing multiple capital calls within a defined period. If it remains a pure short-term working capital facility, we are fine with it. As a fund of funds manager, we even have one to avoid multiple drawdowns, within the same quarter, to our own investors. However, we feel this interim leverage may create some risks and a certain misalignment of interests.
Over the last 18 months, we have noticed a change in how the subscription lines are effectively used. More and more GPs are using those lines extensively and, to some extent, abusing the use of these credit lines by carrying investments for a long time. Some GPs are now pushing hard to increase credit lines in their funds, extending maturity sometimes above one year for an amount that could reach 30-40 percent of the fund.
This could be a dealbreaker for us. As part of our due diligence process, we are now deeply reviewing provisions and disclosures related to subscriptions lines into the limited partnerships, and we intend to try to limit the use of credit lines as much as possible, or at least to have the right disclosure in how those lines are intended to be used and at what cost. We intend to push GPs to take in consideration our concerns, and sometimes they listen.
Credit line providers use the credit rating of the LPs and do not take risk on the fund's assets, they are just taking risk on the LPs' capital calls so they look at the quality of the LPs and lend to the fund on that basis. If we accept that GPs optimise reasonably their annual rate of return by leveraging our credit rating, we believe we should be compensated for that. Why not let the LPs participate?
As an LP managing long-term savings, our duty is to deploy capital, and ultimately to be invested, so why should we have to support – as part of the cost of the fund – some additional indirect costs, when we would prefer to put more money at work? At a certain point, we believe this may push LPs to increase over-commitment and create additional systemic risk.
The subscriptions lines are also increasingly used during the fund-raising period. GPs intend not to call first-comer investors at initial closings but wait until all the investors are committed. Despite the legitimate operational rationale to avoid the equalisation process, there is no longer a benefit for LPs to come at the first closing.
Finally, there is an issue of visibility of the performance. Do you prefer 10 percent per annum IRR with being fully invested or do you prefer 15 percent per annum with only being half invested? By an extensive use of the credit line, the IRR would become less relevant to measure the GP performance and the underwriting risk-profile of the underlying assets.
We know there is a debate within the LP community about this. Some LPs seem to be fine with it. But clearly it's an issue on which LPs should act a little more collectively, and try to lobby the regulators to establish best practices and the right disclosures.