As the mid-point of 2020 approaches, this provides an opportunity to reflect on the current state of play in the Funds Finance market. This article summarises the market in light of the exceptional circumstances presented by Covid-19, and provides a view on the current challenges and the anticipated trends in the future.
Reflections on 2019
Notwithstanding challenging macro-economic factors over the course of 2019, the Funds Finance industry continued to grow, with new entrants seeking to provide facilities to UK and European investment funds. These new entrants contributed to a competitive market where borrowers could benefit from increasingly flexible terms in addition to attractive pricing solutions.
Increased activity from lenders was not limited to origination, however, as a growing number of banks, insurance companies, pension funds and other alternative investors also engaged through a burgeoning syndication market by way of transfers and sub participations.
Over the course of 2019, the market continued to see more complex fund structures with greater focus and flexibility on borrowing and guaranteeing by the entities within the overall fund structure. This was driven by increasing awareness and visibility of the Funds Finance market and the options available under it, as well as a greater understanding by investors of the financing strategies that a GP may intend to use at fund level.
By the close of 2019, notwithstanding the macro-economic factors, market participants were optimistic heading into 2020 and it was expected that the market would continue to strengthen and grow, with more variety of products being offered in an increasingly competitive and diverse market.
The Impact of Covid-19
Since Covid-19 hit the newspapers and the world's consciousness, GPs have sought to increase existing facilities and extend the tenor of facilities, and many lenders have focused on supporting their existing customers – with both GPs and lenders being keen to maintain an open and regular dialogue. There has also been increased activity in adding new borrowers to existing facilities, utilising accordion features and converting uncommitted lines into committed facilities.
There were some initial concerns in the market that GPs may draw down heavily on capital call facilities, but the general market experience has been that has not happened and, if anything, GPs have called down more capital from investors (as has been noted by the Institutional Limited Partners Association) with capital call utilisations then being reduced. This has been in marked contrast to the corporate market where working capital facilities have in many cases been drawn down in full by borrowers.
Despite the obvious challenges presented by Covid-19, the Funds Finance Association (FFA) has reported that there have been no defaults on investor calls by institutional investors in any fund with a capital call facility – and that echoes our experience as well (with no defaults in relation to any category of investors).
Challenges posed by Covid-19 are of both a direct and indirect nature to the Funds Finance market. The impact of the pandemic directly disrupts certain classes of assets, resulting in uncertainty in relation to the valuation of certain assets. This is particularly relevant to NAV facilities. Increased activity and drawdowns (with pockets of bank balance sheets being set aside for government funding schemes or otherwise) as well as cash hoarding in the corporate loans market may also mean that some lenders will be cautious for now when it comes to deploying capital into the Funds Finance market.
Looking forward, whilst we do not see any fundamental changes to the operation of the Funds Finance market, we envisage there may be some more subtle shifts as:
- lenders in the market respond to the varying pressures and dynamics which apply to them – whether that is political pressure on some banks to focus on their domestic markets (or certain types of customers), regulatory constraints (for some US lenders in particular), increased funding costs, or the pressures which inevitably come from an uncertain macroeconomic environment (whether that is to be cautious on any new lending or to be ambitious and take advantage of the opportunities created by market uncertainty). Many of those pressures may only be temporary, but they will exert themselves on market participants in different ways and at different times
- refinancing of portfolio companies may (in some cases) become increasingly challenging or costly, the Funds Finance market may offer an ever more popular and cost effective alternative. The emergence of NAV financings in particular for private equity funds has been talked about for a long time, but the current macroeconomic climate is starting to look like it may prove an inflexion point. There has been a steady increase in appetite for supply from some banks and in particular non-bank lenders, and this is now being met with an increase in interest in demand from GPs (and LPs) looking to maximise liquidity at a fund level to support existing portfolio investments and to take advantage of opportunities created by reduced valuation of assets and market volatility
- increased focus on liquidity may mean there is less appetite for uncommitted facilities than before Covid-19
- market participants continue to develop the range of Funds Finance products available – with hybrid and NAV facilities, preferred equity and other bespoke fund financing solutions complementing the established subscription line facility product. This will lead to a greater focus at the fundraising stage (and throughout the life of a fund) on debt strategies and ensuring that GPs have the appropriate tools in the toolbox for individual funds, enabling GPs to manage funds through uncertain times and also to take advantage of opportunities as they arise, for the benefit of their portfolio companies and investors alike.
Notwithstanding the current challenges, the Funds Finance market remains robust and will continue to develop. It is a market which was extremely resilient during and following the Global Financial Crisis (outperforming many other forms of finance), has benefited from strong growth since and – whilst all market participants have shown good sense and restraint at the outset of Covid-19 – it is poised with an even diversifying range of market participants and products to react to circumstances and opportunities as they develop.
If you would like to know more or would like to discuss anything further, please get in contact.