Contributed By Travers Smith LLP
The fund finance market in the UK is sophisticated and well-developed, particularly for closed-ended private funds. The market includes a range of lenders, from banks to specialist debt funds, who offer finance solutions to funds and their GPs/managers. The most common product is a capital call facility, allowing the fund to draw money from the lender in anticipation of making a capital call from the fund's investors. The main advantage of this type of facility is that it will allow quick and efficient access to capital. The fund documents (eg, the limited partnership agreement) will normally require that at least ten business days' notice must be given to the investors prior to the date of any capital call, whereas the lender under a capital call facility will allow the money to be drawn on shorter notice. This type of arrangement therefore gives the GP/manager greater certainty of funding, particularly when the fund needs capital for investment purposes. It also allows the GP/manager to smooth out when capital calls are made to investors because the fund is able to make use of the facility for irregular cash requirements, such as fees and expenses. In addition to capital call facilities, other types of fund finance have been developed, including NAV facilities secured on the underlying assets of the fund, fund finance arrangements to unlock liquidity for investors and facilities targeted at GPs/managers to assist team members to participate in any “GP commitment” requirements.
As regards open-ended funds, UCITS funds are subject to prescriptive rules on borrowings, as prescribed under the UCITS Directive. A UCITS is permitted to borrow money for use by the fund, provided it will be repaid out of the scheme property and does not conflict with any restrictions on borrowing that may have been included in the fund’s Instrument of Incorporation. This borrowing is permitted purely on a temporary and infrequent basis and must not exceed 10% of the total value of the fund’s assets on any day. Prior consent for any borrowing must be obtained from the Depositary, or for periods of borrowing that may exceed three months. For NURS, the same 10% borrowing limit applies. However, there is no restriction on the length of time for which a NURS may borrow.
Despite the developments in the market, the general principle for closed-ended private funds in the UK is that investors will not want the fund to be leveraged. This is particularly the case for a private equity fund because the investment strategy of the fund itself normally includes leveraged buyouts, so investors will not want a double layer of leverage (ie, at both the fund level and the investment level). Therefore, the limited partnership agreement in a closed-ended private fund will normally impose restrictions on the amount of leverage that may be incurred by the fund (for example, the lower of 20% of commitments made by investors and the amount of uncalled commitments) and any borrowing incurred must be on a “short-term” basis. Further, under AIFMD, any fund that incurs leverage (and for these purposes, short-term borrowing is excluded) is subject to additional disclosure requirements and the AIFM is required to observe a higher degree of regulation. As a consequence, it is important for common forms of fund finance (eg, capital call facilities) to adhere to both the investor-imposed and regulatory-imposed requirements.
It would be usual for the lender of a capital call facility to take some form of security. A common approach would be for the lender to have the right to require the GP/manager to draw down from investors to pay any outstanding indebtedness under the facility. It is even possible for the lender to step into the shoes of the GP/manager and issue draw-down notices direct to the investors. For this to be possible, the lender must have the right to be assigned the right under the limited partnership agreement of the closed-ended private fund to issue these draw-down notices. This can give rise to negotiation with investors as to whether they are required to counter-sign security documents. A possible compromise is that the investor signs an acknowledgment that the right to draw down has been assigned to the lender without the investor being a direct party to the security arrangements. An additional issue is whether the fund or investors are required to provide information to lenders. As a general rule, investors will not want to provide non-public information.
The most common issue in the UK is that investors will not want the fund to be leveraged. This is discussed in 4.2 Borrowing Restrictions/Requirements above.