Funds that are permitted to by their establishment documents can make use of finance in order to enhance returns for their investors and managers and also to manage cash flow. Fund financing products have become more complex over recent years and involve increasingly sophisticated solutions for funds and, indirectly, their investors.
The typical fund finance facility is the “capital call” facility. This allows a fund to borrow from a lender based on the commitments which investors have made to the fund. Security is granted over these “call rights”. The bank or other lender will provide credit based on the amount of uncalled commitments available. The fund manager will typically use these facilities to complete a deal (or series of deals) and then request that investors pay their capital commitments to repay the finance. The main advantage to investors is that they do not need to make capital calls in a compressed timeframe to hit a deal closing target and they may also only be presented with a single draw down request at the end of a certain period (for example each quarter) rather than receiving multiple requests. Lenders are attracted to these facilities as they are generally low risk. Providing the fund documentation regarding capital calls is robust, there is appropriate security in place and investors are credit worthy the default risk should be minimal.
In addition to capital call facilities products such as net asset value (NAV) facilities (effectively a facility lent against the value of a fund’s portfolio) and hybrid facilities (a mixture of capital call and NAV) have become increasingly popular. There has even been an increase in unsecured funding which is subordinated to a secured lender – this first became prevalent in the US so the term “second lien” is often used as this tends to be the US description of this sort of debt. Clearly this form of borrowing is comparatively expensive given the increased risk to the lender so will generally only be used for very short term lending where there is a commercial need for a facility of this kind.
The increasing demand for fund finance combined with the increased number of funds in the market has led to an expansion in the providers of this product. A few years ago there were a handful of global banks who dominated this space. Now the number of providers has increased significantly with debt funds and specialist providers being especially active in the small and medium fund market.
Jersey has the enviable position of having a strong funds and banking/finance centre so is ideally placed as a location for both lenders and borrowers in the funds finance arena. It is also worth mentioning that there are a number of financial institutions, including some specialist debt funds, based in Jersey who provide these products. With interest rates still at historically low levels and an increased awareness and provision of finance available to funds it is likely that fund finance will grow globally and locally.
First Published by Connect, June 2019.