Scottish limited partnerships (SLPs) feature widely in UK and international fund structures as, unlike their counterparts constituted elsewhere in the UK, they have separate legal personality. As advisers to lenders and borrowers on the Scots law aspects of cross-jurisdictional fund finance deals involving SLPs our experience reflects more general shifts observed in the fund finance market; the profile of the types of credit facilities being used, and the composition of the security package taken by lenders, is changing. Various factors are at play, including, significantly, the current interest rate environment (and wider economic landscape).
Financing funds
From a lender's perspective the value of a fund lies in its underlying investments and/or its investor commitments to make capital contributions over a specified period of time. The value of those investments or commitments and the type of finance facility provided by a lender will drive the security package which lenders take in relation to funds.
Types of fund finance facilities
While we are seeing changes in the market, including increased used of hybrid facilities, finance facilities available to funds generally fall into two broad categories, each involving a different type of credit risk assessment:
- capital call or subscription line credit facilities (capital call facilities), which are generally short-term revolving credit facilities allowing funds to bridge capital calls and to access capital quickly, and which give the lender recourse to and security over investor (limited partner) uncalled capital commitments; and
- asset-backed or net asset value (NAV) facilities, which are generally term loan facilities secured over the receivables flowing from the underlying investments.
While capital call facilities are said to 'look up' for recourse to the investor commitments, asset-backed and NAV facilities 'look down' to the underlying investments. As we will come onto, our experience is that the shift towards increased use of downward looking finance facilities continues.
Types of fund security
In cross-jurisdictional fund finance transactions an overriding security document which is not governed by Scots law may be put in place, and jurisdiction specific security will also be taken.
The security package that a lender will take in relation to an SLP depends on the type of facility provided and on the nature of the fund's underlying investments.
Where a capital call facility is being provided, typically the principal security taken is over the limited partner uncalled commitments:
- security is taken over the general partner's or investment manager's right to make capital calls or issue drawdown notices to the limited partners.
- This is effected by an assignation (transfer) in security by the general partner or investment manager to the lender so it can make such calls and issue such notices should the general partner or investment manager fail to do so. Care must be taken to ensure that the lender does not take on the whole role of the general partner or investment manager and thereby assume substantial liabilities.
- security is taken over the proceeds of capital calls and the bank account into which those investor commitments are deposited.
If the accounts are located in Scotland, whether or not an assignation in security of accounts is possible will depend on the nature of the accounts (ie whether they are general / current or deposit accounts) and how the security is to operate in practice.
Where capital call facilities are provided lender risk lies with the creditworthiness of the limited partner investors and their ability to make their capital contribution when a capital call is made.
Where asset-backed or NAV facilities are being provided, typically security is taken over the fund's assets and/or the rights to the cashflow and distributions that flow upwards from the fund's underlying investments:
- security is taken over limited partners' interests in fund receivables due to them by assignations in security from the limited partners to the lender.
- security over the interests in fund receivables of the general partner (or investment manager) is taken by the lender by way of an assignation in security.
- security is taken over the SLP's bank accounts into which limited partner receivables are deposited.
Again, the effectiveness of a Scottish account (if the bank accounts are in Scotland) will depend on the nature of the accounts and how the security is to operate in practice.
A wider Scottish security package is often taken and this may include share security and floating charges, where competent.
In asset-backed or NAV facilities lender risk lies with the value of the underlying assets and cashflows from those assets.
Fund finance trends we are seeing
Background factors of a higher interest rate environment, slowdown in fundraising, more challenging exit conditions and longer hold periods for assets to realise better values have impacted fund financing. Changes we are seeing in this space include increasing numbers of non-bank lenders being active in the fund finance market and shifts in the types of fund finance being provided.
Asset-backed or NAV credit facilities are being used increasingly, continuing the trend for lenders to 'look down' for recourse against the underlying fund investments.
Hybrid credit facilities, where the lender has recourse both to the underlying investments and to uncalled capital commitments, are becoming a more common feature of fund financings. Hybrid facilities enable a longer and stronger fund-lender relationship throughout the fund journey.
Our experience is that faced with a challenging economic landscape the fund finance market is actively continuing to adapt to meet funds' liquidity demands.
Our Legal 500 Tier 1 Investment Funds team specialises in advising on the Scots law aspects of UK-wide and international fund finance deals. Brodies partner Alan Knowles is named as 'Fund finance expert'.
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