Did the SEC consider credit secondaries in its rulemaking?

Getting a fairness or valuation opinion on a private equity GP-led secondaries transaction is a straightforward, albeit costly task. In credit secondaries, however, the rule change creates a cumbersome burden.

Did the US Securities and Exchange Commission take into account credit secondaries when it imposed its GP-led secondaries rule? Market participants don’t think so and warn it will create some difficulties.

Within the private fund advisers rules under the Investment Advisers Act of 1940, which were voted through last month, GPs either based in the US or with US investors must obtain a fairness opinion or a valuation opinion from a third party in continuation fund transactions.

While it’s a straightforward concept to get either a valuation or fairness opinion on a concentrated number of assets involved in an equity transaction, GP-leds involving credit funds – which typically have a higher number of underlying assets than their equity counterparts – will be a lot more cumbersome.

“On the credit side, it’s generally portfolios – and sometimes not even a single fund, [but] multiple funds… oftentimes with a staple commitment to the next fund… You’ve got a lot of parts to it,” said a managing director, speaking at affiliate title Private Debt Investor’s New York Forum this month.

The credit secondaries market saw around $1 billion to $2 billion of volume in the first half of this year, balanced between LP-led and GP-led deals, according to PJT Park Hill’s first-half report. The investment bank anticipates the credit secondaries market will continue to grow in the second half of the year. Alongside opportunistic LPs tapping the market, it expects large GP-led processes will gain traction.

Activity has been fuelled by a number of industry heavyweights that have entered the market in recent years. Ares Management, for example, launched its first credit secondaries commingled fund this year following the official launch of its debt secondaries business in March via a joint venture with Gulf giant Mubadala Investment Company. Tikehau launched its second debt secondaries vehicle in July targeting between $700 million and $1 billion, which would mark a substantial step up on its predecessor. Elsewhere, Coller Capital raised around $1.4 billion for Coller Credit Opportunities I and co-investments last year, nearly double the amount it was targeting.

Most GPs managing senior lending funds will have third-party valuations done on their entire portfolios, said a credit secondaries specialist at PDI’s event. In some cases it’s staggered quarterly, and in some cases it’s all loans quarterly.

“Hopefully if we do get to that point where you have to do a fairness [opinion] on a diversified portfolio, there’s a lot of evidence backing [it] that’s not inventing the wheel, but it’s going to be cumbersome,” the person added.

There are some with more weighted concerns. One legal expert at the event questioned whether the need for either a fairness opinion or a valuation opinion would act as an “ankle weight” in a market where GP-led transactions are beginning to flourish.

With credit managers getting to grips with GP-led transactions, rules that compound the burden is hardly welcome news for credit-focused secondaries investors with cash to spend.