The Institutional Limited Partners Association in late June released the third edition of its principles setting out industry best practice for LPs and GPs.
It addressed new and emerging issues such as GP-led secondaries transactions, recommendations on the use of subscription lines of credit, GP ownership and succession issues, and enhanced fee and expense reporting.
The publication of ILPA Principles 3.0: Fostering Transparency, Governance and Alignment of Interests for General and Limited Partners came eight years after the second edition. Sister title Private Equity International spoke to industry participants on what Principles 3.0 means for them.
As GP-led fund restructurings become more common, ILPA recommended GPs ensure that the processes for secondaries transactions are fair and transparent. This includes engaging the LP advisory committee at the earliest opportunity around the objectives, logic and process of the transaction, as well as the terms and framing of the deal.
Merrick McKay, head of Europe, private equity, for Aberdeen Standard Investments, said his firm often finds itself in tricky situations. Aberdeen has both primaries and secondaries teams.
“It’s riddled with conflicts. There are situations where we can potentially be involved in both sides and we have to split our teams and decision-making process.” McKay added that the firm takes the starting position as an LP, and that GPs have the fiduciary and moral responsibility to act in the best interest of their LPs.
Disclosure on credit lines
In 2017 ILPA issued guidance to LPs and GPs on the use of subscription lines of credit in an effort to encourage greater transparency. Principles 3.0 expanded on this and recommended that GPs provide quarterly and annual reporting on the use of fund leverage, the terms for any such facilities as well as performance information.
Gareth Whiley, managing partner at pan-European firm Silverfleet Capital, said his firm “completely supports ILPA’s recommendation that the terms of any line should be disclosed and that the use of any line should be reasonable in size and duration”.
He noted that Principles 3.0 did not deal with the inherent conflict that exists in the LP community: “LPs that really don’t want any form of leverage at the fund level and those that want the enhanced returns that a sub line can provide.” He said Silverfleet approaches credit lines from a full-disclosure basis so that LPs can compare returns with or without the use of a facility.
McKay said his firm relies on its relationships with its GPs and their full transparency: “It’s important for us to understand what our exposure is at any point in time on a quarterly basis, and GPs are getting better at that.” He added there had been an increased push on GPs to effectively show net returns with and without the use of credit lines.
ILPA’s latest guidelines proposed that GPs “disclose to all LPs in advance, through both the private placement memorandum and limited partner agreement as well as any regulatory filings, a framework for how co-investment opportunities, interests and expenses will be allocated among the fund and any participating co-investors”.
A formulaic approach is not generally appropriate, according to Silverfleet’s Whiley: “Clear communication to our LPs, without drawing up a fixed policy, has worked to date but we will continue to discuss with them the best way to develop our co-investment programme policies.”
Jos van Gisbergen, senior portfolio manager at Dutch pension manager Achmea Investment Management, said the main problem in the industry is that fewer high-quality GPs as well as larger LPs with active co-investments are in compliance with the principles.
“In a market where demand for great funds is exceeding supply, GPs are able to further shy away from best practice,” he said.
Van Gisbergen added that Principles 3.0 could have shed more light on GPs’ sales of stakes to LPs, which are causing a misalignment of interest and potential governance issues.
McKay also pointed out that although some GPs consult the guidelines, there are others that seem to push the boundaries: “There are inherent long-term consequences if an LP thinks, rightly or wrongly, that there has been a breach of trust. It’s a serious responsibility. There could be some short-term gain for long-term pain.”