A US regulation is rearing its head at a time when many institutional investors are under pressure to rebalance their portfolios.
Publicly traded partnership rules require sponsors of limited partnerships that contain US investors to categorise any secondaries transactions that occur in their funds under one of several ‘safe-harbour’ exemptions. Failure to comply means they could be treated as a corporation and subject to negative tax consequences, backdated to the date of the first violation.
Those ‘safe harbours’ include if the total of stakes traded within a given tax year represents less than 2 percent of a limited partnership; if a fund has fewer than 100 partners; or if there is only one trade during the tax year regardless of size.
Secondaries Investor has written at length, such as here and here, about trading backlogs due to PTP rules. As the secondaries market continues to grow, managers and their advisers are having to think about the topic a lot more carefully.
In recent months, we’ve heard about long delays for trades to close due to PTP. Etienne Deshormes, chief executive and managing partner at advisory firm Elm Capital, tells us some investors are queueing into 2025 to sell their stakes in private equity funds because of PTP restrictions.
The topic also came up at a recent secondaries event held by a law firm in London, where attendees heard that some had been postponed into 2024 and 2025.
“Almost every partnership agreement will say that the sponsor is going to do something to prevent [a fund from tripping PTP rules],” one lawyer said at the event, conducted under the Chatham House rule. “What that something is has changed over time, and it has changed over time precisely because all of you have allowed there to be more liquidity in the market, and because there’s more liquidity in the market, there’s more risk that the PTP rules may actually be effective.”
The problem with the PTP rules is that they are quite opaque, the lawyer explained. Although many managers – particularly those with larger funds, which run into this issue more frequently – may feel pretty comfortable that they won’t trip PTP rules when working through the rules, the downsides of potentially getting it wrong can be disastrous. Because of this, there is no real incentive for some GPs to take the friction out of the transfer processes, another lawyer tells us.
Investors are expected to continue coming to market to deal with overallocations to private markets in the coming months – something that may push PTP queues even further out.
Make no mistake: the secondaries market has figured out ways to navigate PTP restrictions. Lawyers tell us that the rule simply delays the timing on who legally owns an interest, and that buyers can benefit from the arbitrage between a trade reference date and when a deal closes, as the buyer receives cashflows from the day of the former.
Still, for those LPs whose deals fall outside of the ‘safe harbour’ rules, it looks as though they’ll have to wait a little longer to redress their overallocations, at least on paper.
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