ILPA Principles 3.0: Choi on what’s new and what’s controversial

The guidelines for best practice incorporate several key issues for limited partners, including GP-led secondaries, subscription credit lines and co-investments.

Jennifer Choi

The Institutional Limited Partners Association has released the third iteration of its Principles, a set of guidelines for the industry calling for alignment of interest, greater transparency and strong governance.

ILPA Principles 3.0: Fostering Transparency, Governance and Alignment of Interests for General and Limited Partners expands, refines and updates the 2011 version – this one is 44 pages, versus 24 – as well as addressing new topics, such as GP-led secondaries transactions and the use of subscription lines of credit.

“Because this is such a dynamic industry, we knew that there were a number of things that simply weren’t addressed in prior editions because they weren’t factors at the time,” Jennifer Choi, managing director of industry affairs and lead developer of the Principles 3.0 guidance told sister publication Private Equity International.

“For example, we weren’t a regulated industry, so talking about the impact of regulation takes on a different lens today than it might have eight or nine years ago. Subscription lines were not a factor, GP-led secondaries had an entirely different connotation than they do today.”

The ILPA Private Equity Principles were first published in September 2009 and are now used by a range of industry participants. Version 2.0 was released in January 2011.

ILPA will not be seeking official endorsements for the document like it did with the previous ones, but will be “encouraging industry-wide adoption of its tenets through supporting guidelines, templates and model documents”.

One reason is, because many of the ideas in the Principles, such as standardised reporting, are widely understood as norms, endorsement does not deliver much more benefit, Choi said.

“Whereas it was meant to be an indication of support, to build critical mass around a set of ideas in the industry 10 years ago, over time we found it was sometimes being conflated with this notion of compliance,” Choi said. “Compliance implies some sort of an assurance mechanism, that someone has gone in and examined documents, practices, behaviours against a standard, and that’s not the case for the Principles.”

Any document of this nature attracts opinions. Choi singled out two particular items she anticipates may not be well received: the recommendation that the industry move to a gross-of-tax clawback model; and the recommendation to calculate the preferred return when capital is invested, rather than called from LPs, to mitigate the effects of a subscription credit line.

The first version of the Principles stated clawback amounts should be gross of taxes paid, but this was switched to a net-of-tax recommendation for version 2.0 following feedback from GPs.

“With that we began to hear about the very high rates that were being applied in computing the tax,” Choi said, leading to the decision to revert back to a gross-of-tax model which, she added, is “really challenging to achieve”.

“Because it hits people in their wallets, so to speak, we anticipate there will be views about that recommendation.”

Choi said she has “yet to hear of any GP supportive of that particular concept” of calculating the preferred return from the time a financing facility is drawn rather than the date the capital is ultimately called, but “I think they do understand that there’s a need to mitigate what might be behaviour-altering effects of the use of these facilities”, particularly when amounts are outstanding beyond a year.

In an effort not to tie regulatory recommendations to any particular jurisdiction, the Principles focus on transparency and disclosure, including looking at which regulatory entities the fund is subject to and if there are regulatory changes that affect the operations of the fund.

The guidance states that, on request, “full access to the results of any regulatory investigation or examination” should be provided to LPs.

“That is not a market norm today,” Choi said.

Choi added the one thing ILPA wants the market to take away from the new Principles is: “We can do better.”

“We can establish a better starting point, we can be better aligned as an industry, and within our individual partnerships.”