Just over half of investors in private markets expect to see an increase in the use of subscription lines over the next 12 months, with fewer than 10 percent predicting a decline, according to Infrastructure Investor’s LP Perspectives 2022 Study.
“There has been no slowdown in demand for subscription finance,” says Jonathan Harvey, head of relationship management, fund solutions, at Investec. “The subscription market is a derivative of the fundraising market; and with interest rates remaining at historic lows, there has been absolutely no decline in appetite from LPs looking to put more money to work in alternatives.”
However, some investors do still have concerns about the nature of subscription finance. “In the past, the only reason to use subscription facilities was because you were prosecuting a greenfield strategy,” says Bruce Chapman, founder of Threadmark. “You would end up with a pretty unexciting IRR if you put all your equity in at the very start of construction, so managers would utilise letters of credit.
“That is widely accepted and very valid. But when you are talking about using subscription facilities for brownfield strategies simply so that managers can defer the drawdown, that is less popular with investors. That is just using the creditworthiness of the underlying LPs to lever up commitments in order to increase the IRR, which then generates higher carry for the GP without really benefitting the investor. This has long been the norm in private equity and I think it will become the norm, at least for the largest and most established managers in infrastructure – unless, that is, LPs put their foot down and block it.”
Brent Burnett, co-head of real assets at Hamilton Lane, agrees: “The GP has to be able to justify why they need that line in place, what the duration of the line is, and whether or not carry is being calculated inclusive of that credit facility.”
“LPs continue to press for greater transparency into how the use of subscription facilities impacts on fund performance, including how the preferred return is calculated,” adds Jennifer Choi, managing director of industry affairs at ILPA. “Additionally, LPs remain concerned about whether the purported promise of these facilities – such as smoothing the administrative burden around capital calls – is translating to actual benefits for LPs in terms of enhanced visibility into capital call timing and amounts. Encouragingly, the majority of LPs report that, in most cases, outstanding amounts on these lines are being cleared down in under 12 months.”
However, Leon Stephenson, co-lead of Reed Smith’s fund finance team, believes that LP attitudes towards fund finance are often born out of personal interest. “If the LP is incentivised to get money out of the door, they are obviously going to oppose subscription lines,” he says. “But if the LP is incentivised based on IRR, then having subscription lines that delay drawdown is a positive.
“If an LP does have concerns, then they have the opportunity to express those when they negotiate the LPA. This is discretionary management. If they don’t like something, they should object upfront, not midway through a fund.”
A force for good?
Subscription lines are also being used as a tool to encourage progress on environmental, social and governance issues. EQT negotiated a €2.7 billion subscription facility that links performance on certain ESG goals, including gender diversity and reducing greenhouse gas emissions, to more favourable interest rates for its latest infrastructure fund. InfraVia Capital Partners also included an SDG-linked bridge facility in its fourth flagship fund.
In addition to subscription lines, NAV financing is on the rise. “The most interesting development in infrastructure fund finance is in the NAV space, where lenders are providing liquidity against the value of the underlying assets,” says Stephenson. “The facilities are proliferating rapidly and a number of the lenders we work with are providing NAV financing to some of the large, established infrastructure players.”
“NAV-based financing is evolving for infrastructure, just as it has for private equity,” Burnett explains. “The options that GPs have available to them at a fund finance level have really expanded, and that means fund finance is becoming an increasingly important component of due diligence. Again, the important thing is that the GP explains what the intent of those lines really is.”
Just over half of the survey’s respondents said they are concerned by the extent to which GPs are using credit lines to fund portfolio investments. Harvey agrees that it is important that the rationale for the borrowing is clear: “LPs need to be able to see the value that the NAV line is creating. If it looks more like a defensive play then I can imagine there would be questions from investors.”