Keynote interview in PEI Fund Administration Special Report 9 June 2020

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Jason Bingham

Chief Strategy Officer

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Due diligence steals the spotlight. Covid-19 will not only impact fundraising, it will also expand the scope and scrutiny of due diligence in the private equity industry.

Jason Bingham, SANNE's Chief Strategy Officer, covered this topic in an interview featured in the June edition of PEI Fund Administration. Read the full publication here and find Jason's interview on page 10.

In the first quarter of this year, private equity funds closed on a total of US$124 billion, according to PEI data – a remarkable 30% increase year-on-year. However, when Q2 numbers are in, the graph is likely to look very different. We spoke to Jason Bingham, Chief Strategy Officer at SANNE, about how the global pandemic has impacted managers’ capital raising plans and the due diligence questions it has raised among both GPs and LPs.

What are the immediate implications of the global lockdown for GPs marketing and fundraising?

The feedback we are receiving from asset managers on their fundraising is mixed. Many funds which were partly through their fundraising seem to be full steam ahead to first close. Some have exceeded targets, as investors look to place cash in safe havens away from the turmoil in the stock and bond markets.

LPs also realise there will be some decent returns to be made on the other side of this. Those that backed away from private equity during the global financial crisis lived to regret it when they saw how the industry rebounded during the subsequent recovery. The current shock is unlikely to shake an underlying confidence in private equity.

For some of the smaller and mid-market fund managers, there seems to be a slowdown or delay on fundraising until the COVID-19 lockdown is relieved. This is particularly true for managers who are dependent on investors from outside the circle of institutional investors (e.g. pension funds), where direct contact and marketing with LPs is critical but currently challenging. For some of our mid-market fund managers we envisage a backlog of fundraisings which will give rise to a substantial number of fundraises occurring once the lockdown ends.

What challenges do GPs face as they steer their funds through the current volatility?

Given the degree of uncertainty we have now, portfolio company valuations are currently challenging. GPs are paying particular attention to the valuation provisions in their fund documents to ensure compliance. The changing valuations of portfolio companies may impact the calculation of the management fees, distribution waterfalls and clawbacks. GPs may also come under pressure from LPs to write down the value of existing portfolio investments and any such write-downs would likely have a negative impact on the management fee after the investment period. GPs are also engaging with their portfolio companies, auditors and valuation advisors as to the feasibility of meeting the applicable reporting deadlines.

How are managers attempting to mitigate the uncertainty?

As you would expect, the number of additional information requests that we have received from our GP clients on matters such as valuations, financial statements and sign off extensions, has increased significantly. The speed of access to underlying investment data has been critical for these managers. Our role in providing look through reporting for GPs to complete critical tasks like investment risk assessment and cash flow forecasting has been vital during this uncertainty.

GPs have been focusing on their portfolios, supporting investments with liquidity concerns and exploring new opportunities in dislocated markets. The data we are providing is enabling GPs to give LPs better clarity over their cash flow requirements as they schedule their capital calls. In the market generally, there have been some LP liquidity concerns although we have not seen any LPs default, and clearly GPs do not want them to.

 From a regulatory perspective, are funds working differently?

There are operational challenges, anti-money laundering compliance being a key one. The severe restrictions that we are all under will make it more difficult to perform effective client due diligence. We take a risk-based approach and use information from multiple sources to conduct checks on third parties to support compliance with local regulations. Our fund clients are well known institutions and their LPs invest across multiple managers. There is a lot of information in the public domain that we can source and verify independently. For smaller managers with a less sophisticated investor base, AML compliance will be extremely difficult.

We are all using technology more in the current crisis. What’s the impact on the fund industry?

If firms are not operating on a common platform like we are, or something similar, then they will find life very challenging. We have more than 1,800 employees globally and have been able to conduct virtual communications with all our staff to deliver crucial global covid-19 updates and keep people engaged with our business activities.

For managers seeking to understand their industry exposure and assimilate information quickly, data extraction technology is key. Those GPs that had not set up data architecture pre-Covid and were not aware of how important data is to their business are probably struggling operationally in this current environment. Relying on information from several providers using a range of platforms is difficult.

What’s the solution?

Some of the more sophisticated managers already recognise that dealing with too many counterparties is inefficient and have already lay down the groundwork from which to do analytics. They are reviewing how they ingest information and collate it for their LPs, as well as internal, governance and regulatory reporting purposes. They want a single repository of information, a customised platform, that they can input and extract information from to generate detailed reports.

For us, supporting our clients’ data needs is possibly one of the most valuable elements of what we do, given that we sit on a huge amount of robust portfolio company and fund information. Based on what we are hearing in conversations with clients, there’s a heavy emphasis on data in terms of security, management and governance across the board. It is not just simply whether we have a policy and procedure but when and how our cyber security framework has been tested. Clients want to see details of our insurance provisions around cyber-attacks and data security. Given the criticality of technology to the support, sustainability and growth of our business, we have invested heavily in this area.  

Looking forward, will this crisis change how GPs invest?

Sector expertise will become more critical than ever. Post-pandemic, some industries will be changed forever, particularly those reliant on consumer demand, such as retail, hospitality and aviation. If managers are going to place smart bets, they need to understand what will differentiate the winners from the losers in any of the subsectors.

The scope of GP due diligence will also change. No one saw this pandemic coming, but it highlights the importance of modeling a range of scenarios in due diligence and preparing for the worst.  Factoring in foreseeable but unpredictable disruption will become a standard part of due diligence in the future. This crisis has drawn attention to several issues, such as resilience to supply-chain weakening and business continuity planning. LPs will continue to focus their questions around business continuity during due diligence, they will want to know that a GP has tested its business continuity plan, and that it will work during an unpredictable disruption, and that portfolio companies are prepared to deal with problems in real time.