The fund finance market in Asia

(Fourth edition) Overview of the Asia-Pacific private capital market developing economies (e.g. China, India and South East Asia), Fundraising although do occur in these regions too, and will become more prevalent as their economies further develop.5 A lot has happened in Asia over the last few years. In terms of deals, the average deal size in 2018 Total private market investor exposure to Asia has tripled over was US$213 million, with almost 75% of total regional deal the past 10 years, and this upward trend is expected to value relating to in China and India. Investments continue, given that Asia still represents less than 10% of global into internet and technology companies made up 50% of all exposure. With Asia GDP forecast to represent just over 34% of deals.6 global GDP in 2019 and 63% of total GDP growth in 2019, Asia’s markets have arguably been underweighted in investors’ Beyond China and India, the Southeast Asian market also saw global allocations, and there is the potential for Asia markets to significant activity. By the end of 2018, there were US$19.2 generate on a similar scale to that of Europe over billion private equity and assets under the next 5–10 years.1 management in Singapore, and US$6 billion in Malaysia. In terms of deals, in 2018 there were 380 announced deals worth By the end of 2018, the Asia-Pacific private equity market a total investment of US$14.1 billion in this region.7 boasted US$883 billion in total , representing 26% of the global private equity industry. Private Southeast Asian unicorns have also recently attracted regional equity funds operating in the Asia market held dry powder headline attention. Grab (Singapore), and Go-Jek and totalling US$317 billion, equating to three years of future supply Tokopedia (Indonesia) attracted more than US$1 billion of at the current pace of investment.2 in 2018. In Vietnam, Techcombank (financial services) and Vinhomes JSC (luxury home developer) each The year 2017 had been a record-breaking one for fundraising, raised US$0.9 billion as pre-IPO funding from sovereign with 593 Asia-Pacific-focused fund closings. Momentum wealth funds and leading private equity funds.8 started to slow throughout 2018, with fewer new fund launches that year (256), which has been partly attributed to global Asia market trends trade disputes and pressure on China-based funds, lenders and investors, to tighten leverage. However, those funds that ESG did manage successful fundraising achieved a higher average This year has seen visible growing public concern relating to size (US$294 million) than the previous year. Despite the the importance of environmental, social and corporate relative decline in 2018 fundraisings compared to 2017, it governance (“ESG”) issues, e.g. climate change, diversity and seemed that larger, established funds with a strong track equality. Awareness of and support for these concerns is being record were still able to raise funds successfully, whereas it adopted by many international corporates, financial was more of a struggle for smaller or newer funds.3 institutions, and investors and general partners (“GPs”) find themselves having to adapt to address these issues. Fundraising in 2019 is expected to be lower than previous record highs. However, there is evidence that larger funds with A number of prominent regional investors are leading the established reputations have still been successful, with new market in championing ESG investment. For example: ASEAN-focused private equity and venture capital funds • Japan’s Government Pension Investment Fund, the world’s averaging a 117% target fundraising success rate.4 There have largest retirement fund with US$1.5 trillion in assets, now also been reports that 2020 will see some of the larger funds in requires its fund managers to incorporate ESG principles, the region return to the market to raise new capital. allocates its investments based on a number of ESG benchmarks, and is reported to have agreed to pay higher Investment activity fees to a fund manager for managing investments in Fund investment strategies in Asia-Pacific tend to focus on accordance with these principles. , growth equity and venture capital in the more developed economies (e.g. Japan, South Korea and Australia). Growth and venture capital are the focus of funds in

1. Hamilton Lane, Private Markets in Asia: A Country-by-Country Guide. 5. Hamilton Lane, Private Markets in Asia: A Country-by-Country Guide. 2. Bain & Company, Asia-Pacific Private Equity Report 2019. 6. Bain & Company, Asia-Pacific Private Equity Report 2019. 3. Bain & Company, Asia-Pacific Private Equity Report 2019. 7. EY, Private equity briefing: Southeast Asia. 4. Preqin as at September 2019. 8. EY, Private equity briefing: Southeast Asia.

2 ⁄ Assessing lender risk in fund finance markets 2020 • Temasek Holdings Pte., Singapore’s state investor, is one of New Cayman regulation the world’s largest investors, investing US$17.6 billion in the The vast majority of Asia-focused private equity fund vehicles previous financial year. In October 2019, Temasek reportedly are Cayman Islands exempted limited partnerships (“ELPs”), declined to invest in Saudi Aramco’s , in which consist of at least one GP and investors who hold LP part due to environmental concerns. In November 2019, its interests. ELPs are extremely familiar to Asian and North Chief Executive Officer announced that it would start American sponsors and investors, and are viewed as attractive reporting its air miles, water, paper and electricity usage as and fit for purpose, not least due to flexible underlying part of an environmentally sustainable corporate legislation and tax neutrality. governance strategy.9 The Cayman Islands, along with many other jurisdictions, have Although there are some global sponsors that now have been required by the OECD to introduce economic substance impact investment funds which have been making investments requirements. Framework legislation to meet the requirements, in the Asia-Pacific region, Asia-Pacific has been somewhat the International Tax Co-operation (Economic Substance) Law, slower than other regions in implementing ESG integration; 2018 (Substance Law), was introduced in December 2018 and often the focus has been on corporate governance rather than this has been supplemented by regulations and guidance (the on environmental or social aspects. “Cayman ES Law”).10

According to Preqin, 55% of Asian limited partners (“LPs”) do As a result, 2019 saw sponsors and managers taking advice on not have an ESG investing policy for private equity, and 60% of whether any changes or modifications were needed to their Asian private equity funds do not require their portfolio existing structures and/or fund documentation in order to companies to report on ESG issues or responsible investment. comply with the new economic substance requirements. Research undertaken by Bain & Company indicates that only 13% of Asia-Pacific GPs have fully integrated ESG If a “relevant entity” is carrying on a “relevant activity”, the considerations at investment committee level. requirements for compliance include carrying on core income- generating activities in the Cayman Islands, being directed However, it is expected that pressure from international and managed in an appropriate manner in the Cayman investors will drive uptake in due course and, accordingly, that Islands, and having an adequate physical presence and an this will be prioritised by GPs and lenders. adequate number of employees or other personnel with appropriate qualification in the Cayman Islands. There is clear evidence that this is starting to take place in the banking community. In October 2019, ING announced it had A more detailed discussion of the economic substance made available a US$65 million revolving “sustainability legislation is beyond the scope of this chapter, however some improvement capital call facility” for Singapore-based relevant headline points are: Quadria Capital Management, being the first in the world to • “investment funds” (as defined in the Cayman ES Law) link the interest rate of a facility provided to a private equity including vehicles through which they invest or operate are fund to the sustainability performance of its portfolios. excluded and are not viewed as “relevant entities” for the Measurement of the ESG metrics would be based on key purposes of the Cayman ES Law; performance indicators provided by an analytics data • entities that are tax-resident outside of the Cayman Islands provider and an independent materiality assessment. are carved out of the ES Law;11 and In response to growing demand, the Loan Market Association • “fund management business” (as defined in the Cayman ES published a set of “Sustainability Linked Loan Principles” in Law) is a relevant activity, in relation to which relevant March 2019 which are intended to promote the development entities will be required to satisfy economic substance and preserve the integrity of sustainability-linked loan requirements in respect of gross income. products.

We expect that sustainability and ESG principles will continue to filter across the range of financial products, and will form increasingly important aspects of lender strategies.

9. Bloomberg, Temasek to Report Air Miles, Paper, Water Usage in Green Push (12 November 2019). 10. As at the date this article was written, the International Tax Co-Operation (Economic Substance) Law, 2018, the International Tax Co-Operation (Economic Substance) (Prescribed Dates) Regulations, 2018, the International Tax Co-Operation (Economic Substance) (Amendment of Schedule) Regulations, 2019 and the International Tax Co-Operation (Economic Substance) (Amendment of Schedule) (No. 2) Regulations, 2019 and the related guidance published on 30 April 2019 (as amended on 17 September 2019). Please note that the Cayman ES Law is subject to change. 11. Such entities will be required to produce evidence to the Tax Information Authority of the Cayman Islands substantiating the exemption claimed, such as a Tax Identification Number or tax residence certificate, as applicable.

Assessing lender risk in fund finance markets 2020 ⁄ 3 So while investment funds and their GPs would generally be product to quickly develop from being a bespoke relationship excluded from the provisions of the Cayman ES Law, deal into a much more commoditised line. Terms and managers are now seeking advice in relation to whether documentation are often derived from North American or Cayman-incorporated investment managers, investment European precedents, but certain local market adaptations advisor entities, portfolio companies or upper tier carry have clearly emerged, e.g. the use of Cayman law to govern vehicles are subject to any requirements. There are a number security over capital call rights, as opposed to using New York of restructuring options available (some of which are more or English law. simple than others) in order ensure compliance with the Cayman ES Law; however, it is important to note that there is However, in addition to these traditional subscription line no universally correct approach, and managers will need to financings, the market has also seen an uptick in the strike a balance between various competing onshore and availability and use of more structured and bespoke facilities. offshore considerations. These typically fall under the four categories below, although some lenders are able to offer tailor-made credit facilities for Sponsors should continue to monitor the Cayman ES Law, and their fund clients: we anticipate that the year ahead will bring greater familiarity • Net Asset Value (or “NAV”) Facilities: These facilities are with the legislative requirements, and comfort around raised against “concentrated NAV” (i.e. a small pool of the available solutions to existing structures. underlying investments of the fund), with recourse to the cashflows and distributions from the fund’s underlying Summary investments (as opposed to recourse against the GP’s rights The years 2017 and 2018 saw robust activity in respect of new to call undrawn capital from LPs). These facilities are helpful launches, capital-raising and deals, although levels have during the later stages of a fund’s lifecycle when there may declined throughout 2019. no longer be uncalled LP commitments to include in a lender’s borrowing base. There is plenty of dry powder in the region and, although it is becoming ever-harder to identify and win appropriate new • Hybrid Facilities: Hybrids involve a combination of capital investments, and many funds are still early in their lifecycles, call-style recourse to the GP’s rights to uncalled LP there will soon be pressure on GPs to deploy that capital in commitments, and also NAV facility-style recourse to the order to generate returns for investors. underlying assets. • and GP / Management Co-Invest Facilities: These take a number of forms but typically involve Fund finance in Asia-Pacific lending to a GP or management company in its own capacity, with recourse to GP or management fee income, Overview of the fund finance market and may be supported by personal guarantees. These can There is a healthy level of debt available for fund level be used to provide working capital to the GP or financings in the Asia market. In recent years, Asia-based management company, pending receipt of GP profit share financial institutions have significantly ramped up the sizes of or management fee income. These facilities are also used to their teams as a direct response to the huge amounts of help fund capital calls made on the vehicle through which private capital being raised in the region, and non-bank the GP or management team has invested (the latter being lenders have also been entering the market. There has been useful for larger funds where investors expect management significant growing interest and appetite among international, to have significant skin in the game). regional and local banks to offer a more diverse range of fund • Preferred Equity Financings: GPs have also been looking to financing products. raise finance at the fund level through preferred equity Fund financings in the Asia market are typically done on a structures. Increasingly, lenders are helping preferred equity bilateral basis, but there have also been examples of investors provide that equity funding through leverage to financings completed on a club or syndicated lender basis, in the investor, with security over the preferred equity cases where the size of the facility is too large for a single investment. lender to underwrite on its own. This will likely become more There are a limited number of lenders in the market who have common as larger funds are raised in the Asia market. the appropriate internal resources to be able to offer the more The majority of the fund financings in the Asia market so far structured fund finance facilities. For the lenders who are able have been traditional subscription line (or “capital call”) to do so, these types of facilities offer more attractive pricing facilities, where security is taken over the GP’s rights to call than subscription line facilities, which tend to be at lower undrawn capital from LPs. The high volume of new fund pricing levels given the competition between lenders for that launches in 2017 enabled the traditional subscription financing

4 ⁄ Assessing lender risk in fund finance markets 2020 product. This is also reflective of the higher risk of these Key legal due diligence points for funds and lenders in the Asia facilities, given that lenders need to make an assessment of market the potential for cashflows/distributions resulting from the There are, of course, a number of points which both funds and fund’s underlying assets and investments. their lenders will need to consider for any fund-level financing. However, we think funds and lenders in the Asia market will be As GPs look for additional ways to increase returns to investors particularly focused on the following legal due diligence and more lenders seek to diversify their fund finance loan issues: portfolios beyond subscription line finance in order to continue to execute new deals, it will be interesting to monitor the extent • Do the fund documents facilitate different types of fund to which these products get used. financing transactions other than subscription line financings (e.g. GP management fee financings)? Asian fund structures and fund documentation for fund • What ability does the GP have to issue drawdown notices facilities: Key issues and use capital to repay newly incurred bank debt following From a basic structuring and formation perspective, it is now expiration of a fund’s commitment period? much more common that new Asian fund documents contain • What are the circumstances in which investor commitments provisions which specifically permit the fund (or a portfolio could be cancelled or reduced? company) to incur subscription line finance debt, create • What happens if a fund unilaterally releases or waives the security and grant guarantees. There is now often language commitments of its investors without lender consent and that seeks to facilitate the taking of security over uncalled what contractual protections (if any) could be deployed to capital commitments and reduce the potential for further steps mitigate this risk? needing to be taken with their LPs in connection with any fund • Are there restrictions around the transferability of LP level financing. Making sure that a fund has the legal capacity interests (at least for those LPs who have been included in to enter into the transaction and grant security forms the core the borrowing base)? of lender legal due diligence for this product. Parties are becoming more familiar with lender due diligence • Will investor consent letters or other further deliverables be requirements, and there are now fewer examples of fund required from any LP to put in place the financing (e.g. documents containing problematic restrictions in respect of acknowledgments or courier delivery receipts in respect of basic capacity. LP notices)? GPs are particularly sensitive in Asia to further interactions or detailed information requests being required However, thinking ahead to the opportunity to put in place the with their investors. In some cases, GPs have even tried to more structured financings noted above, fund sponsors should resist providing copies of side letters to their lenders to avoid consider ensuring that: (i) the GP entity and management disclosing commercial terms agreed with investors. company are set up as separate entities (this has not always • Is the permitted use of proceeds of the facility wide enough been the case for local/regional funds); (ii) there is an SPV in such that, in addition to being available to bridge capital any structure set up for a portfolio investment in respect of calls to make investments, it can also be used to fund which share security can be granted and/or which can itself distributions to LPs as a bridge to receiving disposal grant security to support any potential NAV financing; and (iii) proceeds, or to bridge any timing delay caused by currency there are no restrictions on assignments of rights to conversions (e.g. when RMB proceeds are received onshore management fees, or any other rights to distributions by the and will be subject to lengthy PRC regulatory approvals fund or the GP. before they can be remitted offshore to the fund)?

In addition, when parties negotiate a subscription line facility, it Given current market conditions, we think it is essential that may also be worth considering including a permission to grant both lenders and GPs have a comprehensive understanding of second-ranking security over and recourse to undrawn LP these types of legal due diligence issues. This will permit a commitments, to allow this to be provided to any hybrid/NAV wider range of financing deals, and ensure that sufficient facility lender in the future, to the extent that subscription line protections or flexibilities are included in the finance facility is still in place at that time. documents.

Assessing lender risk in fund finance markets 2020 ⁄ 5 Outlook for 2020 in a slower pipeline of new traditional subscription line financings as we head into 2020. Increasing competition and uncertainty brings opportunities There is growing competition to raise funds and, at a time However, at the same time, there is increasing pressure on GPs when there is a large amount of dry powder in the region, to raise debt to manage liquidity and potentially help increase there is also a huge amount of competition over the best deals investor returns, especially in later life funds. to deploy those funds. GPs will face the challenge to identify attractive new investments in what is now a relatively mature A new fund’s primary concerns may be bridging capital calls market, against the backdrop of uncertain market conditions. or utilising leverage to increase liquidity and boost return on The performance of funds operating in the Asia market will be new investments – which can be served by the traditional closely monitored by investors, who are increasingly looking to subscription line facility. On the other hand, a later-life fund’s consolidate and reduce the number of their GP relationships. commitment period may have expired and the GP not be able to draw capital commitments in order to repay newly incurred This year has seen significant regional geo-political events, debt. A GP may also manage multiple funds with illiquid which have hindered new private equity downstream deal assets. opportunities. Pressures caused by the US-China trade war have disrupted new mandates, rendering clients hesitant to If available, bank debt can provide effective relief to these commit to new deals in an uncertain economic landscape. In types of funds. Bank debt could consist of simple working addition, Hong Kong’s economy entered a technical recession capital facilities, NAV facilities, hybrid facilities or loans to the following a contraction in Q3 of 2019 caused by months of GP itself. Lenders will consider the liquidity of any remaining socio-political unrest and public protest. assets, the availability of remaining commitments, and will need to have a full understanding of the fund’s business and Looking ahead, it is also unclear what effect the upcoming US cashflows. Until relatively recently, this has really only been the elections will have on the global and our regional economies territory of a few bespoke lenders as well as direct lenders and in 2020. Election years typically result in somewhat stagnant credit funds. and conservative US markets. It remains to be seen what the ripple effect will be on the Asia-Pacific markets. We expect to see greater use of NAV, hybrid, GP management fee or other, more bespoke facilities. This would create new Despite any uncertainties, private capital takes comfort from its opportunities for lenders to diversify their books, expand fund reputation for outperforming during downturns. While the relationships and offer potentially more lucrative financing extent of any downturn is to be determined, it seems likely that, products. in the first instance, going into 2020, there will be a transitional period where participants react to market conditions and seek Another way in which investors and managers have both to identify new opportunities. sought to manage their liquidity profiles or fund further growth has been via secondary market trading. Secondary fund Although GPs may exercise caution during this period, wary market activity has grown in 2019, with deals worth US$42.1 that rushing to deploy capital early in a new fund’s lifecycle billion completed globally in the first half of the year.12 Although could prove costly, we also see this as being a period where there is currently little precedent in Asia in respect of lenders GPs can take advantage of opportunities brought to them by financing large secondary market portfolio transactions, this is uncertain market conditions and increasing competition. an area where we may see debt financings becoming more widely used in the future. As GPs grow more mature and competition increases, GPs are diversifying their strategies in order to widen their nets and are Summary becoming more specialised by sector or theme. There has been a notable trend towards infrastructure-focused Current economic and market uncertainties, combined with strategies, aimed to target opportunities relating to regional increased competition and increasing demands from infrastructure development needs (e.g. the Belt and Road investors, will require participants to balance conservatism Initiative) and any related funding gaps. There has also been a against a need to diversify their strategies, find new notable uptick in enquiries relating to debt-focused strategies, opportunities and achieve additional liquidity in order to reflective of increasingly tough market conditions. generate higher returns to investors. At the same time, many of the more mature GPs will be looking to raise ever-larger funds Increased focus on debt to manage liquidity and increase which, in turn, will need increasingly larger debt facilities. returns The fund finance market in Asia Pacific looks well placed to The amount of existing dry powder, combined with the decline assist GPs throughout these processes and ensure they can in the volume of new private equity fund launches, may result manage liquidity throughout all phases of a fund’s life cycle.

12. FT, Private equity secondary deals soar (16 September 2019).

6 ⁄ Assessing lender risk in fund finance markets 2020 Authors

James Webb Daniel Lindsey Emma Wang Partner, Carey Olsen (Hong Kong) LLP Partner, Goodwin Procter (Hong Kong) LLP Managing Director, East West Bank D +852 3628 9012 D +852 3658 5331 D +852 2218 9088 E [email protected] E [email protected] E [email protected]

James is a partner in Carey Olsen’s Daniel is a partner in Goodwin’s Debt Emma has 13+ years in fund finance in Corporate and Finance groups, based Finance and Private Equity groups, both the US and China. She is Head of in Hong Kong. James specialises in based in Hong Kong. Daniel has 10+ Private Equity for East West Bank HK Cayman Islands and British Virgin years’ experience working on debt Branch, and specialises in providing Islands (BVI) law and advises on a finance transactions for private equity customised and creative transactions to broad range of debt transactions, and debt funds across a broad range of private equity firms in Greater China/ including acquisition and leveraged product areas, including fund-level Asia. Before joining East West, Emma finance, real estate finance, fund financings, acquisition and leveraged was responsible for developing client finance, margin loans, structured financings, margin loans, minority ‘back relationships and managing a portfolio finance, bond issuances, distressed leverage’ financings, mezzanine in the US at Comerica Bank for six years. debt, security enforcements, work-outs financings and distressed debt Previously, she worked at MUFG’s New and debt restructurings. In addition, he investments. York office. acts on corporate transactions, including on all downstream private Prior to joining Goodwin, Daniel was a Emma holds a Master’s in Finance from equity deals, investments, mergers and partner in the Hong Kong office of Brandeis International Business School acquisitions, joint ventures, shareholder Kirkland & Ellis, and previously practised and a BA from Osaka Prefecture arrangements and corporate at Linklaters. Daniel has been based in University. Emma is trilingual, speaking restructurings. Asia (Beijing and Hong Kong) since Chinese, Japanese and English. February 2012. Prior to moving to Asia, James has previously lived and worked he was based in London. Daniel speaks in both the Cayman Islands and BVI. English and conversational Mandarin Before moving offshore in January 2012, and is admitted as a solicitor in Hong James started his legal career with Allen Kong and England and Wales. & Overy, and spent nearly a decade working in its London and Singapore offices.

Originally published in conjunction with Global Legal Insights. Please note that this guide is only intended to provide a very general overview of the matters to which it relates. It is not intended as legal advice and should not be relied on as such. © Carey Olsen 2020

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