For NAV finance to be a winner, don’t underestimate the obstacles

The fund finance market is producing innovative solutions to the liquidity crisis, but they come with complexities.

Fund finance may not be the most glamorous corner of the alternative asset universe, but one experienced professional could barely contain his excitement at the sudden popularity of net asset value-based facilities. “I’ve been working in and exploring this area most of my career, and it’s finally really growing at a rapid rate,” said Leon Stephenson, London-based partner and co-head of the funds finance team at law firm Reed Smith, in a webinar last week entitled “Structuring NAV and hybrid fund finance facilities to PE funds”.

This newfound popularity has come about due to the economic paralysis caused by the covid-19 outbreak and the desperate need for liquidity. NAV facilities, which operate below the fund level and above the portfolio company level, are secured against the cashflows of the fund rather than – as is often the case with fund finance – against LP commitments. Stephenson says “record numbers” of these facilities are being put together, and they provide one answer to the liquidity crisis.

But funds viewing NAV facilities as an easy way to boost liquidity may have underestimated the practical difficulties. One participant drew attention to issues with Unrelated Business Taxable Income, which put the onus on very careful structuring of such facilities for US investors. For European investors, meanwhile, there is the possibility that Financial Conduct Authority or Prudential Regulation Authority approval may be required if security is being given over a regulated entity.

Given that they constitute a relatively new arrival in the fund finance market, some wonder whether the lenders themselves fully understand the nature of NAV facilities. “Some lenders want to go down to the operating company level with their due diligence, which is just not going to work, so we spend time with the lender to help them understand the portfolio, the structure of investments within the portfolio and the actual risk they are taking, which not all lenders understand,” said one fund manager source.

There is also a danger of the market becoming commoditised when its complex nature arguably demands tailored solutions. Gavin Rees, who heads Silicon Valley Bank’s global funds banking team in the UK, said he is often approached by intermediaries – rather than the GPs themselves – who don’t beat around the bush with the direct nature of their questions: How much can we get? How long can it [the facility] last? What will it cost?

Rees said he struggles with this approach and has his own list of questions by way of response, designed to foster more of a relationship-based approach: What’s the purpose of the facility? Where is it being used in the life of the fund? Why has the need for it arisen now? “Getting the rationale clear is essential,” he said.

When the need for them are well understood and the structuring can overcome any practical difficulties, it is clear that NAV facilities deserve to be seen as an increasingly valuable option to deal with current liquidity issues. As the webinar made clear, however, the challenges should not be underestimated.

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