Guidance issued by the Institutional Limited Partners’ Association on subscription credit lines used by general partners has been criticized by two Cleary Gottlieb lawyers.
Robert Raymond and David Yudin, a partner and senior attorney at Cleary Gottlieb, questioned a number of points in the ILPA’s guidance to members released in June, in an opinion published on the website of the American Investment Council.
On the subject of GPs’ use of subscription credit causing “liquidity risks,” the lawyers’ said that “where the subscription lines are simply funded by LP capital already committed to the funds, in essence there is very little liquidity risk in the case of a subscription line.”
The lawyers also said that, in their experience, any artificial increase in a fund’s internal rate of return would generally not be material over the life of the fund, because capital will eventually be called from LPs and the IRR is principally driven by returns.
ILPA had said credit lines artificially increase a fund’s IRR, enabling GPs to be paid carry earlier.
“Moreover, subscription line borrowing would not have any effect on other commonly used performance metrics such as Multiple of Money,” Raymond and Yudin said.
The lawyers said ILPA’s recommendation that a fund’s preferred return starts from when the capital is drawn from the subscription line instead of when it is drawn from an LP, to better align investor and manager interests, was “extreme.”
“This dramatic change would only serve to increase the cost to the GP of using subscription lines in a manner that would likely make their use prohibitive. The preferred return is meant to guarantee investors a return on dollars they put into the fund, it should not be turned into an arbitrary mechanism for addressing an immaterial issue,” they argued.
ILPA’s nine-point guidance had been anticipated since February, when it announced it was surveying industry views.
It encouraged managers to clearly disclose its subscription credit usage policy, “as part of the due diligence packet provided to LPs, including the intended use of proceeds from current or future utilization of such lines, and how the impact will be disclosed to LPs.”