Is the Business Finance Partnership guilty of strategy drift?

As the second round of funding by the UK government’s Business Finance Partnership approaches several unsuccessful first round applicants have raised concerns that the Treasury’s choice of recipients runs contrary to its aim of developing the market for non-bank lending to UK businesses.

K-based debt fund managers are eagerly anticipating hearing from the UK Treasury in the next few months. The Treasury is poised to soon reveal the favoured asset managers who will collectively receive £500 million ($907 million; €701 million) of public money in the second tranche of funding by the Business Finance Partnership.

The first tranche of investments, announced in December last year, awarded the initial £500 million to some of the world’s largest asset managers. Of the six managers named, Haymarket Financial stood out as the only UK-listed asset manager. The other managers were Alcentra Limited, Ares Management, M&G Investment and Pricoa Capital.

When the UK Chancellor initially announced in November 2011 that the government would make available up to £1.2 billion for lending through non-bank lending channels as part of a package of measures aimed to increase the supply of credit to SMEs in the UK, dozens of fledgling debt fund managers saw the scheme as a doorway to much-needed funding. 

In its proposals, the Treasury (HMT) first outlined its broader priorities. First, it would seek to reduce the structural deficit in a fair and responsible way. Second, it would create conditions for an economy that would grow sustainably, is more resilient, and is more balanced between public and private sectors and between regions. Finally, it would reform the regulatory framework for the financial sector to avoid future crises.  Within that context, the BFP was designed to assist small businesses who play an essential role in the UK economy, but may not have had access to the same range of funding options as their larger counterparts.

A spokeswoman for the HM Treasury tells Private Debt Investor: “The key aim of the BFP has been to attract new private investment into non-bank lending to mid-sized businesses.”

One key point is worth highlighting from the proposal however: “The aim of investing in such funds is to support the development and expansion of this market, including by – in the medium term – encouraging new managers and investors.”

There is an incongruity here. On the face of it, HMT announced it would invest on ‘arms length’ terms through the private sector – broadly, new asset managers with up to around £500m consolidated annual global turnover. But then there’s the small print.

The Treasury noted it would only select managers with a proven track record, demonstrating their ability to manage funds successfully. Unsurprisingly, this requirement meant most newly-formed managers who sought funding were deemed unsuitable, and consequently ruled out.

“It appears that the way in which the incentive has been executed is somewhat sub-optimal,” according to a partner at one London-based asset manager, whose application for funding was rejected by the Treasury. “It is a reflection of the lack of consensus between those who worked in the formation of the policy and those who executed it.”

“On the whole, commitments have gone to managers who are absolutely the least deserving of public funding. You can’t help but ask yourself why has the British Treasury used tax payers’ money to invest in companies that specialise in American buyouts and leveraged loans?” added the fund manager.

And he isn’t alone. “The BFP has been appallingly implemented,” says another unsuccessful, London-based debt fund manager. “The incentive slowly went from being about fostering the burgeoning debt market by assisting new managers, to making sustained profits from the funds managed by some of the largest asset managers in the world.”

Their frustrations are understandable. Alcentra , an asset manager focused on the US and Europe, has a track record that dates back to 1998 and spans 48 separate investment funds totalling approximately $15.1 billion. Meanwhile, Pricoa Capital Group and M&G Investments, both European investment arms of US-based Prudential Financial.  And Ares Management too started life as a US business and now has $59 billion in assets under management.

So the BFP’s strategy has evidently shifted since its inception. “The Government has focused on those fund managers best able to originate loans to mid-sized businesses and attract private investment – this is the key objective,” a spokeswoman says.

“Establishing new funds, especially to exploit new market opportunities, necessarily involves a process of due diligence and fundraising,” she adds. “There are no fixed fund manager size criteria, beyond the need for a minimum Government investment of £25m in any one fund.”

The Government needs to know it is not putting the country’s balance sheet at risk for little return, argues Lee Doyle, a banking partner at law firm Ashurst. “The basis of these arrangements is to leverage every pound that they are investing,” he adds. To that end, the choice of experienced managers versus start-ups was entirely understandable.

Officials at HMT explained to asset managers during the selection process that it is was targeting institutions who were best equipped to stimulate and support the development of a non-bank channel of credit providers to UK middle market companies. 

Effectively, “HMT recognised it needed to expand beyond its reliance on the banking sector to fuel domestic GDP and employment growth,” says Mike Dennis, managing director at Ares’ private debt group. “The only difference between this programme and the similar pools of capital we manage is that the companies [we invest in] need to be UK-based.”

For the Treasury, the real priority has clearly been securing reliable returns. 

If the first round of commitments bear fruit, there could well be an easing of the criteria in future tranches to accommodate grants to fledgling managers, many of whom are unquestionably in need of capital.

It is tempting to argue the current recipients – all substantial, established asset managers – have no need of relatively modest commitments with somewhat restrictive conditions attached (i.e. investments must be in the debt of UK companies). But if the initiative helps to promote to the wider LP community the virtues of the asset class, then longer term it will help to spark allocations to private debt more broadly, and that in turn will benefit the UK economy. 

“The incentive marks a significant move. It means that we have momentum in establishing a long term corporate debt fund market,” says Mark Hutchinson, head of alternative credit at M&G Investments, also one of the successful applicants of the BFP. “Whether the market sees growth or not will require the demand from corporates for long term credit to meet the growth in supply from Business Finance Partnership,” says M&G’s Hutchinson.

In the meantime, a host of managers await news of the second round of funding commitments. For some, a successful application could make their fundraising; for others, it may simply be a welcome vote of confidence from a sovereign body.