The three biggest admin issues for debt fund managers

Amid the current crisis, firms must not take their eye off the ball in areas such as fiduciary obligation, operational risk and regulation. Michael Johnson of Crestbridge explains why.

Michael Johnson

The three most pressing administrative issues for debt fund managers in the face of covid-19 can be categorised into three distinct areas: fiduciary obligations, operational risks and regulatory issues. These administrative services are intrinsic to the successful management of debt funds regardless of the broader socioeconomic climate, but in times of crisis like these they become critical and neglecting any one of them could compromise portfolios and adversely affect internal rate of return.

Caution needed

Starting with fiduciary obligations, it can be further divided into a series of composite parts, each with their own intricacies and requirements.

Arguably the most important is valuations. Asset valuations are incredibly volatile at the moment, and so those fulfilling fiduciary roles will need to understand the latest guidance, particularly when it comes to operational assets negatively impacted by covid-19.

Crucially, debt fund managers must pay strict attention to the underlying liquidity of portfolio assets. If these are within sectors such as retail, travel or leisure which have been especially affected by the pandemic, then they may not be able to service the debt owed to the fund. Valuations of portfolio assets, therefore, should be at the top of every debt fund manager’s mind.

Another aspect of fiduciary responsibility which debt fund managers should take note of in this crisis is new transactions. Although, in this instance, the consequences of covid-19 look set to be decidedly positive. As firms across sectors face issues with liquidity, and as banks are reluctant to issue new corporate loans and take on more debt, private debt fund managers should expect new opportunities to arise.

This has been the case in the past, for example in the 2008 financial crash when so-called ‘shadow banks’ entered the market to provide liquidity to firms when banks were unable to do so. This indeed can be seen as the inception of private debt funds, and as they did well in the previous crisis there is every reason to believe that this success will be repeated. There could be a silver lining, therefore, to this otherwise unfortunate situation.

The next area in which issues are likely to arise for debt fund managers is operational risk – again fiduciary valuations come into play here as well. The current volatile pricing on liquid assets is triggering heightened control checks, which raises the risk of errors being made. Questions should be raised, and due diligence carried out, towards service providers and pricing sources. When quarterly and monthly valuation points come up, boards should approach them critically and not take anything for granted.

Within operational risk lies the issue of fraud. The changing environment could mean management at debt funds and service providers are distracted. This could pose a higher fraud risk, therefore debt fund managers must be incredibly alert and exercise great caution and scrutiny.

The final administrative area which debt funds must take note of is regulation. The rapidly changing environment could potentially result in breakdowns of control frameworks. This could pose a higher probability of regulatory breaches, and therefore managers must be vigilant.

Catalyst of change

It is interesting to note as well that covid-19 has in some regards been a catalyst of changes which would have eventually occurred. For example, the rise of video verification for investors, board meetings and substance requirements occurring via video calls.

These changes enhance efficiency within the industry, reduce the amount of time spent onboarding new investors, and generally benefit the management of portfolios across asset classes, with private debt being no exception. Therefore, we are again seeing some form of silver lining to come out of the covid-19 crisis.

It is clear that addressing the three biggest administrative issues which the current situation has brought about is not straightforward. There are multi-faceted considerations to take into account throughout, and issues are often interconnected with each other. And while there are certainly challenges being faced by debt funds as a consequence of covid-19, there is also optimism to be found if you look hard enough.

Ultimately, the state in which firms will emerge at the end of this pandemic is entirely within their own hands. There is hard work to be done to ensure administrative standards are maintained throughout these unprecedented times, but this work will pay dividends once these times are behind us.

Michael Johnson is group head of fund services at Crestbridge, the global administration, management and corporate governance solutions business.