New Guidance on Subscription Lines of Credit Explained

by Robyn Tolhurst, Public Affairs Manager | Australian Investment Council

In June 2020 the Institutional Limited Partners Association (ILPA) released new guidance on Subscription Lines of Credit which aims to foster more transparency between Limited Partners (LPs) and General Partners (GPs) regarding exposure, capital calls and performance impacts.

It builds on ILPA’s 2017 guidance which addresses the how the use of subscription lines of credits impacts LPs and includes specific recommendations for more disclosure in reporting and clarity in partnership agreements regarding the parameters for their use.

Over the past few years, the use of subscription lines of credit has grown, particularly in the US, which has made it more difficult for LPs to measure and assess both exposure and performance at the fund level and for their PE programs in the absence of relevant disclosure around subscription lines.

While transparency generally has improved, both GPs and LPs indicate that disclosures are not being consistently or systematically provided to LPs. Importantly, both LPs and GPs have stated that greater standardisation around disclosures related to subscription lines will benefit the industry.

The latest guidance aims to resolve this.

Alicia Gregory, Head of Private Equity for Australia’s Future Fund and member of ILPA’s international membership group, and Suzanne Tavill, Partner and Global Head of Responsible Investing at StepStone, recently provided insights into the new guidance as part of the Australian Investment Council’s Knowledge Sharing Series.

“If you work as a GP, you want to know what others are doing and what the best practice is. As an investor, you need to know what your credit worthiness is being used by GP’s for, and as an adviser, you need to know what both LPs and GPs are thinking,” Gregory said.

“The aim of this subsequent guidance is to lay out more specifically the incremental disclosures that will aid LPs and GPs in gaining clarity around the impact of subscription lines, particularly with respect to an LP’s cash flow modelling and commitment pacing, as well as the performance impacts posed by subscription lines.”

Subscription lines of credit are worth approximately US $550bn on a global basis and on average, the facilities are utilised at about 50%. They can provide GPs with tremendous benefits in the early stage of a deal, for example, where a rapid availability of cash is required, and to avoid multiple small capital calls or the need for LP top-ups during fundraising.

Gregory also said that when used properly and efficiently, subscription lines of credit are generally supported. In this context, it is essential for LPs to understand how the facilities are to be used and how much they have exposed on credit lines to gain an appreciation of their cash projections.

“Clients views have been evolving as the subscription line market has matured,” Tavill added. “While initially there was some concern about unknown risk, what we have seen is a shift towards understanding how beneficial these subscription lines can be.”

The guidance seeks to address risk areas such as a recommended cap on debt of 15-25% of commitments and an optimal draw-down period to 180-days. However, there have been instances where this period has been pushed well-beyond the recommended guidance to as much as two years, which could introduce systemic risk.

The intent of subscription lines of credit is to smooth cash flows calls and not create an entire synthetic cashflow profile.

Tavill said the challenge to this was two-fold. “In the due diligence process LPs want to make sure that the numbers are being unravelled so they can have confidence in the like-for-like peer return comparison between GPs, and secondly, in their internal systems around recognising that there is a difference between the actual drawdown and exposure versus the synthetic cash drawn down.”

This makes the need for an analysis of cash flow with and without the line or credit all the more important so LPs can really understand their position.

Clear consistent communication and disclosure is central to creating any issues. The ILPA guidance recommends quarterly and annual disclosures to provide LPs with the visibility they need to better monitor the impact of subscription lines on both exposure and performance, as well as the key terms and costs associated with subscription lines in use.

Tavill described the work done by ILPA in this area as important for “gaining a consistency of approach.”

“A lot of concerns around defaults, risk of defaults how the line is being used can be resolved through constant communication between the LP and GP. For a GP, following the guidance that ILPA has put out should remove 90% of the questions from LPs on what you are doing,” she said.

Both panellists concurred that there is an expectation in the industry, particularly in the US that subscription lines of credit will be used.

“If you want to attract US LPs to your fund you need to at least have the conversation about subscription lines of credit and demonstrate how you will adjust performance with or without them,” Gregory said.

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