A subscription facility, also known as sub-line or a capital call facility, provides liquidity to funds at the beginning their life cycle, bridging the gap between receiving capital contributions from investors and executing investments. In addition, “the subscription line is based on the security of uncalled capital commitments from the investors which morphs at some point in times into a Nav facility where the security changes on the assets,” said Dirk Kaiser, managing director, fund finance EMEA at Wells Fargo. Kaiser participated in a panel moderated by Audrey Mucciante, DLA Piper, on fund financing at the Association of the Luxembourg Fund Industry’s Private Assets conference on 26 September 2024.
Subscription lines have become a standard tool for private market funds [that] has grown to around $600bn to $800bn
He explained that the maturity of the sub-lines run for two to three years to cover the investment period before being restructured into a Nav-line with a longer maturity “in order to make sure that over the life of the asset and the harvest period, there is liquidity in place.” The proceed of the sub-line is used for “all kinds of management expenses and for bridging the first investments.”
On pricing, Kaiser noted commented that “you can expect a little bit of a cheaper option on the sub-line versus the Nav facility.”
Koekkoek: “A niche market”
“Subscription lines have become a standard tool for private market funds [that] has grown to around $600bn to $800bn, globally, or maybe even a trillion,” said Jules Koekkoek, senior portfolio manager private ABS and infrastructure at Aegon Asset Management.
To give the perspective of a user, he explained that it enables general partners (GPs) to act swiftly when acquiring a portfolio of companies. It is easier to draw upon a capital facility from one bank, as opposed to call capital from 50, 100 or even 200 limited partners (LPs) on short notice.
The sub-lines enable GPs to be operationally efficient and limit the number of capital calls to LPs, down to, say, twice a year. Besides, “the recourse to LPs, also means that sub-lines are relatively cheap funding instruments for funds, and it gives a bit of leverage in the very short term, which boosts fund return,” argued Koekkoek.
Competitive market
“Banks tend to provide revolving credit facilities (RCFs) to funds. We typically act as a lender on behalf of institutional investors,” commented Koekkoek. He noted that institutional investors are generally cash rich and understand the credit risk as they often already invest as LPs in these funds.
Koekkoek thinks that GPs committed RCFs don’t fit the needs of GPs as they prefer either a drawn loan or an uncommitted RCF. Without going into details, he noticed some development in crypto in the US.
Challenges, requirements and recent development from borrowers
“The most important part… is to start with a solid legal representation in order to have the fund documents set up and allow leverage from day one, and also allow leverage beyond the investment period,” advised Kaiser.
Secondly, Kaiser argued without further explanation that “pricing is a very good tool for borrowers to keep the lenders honest.” Third, banks need to display a high level of flexibility as the borrowers request “extension options, upsized options and also various currencies under their subscription lines” in order to react very quickly to opportunities. It worth noting that FX such as the sterling, the Swiss franc and Nordic currencies are becoming more important in this space.
Kaiser also observed that there is a need for an accordion financing, i.e., “to start with a smaller facility size and ramp it up when fundraising goes up in order not to pay too much upfront fees or unused fees over the life of the facility.”
Finally, Kaiser argued that fund managers are looking for ancillary services such as providing financing at the asset level. On the flip side, it will not come as a surprise for anyone that lenders are also looking “to sell more products to the same fund.”
Emerging trends
“From a Basel perspective for banks… there has been requests from them to get these facilities rated… to optimise their exposure,” stated Koekkoek. Interestingly, he commented that the rating business used to be dominated by Kroll Bond Rating Agency. However, recent years have seen three big agencies (Fitch, Moody’s and S&P) publishing their methodologies as well.
For the clients of Aegon, who are typically solvency 2 investors, “ratings are nice to have, but not necessarily a requirement... [as sub-lines] are very short, dated and high-quality… those investors tend to like the rating for transparency around the credit risk.”
ESG and fund financing
Counting ASR Insurance as a client which is “the most sustainable insurance company in the world according to Sustainalytics,” compelled Aegon “to come up with an ESG methodology and to integrate that in our writing process for sub-lines.” Koekkoek also noticed that ESG targets such as net-zero reporting, governance and diversity are incorporated in the loan documentation. “Those targets can actually lead to a small reduction in coupon or on the margin.”
What to expect in the coming future?
“The circle of receiving distributions and recommitting to funds was broken in [2023 and 2024], and hence the fundraising was subpar or challenging… resulting in less demand [to lenders],” observed Kaiser. Yet he is constructive about the future given the recent positive signs coming from the M&A and IPO markets and the cuts in interest rates, in the US, in particular. “We are looking ahead to stabilise valuations across a lot of asset classes.”
“A lot of banks have realised what a good product subscription finance, per se, is, and therefore there's a lot of supply with a reach for yield,” said Kaiser. He thinks that several banks have financial targets which may be reached with the help of ancillary products.