Private Capital Pulse: Episode 4 – Investment Governance Overview

TRANSCRIPT EPISODE 4

Hello and welcome. One of the biggest stories in recent years has been the stellar growth of private capital investing. Now measured in the trillions, private markets dominate as investors chase higher yields and alternatives to public markets with different solutions and structures, as well as an increasing array of asset classes.

Welcome to the latest edition of Private Capital Pulse. My name is Jon Ireland, I'm a corporate funds partner based here in Sydney at DLA Piper.

We're delighted to bring you this latest edition, and for those of you that are new to the series, we cover a range of topics, but primarily focusing on the themes and developments in private capital brought to you with the assistance of experts from our teams and other places.

So, we're going to actually switch things up a little bit today because I'm very pleased to be joined by Abhi Ravishankar from our Sydney funds team. Abhi, lovely to have you with us today.

Thanks Jon, it's great to be here. So, in today's episode, we're going to be covering the current trends in investment governance and fund formation. So to switch things up today, I'm going to actually pose some questions to Jon and have him answer them.

Thanks, Abhi. It's great to have you with us and, to be doing a bit of a 'switcheroo' today and as you know, these are sorts of issues that are facing a lot of our clients at the moment. So it's great to have you on board.

Great. So, to kick things off, would you mind talking about some of the current issues and developments that we're facing in the fund formation side?

Yeah, absolutely, and there's heaps going on. Certainly, private capital is very much a key area of interest for fund sponsors.

Lots to cover, but just really briefly in terms of hot areas, what are we seeing?

Private debt – that continues to flourish, real interest in that both from an investor perspective but also in terms of deployment. Obviously, private debt has come in through thematics including, traditional bank lending lines leaving the market and private funds coming into those.

But aside from private debt, infrastructure, energy through the energy transition and specialised real estate as well are areas where we're seeing fund formation being quite buoyant.

The specialised real estate really speaks to essentially things like data centres and logistics. Lots of interest in BTR and living sector as well. Arguably not quite so advanced in Australia as in other jurisdictions in that space, though.

The second point is around the Corporations Act test for who the wholesale client is and the test creep that we've seen over the last couple of decades. Essentially in the early 2000s, we had dollar based thresholds introduced for what constitutes a wholesale client. Which meant that what would otherwise be a retail client, those consumer protections would not be in place for wholesale clients.

Now that's changed through inflation. So, now that we're seeing a larger number of what would have otherwise previously been retail investors meeting the wholesale test. So, this is allowing essentially different types of products to come to market and so in that sense, the private debt, the infra and other real assets can be brought in different ways into that wholesale space, creating particular sets of challenges for issuers in a sense, and when you bake into that as well, what's been termed the "democratisation of private capital", which is on the other side of the ledger and the shifting of funds of these private asset types into the retail space, we really see some operational and risk management challenges for issuers as they manage things like liquidity, valuations, transparency and conflicts management, and even for managers themselves facing retail rules around how products get to market, if they're taking on a distributor role, they may even be facing things like the design and distribution obligations.

So quite a moving piece here on which products are getting set up, which funds are being issued and how they're getting to market.

And I suppose wrapping all of that together, not so much of a surprise to then see ASIC in the last couple of months release its latest corporate plan for the next 12 months and an additional 5th pillar in that, which focuses on private capital.

And we'll say a little bit more about how that fits into the international picture a little later on, but certainly more to see in that space as the private capital type funds even fall then under a bit more of a regulatory focus moving forward.

Thanks Jon, there definitely sounds like there's a lot happening and I know ASIC's focus on private markets has captured our team's attention recently.

So then moving on to investment governance, what kind of developments are you seeing on the strategy and execution of investments?

Yeah, this is a key piece. As you know, we look at this through the lens of the regulated investor cohort. So, it would be pension and super funds, insurers, sovereigns, other types of regulated fund of funds. So, when those investors are looking to deploy, or invest, they may be looking through mandates or through pooled investments or other types of structures.

On the mandate side. Institutional mandates. Certainly we've seen additional levels of detail and complexity around the terms by which institutions are appointing managers. The investment management agreement is getting just simply longer and more detailed. To a degree we've got initiatives like CPS 230 APRAs, operational risk management standard to thank for that, and also the development of more detailed inhouse templates essentially, which are featuring more lengthy obligations in terms to meet the marriage of the investor's own obligations under law and regulations.

So, what are the manager's looking at that? You know particular challenges that we're seeing around data security terms and certainly having to translate those through for offshore managers, for Australian investors, negotiations can be reasonably involved on those aspects.

Looking then on the other side and the pooled investments. Similar sort of story on complexity, we're seeing more detailed due diligence and side letter terms to meet regulated investors own obligations.

Another APRA standard in the form of SPS 530 for superannuation funds and investment governance putting additional pressure on what's needed to be looked at, particularly in private capital because of some of the key features around liquidity and valuations.

And arguably, a number of these terms and negotiation points raising the bar for market terms. It is, though, coming at the cost of resourcing. We're hearing from managers on the operational due diligence requirements that are needed. They're facing extended checklists and information, questionnaires and even sort of mid-size managers looking to have to set up dedicated teams to deal with those.

So, it's very much a story of complexity and then that kind of tipping into the balance of power and how LPs and GPs effectively come together to execute those sorts of deals.

Which is also a time factor I guess as well. You know, how to get these deals done, bearing in mind that you can tailor to some extent and we see custom funds and funds of one being a version of that, but there are some limits.

Yeah, definitely, and we've had a lot of deal deadlines that were quite tight recently, which is arguably put pressure on negotiations.

So, finally then just taking things up a level. What kind of global investment trends are you seeing have an impact on us here in Australia?

So, I talked to you a bit earlier about ASIC and its Corporate Plan for the next little while and focus on private markets. You know, in a sense, that's sort of fitting into an international picture for the SEC and its Private Fund Rules vacated earlier this year, but still the law and regulation in the US is very much informing how international things get done.

Recently the FCA released an evaluation review late last year and more recently, the Singaporean and the Bermuda authorities, looking at so-called private equity insurers and how they're managing their own private market asset exposures.

So, it's fair to say there's a degree of a thematic here internationally around the issues that are well ventilated around private markets coming into the regulatory sphere, and the focus, and whether that be attempts to manage perceived systemic risks or just the need to have more orderly operating markets certainly coming into focus.

And as I said, with the ASIC and the APRA attention that that is getting, we'll see that here too in Australia.

The interrelationship, I just wanted to speak about very briefly, between the getting the deal done side and the overlay of the legal and regulatory expectations on investors is a key piece and there might not be so much a direct connection with discrete law on the point but it nevertheless can impact deal terms, and we see this in things like where investors need to unpack fees and charges of underlying structures and manager arrangements, the emphasis on reporting and where investors have net zero or other sustainability objectives, they need to ensure that these deals have a life to them so that there can be ongoing monitoring to meet those obligations.

So, very much a continuing story along those lines and the management of areas like valuations will continue I think to be a hot topic of conversation for time to come, and I love this concept of "volatility laundering", which has really gone to the heart of the debate, which is essentially quite a circular debate, around what it means to have less frequent valuations in private markets, and as to whether that is a good thing or a bad thing. It can depend on the eye of the beholder. The volatility in public markets potentially creates additional noise or as a smoothing might create a truer, more medium term sense. But on the flip side, less frequent valuations can cause pressure on the accuracy of balancing diversified portfolios.

And lastly, just to tip a hat to the rise of the secondaries market. Now we'll have more to say about this in a future episode, but certainly the secondaries market globally, certainly here in Australia, is seeing new LP's come into that space and exploring opportunities, and in and of themselves, they're an interesting feature I guess looking at that against evaluations, because arguably there's a, you know, there's a price discovery piece in that too.

So, that's probably a very quick cantor and I expect we are running up against time today, so I'll just pause there. Thanks, Abhi.

Well, there you have it. Thanks so much for that, Jon.

Terrific. No, thank you. That was great having you on for the questions today, really appreciate it.

So in terms of just the wrap up, obviously we're very keen on these episodes to be delivering what you want to hear.

So, please do reach out to us with any suggestions for future topics and we'll be keen to take those on board, so please do keep in touch and stay tuned for future episodes.

You'll be able to see us or hear us wherever you get your podcasts, and also on our website at dlapiper.com

But that's all for today. So, thanks for listening and I'll see you next time.