The coronavirus pandemic (COVID-19) has created a series of unprecedented challenges and opportunities for fund sponsors (either regulated or non-regulated) and investment fund managers including in particular alternative investment fund managers (AIFMs) and general partners managing investment funds (collectively the “Investment Fund Managers” or “IFMs”).
We believe that the below deliberations, which under no circumstance claim to be exhaustive, would help IFMs to maneuver through the array of changing legal, operational and commercial matters during the COVID-19 impacted period and successfully manage their investment vehicles.
1. PORTFOLIO MANAGEMENT
Although the considerations outlined below do not necessarily suggest immediate actions, should a change to the fund documents (e.g. issuing document / private placement memorandum, partnership agreement, articles of associations etc.) be contemplated, respective legal and regulatory requirements (e.g. investors consent, prior approval of the regulator, etc.) must be analyzed and assessed prior to the implementation of those changes.
Private Equity, Real Estate, Venture Capital, Infrastructure and Debt strategies
Investment opportunities: In order to manage challenges or size new opportunities Investment Fund Managers may review their business models and investment programs with the view to adapt those to the current economic situation. In particular, the investment strategy and restrictions set out in the fund documents (e.g. geographic scope of target investments, diversification thresholds, specific market limitations or investment class) should be assessed whether those rules are broad enough to pursue new opportunities presented by the current investment environment. Otherwise, IFMs should consider changing the fund documents.
Fundraising: Remote working mode, economic slowdown and uncertainty about the timing of the economic recovery could potentially lead to holdups in fundraising process caused by delays in the investment due diligence and through more conservative approach in taking investment decisions by prospective investors. Hence, the IFMs should examine the commitment / offering periods of their funds and if necessary seek an extension to ensure that they have adequate time to raise capital necessary for the achievement of the envisaged investment strategies.
Exit: Funds pursuing closed-ended investment strategies will typically harvest the generated value within a finite period as foreseen in the respective fund documentation. It is hence important that the exit strategy is adapted to the market conditions at the time of exit. In that context Investment Fund Managers may consider to extend the term of a particular fund or sub-fund to provide more time for realization of the fund’s portfolio.
Permitted reinvestment (recycling): Inter alia new investment opportunities and expected turbulences on the markets could lead to an earlier return of investments and the IFMs should review their powers and limitations to reinvest the proceeds of an investment. In particular, the maximum recycling amount and the period during which the recycling could be made may become subject to amendments.
Borrowing and guarantees: In times of possible liquidity difficulties, IFMs may feel the need to borrow more than initially foreseen and should therefore consider reviewing the limits on borrowing and conditions to provide guarantees as set out in the fund documents. Furthermore, early adapting existing credit facilities could secure further liquidity flexibility as may be required for the efficient management of the fund portfolio.
Investor’s liquidity challenges: Potentially limited liquidity on the market could transpire in limited liquidity of already committed investors. IFMs would do well to review and test the defaulting investor provisions in the fund documentation and prepare contingency plans in case investors are unable to meet capital calls obligations, e.g. make additional drawdowns from non- defaulting investors to make up the difference.
Valuation and investment restrictions: In view of the higher volatility and likely changes in valuations of certain types of assets that may impact management fees, distribution waterfalls and claw backs, IFMs should ensure compliance with the valuation provisions in the fund documents. Increase or decrease in value of a particular asset may also lead to passive breach of investment restrictions, which should be carefully monitored and reported or eliminated as may be required.
New risk disclosures: Depending on the life stage of the fund, its documentation might need to be reviewed to ensure that in addition to the general market risk disclosures, specific risks associated with COVID-19 are illustrated, in particular when new shares/interests are issued to new investors.
Hedge fund strategies
Liquidity management and review of the fund documentation: Various tools are available to Investment Fund Managers to help managing liquidity issues that may arise during the COVID- 19 and face expected and unexpected redemptions requests from investors. Investment Fund Managers should understand and be prepared to implement the below tools which are available under their fund documents or consider updating the documentation to include them.
Side pockets or similar approaches that specifically foresee segregation of illiquid or hard-to- value assets which do not allow redemptions from liquid assets to which common redemption rights are attached, might be considered by the Investment Fund Managers to deal with liquidity challenges. As a reminder, regulated non-UCITS[1] funds may follow a fast track procedure of the CSSF[2] allowing them either to spin-off the shares and create a new share class or to spin-off the sub-fund and create a new sub-fund for those illiquid assets, putting either one in liquidation upon launch. This procedure cannot contradict fund’s constitutive documents and be used (i) if the assets concerned by the side-pocketing represent more than 20% of the relevant fund’s total net assets or (ii) to solve temporary valuation or potential or presumed illiquidity of an asset. Once becoming liquid again, any asset part of a side-pocketing arrangement must be promptly realized and can hence no longer be held by the fund. Situations falling outside this procedure’s scope of application do not benefit from the fast-track treatment and will be considered by the CSSF on a case-by-case basis.
In-kind redemptions allow for a direct transfer of illiquid or other assets of the fund to redeeming investors, provided the underlying investments are not subject to transfer restrictions.
Gate is a mechanism that grants the possibility to limit the percentage of the fund’s assets available for redemption on any redemption date. Enacting of a gate provision will often involve communication with fund’s directors and the CSSF for regulated funds and the review of the fund documentation to ensure compliance with the rules contained in it.
Suspensions/Redemptions: Investment Fund Managers should review the fund documentation that usually allows for suspension of redemptions, subscriptions, net asset value calculation and/or payment of redemption proceeds under certain prescribed circumstances and asses the suspension needs in the best interest of the investors.
The above tools are in principle subject to compliance with the fund documentation, applicable regulations, approval of the fund’s directors and as the case maybe, prior regulatory approval. At the same time, Investment Fund Managers should carefully review existing side letters for any limitations or exceptions to their ability to implement restrictive liquidity measures, either in general or in the event of significant drawdowns or exceptional market circumstances.
Valuations considerations: In view of the higher volatility and likely changes in valuations of certain types of assets that may impact withdrawal/redemption values, performance allocation, management fees and other remuneration arrangements, IFMs shall ensure compliance with valuation provisions in the fund documents and their valuation policies (especially for less liquid investments and investments that are the subject of any side pocket or in-kind distribution determination). IFMs should also even more accurately monitor the valuation of the assets to the extent that an increase or decrease in value of a particular asset may lead to passive breach of investment restrictions which shall be reported or eliminated as may be required.
New risk disclosures: Depending on the life stage of the fund, its documentation might need to be reviewed to ensure that in addition to the general market risk disclosures, specific risks associated with COVID-19 are illustrated, in particular when new shares/interests are issued to new investors.
2. INVESTORS MANAGEMENT
Communication with investors: Investment Fund Managers should consider maintaining regular contact with investors to give them comfort about the IFM’s manner managing the fund’s investment portfolio the operational functioning of the fund and the contingency plans for remote working during the pandemic. Not different from other correspondence with investors, those COVID-19 related communications must be fair, clear, accurate and in line with respective regulatory requirements. Furthermore, Investment Fund Managers should anticipate an increased number of investors requests, particularly relating to investment strategies, investments allocations (including when applicable past performance during previous market dislocations) and implementation of the fund business continuity plans during the pandemic.It is hence worth considering to create standardized information letter with updates or organize a call with investors to consistently disseminate information to all investors.
Side letters: Investment Fund Managers should review the existent side letters, examine the possibility to fulfil the obligations thereunder and alternatively discuss with investors any delay or impracticality to adjust their expectations with respect to matters such as physical meetings, extra reporting, etc. in light of the ongoing business interruption resulting from COVID-19.
3. REGULATORY CONSIDERATIONS
CSSF Communication: The CSSF reminded that it remains operational and is available for meetings by telephone or videoconference and that all communication should be done either through the eDesk for those who have registered, or by e-mail, instead of or in addition to regular mail.
From the outset of the COVID-19 the CSSF has published a series of FAQ on its website with the latest update being made on 20 April 2020:
CSSF annual and semi-annual reports: Regulated funds and AIFMs must inform the CSSF promptly in case any report is expected to be published beyond the regulatory deadlines with an indication of the reasons for the delay and, to the extent possible, the estimated date of publication. They must also inform the investors as soon as practicable about such delay, the reasons for such delay and, to the extent possible, the estimated date of publication.
Swing pricing/dilution levy factors (Hedge Funds): The CSSF has confirmed that swing pricing/dilution levy factors can be applied beyond the maximum percentage set forth in the prospectus of UCITS, Part II funds and SIFs under specific circumstances as described in its FAQ. The swing pricing mechanism is further detailed in the FAQ.
Deadline extension for the reports to be submitted to the CSSF by UCIs[3], SIFs[4], SICARs[5], investment fund managers: The CSSF has listed in its FAQ the deadline extension for the relevant reports to be submitted to the CSSF.
Short-selling (Hedge Funds): Pursuant to a CSSF press release dated 16 March 2020, the CSSF informed that the ESMA shall request the short sellers under the new temporary regime to report a transaction if its net position reaches or exceeds a threshold of 0.1% of the issued share capital, instead the previously applicable threshold of 0.2%. Consequently, Investment Fund Managers should prepare internal controls to identify short selling and agree with services providers to report on net short positions should they reach or exceed 0.1% of issued capital. Furthermore, IFMs should be ready in case some regulators ban short selling for a certain period of time. Several national competent authorities, including FSMA (Belgium), AMF (France), HCMC (Greece), CONSOB (Italy), CNMV (Spain) and FCA (UK) have already decided to prohibit short selling of securities which are admitted to trading on their local trading venues and such decisions have been validated by ESMA.
AML/CFT survey: The CSSF extends the deadline for the submission of the 2019 Survey related to the fight against money laundering and terrorist financing (CSSF).
4. OTHER CONSIDERATIONS
Corporate governance: The governing body of the fund remains ultimately responsible for the overall management and operations of the fund and protection of the investors’ interests and hence should carefully regularly review the performance of all necessary functions.
By decree dated 20 March 2020, the Luxembourg government took measures to facilitate board and shareholders meetings (including the annual general meeting) which may be held by videoconference or other means of telecommunication allowing their identification notwithstanding anything to the contrary in the articles of association of the relevant company and regardless of the number of participants. IFMs should consider holding board meetings without physical presence to avoid the spreading of the virus and continue taking corporate decisions.
Service providers: During the COVID-19 it is crucial for the governing body of the fund to monitor and supervise fund’s key service providers, including portfolio managers, depositaries, administrators and IT providers to ensure that these actors have functioning business continuity plans in place enabling them to remain reachable and operative with as little disruption as practicable going forward.
On the basis of the service provider contracts it should be analyzed whether COVID-19 triggers the implementation of the force majeure clauses. In such case, those clauses may excuse one or all parties from duly performance of the contract to a certain extent and a dialog with respective service provider must be sought to address any operational issues arising from it.
Business continuity plans: The CSSF urged the financial institutions under its prudential supervision to favour working from home as part of their business continuity plans. Investment Fund Managers (regulated or non-regulated) should monitor their business continuity plans in order to address staff absenteeism, use of remote offices, travel limitations and technology interruptions or slowdowns) and review their remote working policy to ensure compliance with GDPR requirements.
Data protection/IT security: Investment Fund Managers should ensure that data protection backup and recovery processes are functioning to secure the books and records and should ensure cybersecurity in the context of working remotely.
Review of insurance coverage: Investment Fund Managers should review the insurance coverage applicable at the manager and fund levels, expand it if necessary and evaluate what claims, if any, are available under existing coverage (e.g. costs of cancelling business travel). It is expected that insurance companies will add COVID-19 related insurances in the scope of their products.
Records of the implementation steps: It is expected that after the end of the pandemic period investors, fund directors or regulators will express interest in understanding how the responsible entities and/or individuals have fulfilled their obligations during periods of market disruption. All steps undertaken to prepare for and through the effects of the COVID-19 outbreak should be accurately documented.
5. CONCLUSION
Although the COVID-19 will certainly have impact on markets and businesses all over the world, Investment Fund Managers should focus not only on relating challenges, but also on the unique opportunities arising from the current situation.
In order to be fully prepared and maintain quality of services, Investment Fund Managers should undertake additional work including reviewing and adapting offering documentation, processes and contracts surrounding the life of their funds.
If you have any questions please contact one of your regular contacts at AKD, send an email to [email protected] or visit the website of AKD’s Corona Taskforce.
[1] Undertakings for the Collective Investment in Transferable Securities
[2] Commission de Surveillance du Secteur Financier – Luxembourg’s Financial Sector Supervisory Authority.
[3] Undertakings for the Collective Investments
[4] Specialized Investment Funds
[5] Société d’Investissement en Capital à Risque (SICAR)