NEXUS 2024 Preview: ILPA takes on NAV, PFA rules

Private Funds CFO interviewed Institutional Limited Partners Association president Jennifer Choi, who serves on the board of PEI Group’s NEXUS 2024 summit coming up March 6-8 in Orlando. Choi shared LP concerns over the use of NAV facilities, the Securities and Exchange Commission’s Private Fund Adviser rules package, and how managers have become more proactive about transparency. 

What are your members most concerned about, right now?

Jen Choi: The use of NAV facilities is the topic that comes up the most often today with the membership. There’s a desire to understand them better. There are disclosure and notification challenges we need to get in front of – for example, when they’re being used to make distributions to LPS. ILPA members consistently call that out as a worrying practice.

Beyond that, it really is about peeling that onion on the leverage and understand exactly how embedded that leverage now is into the business and operating models for private equity and credit funds. NAV facilities are being used by individual partners to fund their commitments. They’re used to generate cash for the management company for succession planning or other long-term strategic reasons. Of course, they’re used at the fund and asset level.

We need to understand how many layers of leverage LPs are being exposed to now. In the past, LPs understood that exposure as being limited to the use of subscription lines and to the leverage used to purchase fund assets.

Some LPs are saying they’ve discovered the use of NAV facilities when they catch it in a footnote in fund documents, or they’ve backed it out of the reporting they get. That’s not the ideal way to disclose that these facilities are being used.

The use of leverage has gotten a lot more innovative and creative in recent years, but also more opaque, and managers are using more of it.

That doesn’t mean we think NAV loans are wholesale good or bad, just that investors need to know what risks they are exposed to. So the guidelines that we are working on will be squarely focused on that.

And they’ll be guidelines, as opposed to any templatized reporting; at least, that’s the state of play today. That may evolve as we engage with stakeholders over the next several months. We’ll have to see, but we will be issuing guidance in the first half of 2024. 

ILPA had a lot of success in influencing the Securities and Exchange Commission’s regulatory initiatives under chairman Gary Gensler. What else are you looking to accomplish on the regulatory front in the future?

JC: There is a lot of work to do with the SEC’s Private Fund Adviser rules since we analyzed them in August of this year. The primary focus for us now is reevaluating how all of our released templates and guidance regarding reporting align with the substance of those rules and the obligations therein, and ensuring that they reflect the current best-in-class reporting practices.

We’re also focused on the verbiage of the final rule that is open to interpretation. The phrase “material economic” is one example [The rule states that all “material economic” terms that are given to to an investor or investors in a fund must be disclosed after the investor’s commitment, but the SEC does not define what material economic means]. We’re going to do as much as we can to get to, at a minimum, a more widely shared understanding of how it would be interpreted in practice in a way that’s sustainable and scalable for the industry.

One of the challenges, of course, is that we’re doing this without the benefit of the ability to engage at a granular level with SEC staff. As long as the litigation is still pending, we’re forced to do this purely as an industry and without the active engagement of the regulator, which is what we would have under other circumstances.

There’s been a deluge of continuation funds since interest rates began rising and economic uncertainty started creeping in, and there have been investors upset or concerned about managers keeping them in the dark on certain aspects of these deals. What’s the state of play there?

JC: We are hearing anecdotally that practices around how LPs are being informed and LPACs engaged has begun to improve, with managers being a little bit more transparent and more thoughtful about how the process is being run and about what kind of information is being put in the data room. And we’re starting to hear that some LPs have been able to come into the CV under the same economic terms as the original fund, as regards fees.

Have we seen wholesale change? I think not yet. We’re still early in the learning curve and the adoption of better practices, but the third party advisors to these transactions get it. They understand that we have to embrace better standards as an industry in order for these transactions to continue to be accepted.

And CVs will have higher participation rates when LPs are given more time and information. If you’re stingy with the amount of time you’re giving LPs to evaluate the deal and decide whether to roll capital into it, you’re going to see fewer LPs willing to do that.

Editor’s Note: NEXUS 2024 offers a rare opportunity to hear from influential LPs, including: Christopher Ailman, CIO, California State Teachers’ Retirement System (CalSTRS); Lori Hall-Kimm, senior managing director and head of global private equity, Healthcare of Ontario Pension Plan (HOOPP); and Britt Harris, acting CEO and COO, Texas Permanent School Fund.