The increasing use of subscription credit facilities is catching the attention of the Securities and Exchange Commission as well as investors, according to a note from law firm Dechert.
In its winter 2017 private equity newsletter released this month, the law firm wrote that private equity funds have traditionally used subscription lines solely as bridge loans to smooth capital calls for investors and to provide greater flexibility to move faster on deals. In those instances, the loans would be repaid with capital called from investors, usually within a few weeks.
But some private equity funds are now using subscription lines for longer-term borrowing, Dechert wrote, adding that such use may result in an increase in the sponsor’s carried interest and that in some cases, such loans can resemble semi-permanent capital in the investment structure.
“Both investors and regulators are beginning to focus more on the practice,” Dechert wrote. “Investors are beginning to ask for clarification of when the preferred return begins to accrue if subscription line facilities are used and whether or not the sponsor plans to use subscription line facilities as more than bridging capital in portfolio investments.”
Dechert noted that the SEC is also looking into the issue. The regulator has not yet provided any further details on its views on the practice, and declined to comment for this article. Dechert wrote that “based on the general principles applied by the SEC, however, it is likely that a focus will be on the adequacy of the disclosure provided to investors regarding the risk, costs and impacts of the practice and management of any conflict of interest”.