Some private equity executives are feeling a little anxious about the Institutional Limited Partners Association (ILPA) and its pending fee reporting template, which in coming weeks will be unveiled and open to consultation.
The reason for their nerves? No one is quite sure how standardized fee reporting will actually work in practice, given the complexity and variance of terms across partnership agreements (not to mention ad hoc side letters). But market practitioners do understand the theory behind ILPA’s latest initiative: LPs are under pressure to find a sensible way to gather and analyze key fund terms across a portfolio of fund managers, which is currently difficult, if not impossible, because of the various templates and reporting styles being used by GPs.
pfm has spoken with a wide range of industry sources, including LPs, GPs, auditors and accountants to gauge opinion on this fee transparency initiative. What we discovered were strong opinions all around, which varied from person to person and often related to very specific types of fees (and not applicable to all types of charges) – all of which highlights the challenge ILPA has on its hands.
One concern voiced by GPs was around how the data will be used and/or potentially misused. A standardized template provides LPs the ability to aggregate and benchmark managers on things like portfolio monitoring fees, which sounds nice in principle, but may gloss over some important facts. For instance, some funds offset portfolio monitoring fees on a 50/50 split. Increasingly so, other managers offer a better 80/20 split or full 100 percent rebate. A manager that charges lots of portfolio monitoring fees, but provides a full rebate, may look bad on paper out of context. Or, conversely, imagine that manager had already rebated 100 percent of the management fee, but continues to extract significant amounts of cash from portfolio companies, to the detriment of LPs.
Others have told us the ILPA initiative is a redundant exercise, arguing all the information LPs want is already present in audited fund financial statements, and it’s up to them to organize the information in a way that makes sense internally. While technically true, it seems like GPs ought to be able to provide information in the format desired by LPs; however, another source pointed out that, even if they’d like to help make things easier, it’s difficult for GPs to do so given variations among investors themselves. For example, some LPs record management fees as an internal expense, while others include the fee in their cost basis when calculating returns, which leads to a discrepancy in how LPs calculate their percentage gain or loss, and thus how they communicate about GP performance.
There’s another, bigger point to consider in all this, too: ILPA and the Securities and Exchange Commission (SEC) have been in talks during creation of the template, according to a source close to the process. Remember that a coalition of state treasurers recently sent SEC chair Mary Jo White a letter urging the commission to take action on fee reporting. It’s not unreasonable to believe that the SEC views ILPA’s initiative as the unofficial solution to the problem. But if the template doesn’t work, the SEC may feel compelled to intervene in the name of investor protection. Given the SEC’s respect for sophisticated parties to negotiate their own affairs, that seems unlikely, but it wouldn’t be an unprecedented move. Mutual fund prospectuses, for example, must follow a set template provided by the SEC. The commission could conceivably add additional mandatory reporting requirements to the Form ADV.
ILPA is expected to reveal its draft template very soon. We’ll provide more analysis once the template is available to dissect, but until then it is important to acknowledge now that the template deserves serious consideration by all parties for the reasons listed above. GPs who feel nervous about its creation should make sure to take part in the upcoming consultation. Not doing so is an even riskier strategy.
In the meantime, we’re interested in hearing your thoughts on the template, both before and after its release. Email pfm editor Nicholas Donato at email@example.com.