Recent Private Equity and Other Alternative Asset Investment Developments and Investor Concerns Reflected in New ILPA Principles 3.0

 

ILPA Updates Its Best Practices Guidance in “Principles 3.0.” Responding to private equity and other alternative asset investment trends and new issues, the Institutional Limited Partners Association (ILPA) recently released “ILPA Principles 3.0: Fostering Transparency, Governance and Alignment of Interests for General and Limited Partners.” ILPA Principles 3.0 updates and expands on prior ILPA Principles 1.0 (2009) and 2.0 (2011). 

 

 

While ILPA 3.0 builds on and comprehensively reiterates prior principles last fully enunciated in ILPA 2.0, it addresses several aspects of private equity and other alternative asset investment that are either recent developments, or were not addressed previously. Summarized below are some of these areas that were not previously addressed by ILPA 2.0, along with the primary ILPA 3.0 recommendations.

 

Co-Investment Allocations. General partners of funds (GPs) should disclose the framework for allocation of co-invest opportunities and how related expenses will be allocated, including any prioritization. Existing side letter co-invest rights should be disclosed. Where co-investment opportunities have been offered any other GP-managed vehicle, the GP should disclose any potential conflicts to the limited partner advisory committee (LPAC).

 

Fee and Expense Allocation and Reasonableness. Travel relating to sourcing deals, networking and preliminary deal diligence should be borne by the manager, until the potential investment advances past the initial term sheet. Technology, cybersecurity and software upgrade expenses that “solely or chiefly benefits the GP, and can be utilized over multiple funds over time” should be borne by the manager. Cost of regulatory compliance at the management company/GP level or remedial actions as a result of regulatory review should be borne by the manager.

 

GP Ownership and Succession Issues. GPs should proactively disclose ownership of the management company and any ownership changes over the life of the fund. Transfers of GP interests to third parties (even if not restricted) should be notified to LPs in advance, accompanied by information on goals and rationale, and how GP-level as well as fund-level economics may change, including any impact on GP/management members not participating in the transfer.

 

Subscription Lines of Credit. Where advances are drawn under a subscription facility secured by LP capital commitments, the preferred return accruing to investors should be calculated from the date the subscription facility is drawn upon (which is when the LP commitment is at risk), rather from the later date capital is called from the investor. Offering prior performance and ongoing reporting data should be presented both with and without the effect of subscription credit facilities. Investors should be offered the option to opt out of a subscription credit facility at the time of their initial admission to the fund. Subscription line facilities should reasonable in both size and duration, and there should be full disclosure of anticipated size, duration limits, parameters around use of proceeds, and costs incurred, and how treated in context of overall leverage limitations. Many of these recommendations first appeared in 2017 in ILPA’s “Guidance on Subscription Lines of Credit.”

 

GP-led Secondaries. The GP should engage the LPAC as early as possible regarding the proposed secondary sale transaction. Any conflicts should be disclosed, mitigated and approved by the LPAC before the transaction is presented to all LPs. A “status quo” option should be offered for LPs wishing to “roll” their interests rather than sell. GPs should engage an advisor to solicit bids at the GP’s expense (not the fund). The LPAC should review the advisor engagement. Disclosure to LPs should include: the number, range and content of bids received; economics and/or any “stapling” (LPs allocating primary capital); and any other meaningful changes in terms vs. the original fund. Most of these recommendations first appeared earlier in 2019 in ILPA’s “GP-led Secondary Fund Restructurings: Considerations,” which includes a more expansive discussion of these issues. 

 

Other new areas addressed by ILPA 3.0 include: Disclosures regarding ESG (environmental, social and governance investing), Code of Conduct and Regulatory Compliance; and Scope of the Fund Audit.

 

 

ILPA 3.0 also clarifies and expands on previous recommendations made in ILPA 2.0 in areas such as fund economics, fiduciary duties, key person provisions and LPAC responsibilities. 

 

Unlike in the release of ILPA Principles 1.0 and 2.0, ILPA will not be seeking official endorsements for the document, possibly reflecting the past mixed industry reception for Principles 1.0 and 2.0, as well as the rapidly evolving and relatively recent nature of some of the issues addressed in Principles 3.0.