AIF - Handling macroeconomics-driven stress situations
Summary article
Each of the crises faced by the fund sector since 2008 has been a unique learning experience for the industry and regulators. There have been challenges around debt refinancing, investor liquidity, valuation, lower-than-expected performance, long-term viability, and more, with each impacting operating models. The ILA Alternative Investment Fund Committee organised a panel of governance specialists to give the benefit of their experience and answer questions on how to handle current and future stress situations.

Current outlook

Hosted by EY on 20 February, the session began with an overview of the current macroeconomic outlook by Maria Löwenbrück, a member of the board of Union Investment Luxembourg. While growth is likely to be respectable in the USA and Japan, she said it is on course to be disappointing in the eurozone and China. Inflation is falling, and “markets expect the Fed to ease interest rates more rapidly than the ECB this year,” she said. As well, she highlighted the numerous potential geopolitical tripwires which could trigger macroeconomic stress through short and long-term disruptions of global trade flows. As for the private asset market, distress is affecting the number of deals, exit timing and the speed of fundraising, but there is an improving outlook for pricing and performance.

Have policies in place

Session chair Jesus Orozco, a partner at EY, asked how boards should face the polycrisis. “It is quite ambitious to account for every possible future stress situation, but some general principles apply,” said Adrian Aldinger, a partner with Arendt & Medernach. “Have policies in place that are specific enough to be helpful, but broad enough to cater for unforeseen events,” he recommended. He pointed to how many fund documents had specified pandemics as potential risk scenarios prior to Covid.

What if agreements fall through?

While recognising the importance of documentation, Keith Burman, a non-executive director with a background in real estate underlined that issues can still occur. “For closed ended funds, will your current set of investors be able to meet future cash calls? Even though they have pledged to in a contract, they may not,” he said. For open ended funds, ideally liquidity management tools will be in place, “but not all funds have this, nor does everyone necessarily understand how to operate them,” he added. 

Funds could decide to exclude investors or extend the cash call to others, even if these ideas are not in the original fund documentation. However, the panel warned that robust action might exacerbate reputational damage risk. 

Transparency is key

Although redemptions in the real estate sector have been relatively low over the last 12 months, and the industry has improved transparency regarding valuations, “boards should be anticipating potentially difficult discussions,” Mr Burman said. If drastic measures have to be taken (such as suspending distributions) he advised adopting a policy of openness. “Get in front of the investors and explain your rationale, talk about some of the things that might be necessary.” 

CSSF approved liquidator Eric Chinchon, a founding partner of M.E. Business Solutions, agreed with this approach. He cited the example of continuation funds and the need to “discuss with your investors, make sure you're aligned with their interests, find out who wants to redeem and who wants to remain, all the time making sure and explaining the rationale behind each stance given the market situation,” he said. He added that all such discussions and decisions need to be well documented, ideally approved by an EGM or AGM. “Ultimately this is about risk management,” he added.

Looking at other illiquid private asset classes, Forbes Fenton, a conducting officer with M&G Luxembourg gave his experience of the 2008 crisis, noting that for some highly leveraged vehicles “it was the refinancing and the structuring that killed them, not the valuation of the underlying assets.” He sees substantially less leverage now, suggesting a more stable outlook. As for private asset valuations, these can tend to be less variable than for some liquid assets. However, he noted the challenge of higher interest rates having made alternatives less attractive.

Dealing with sanctions

As well as sanctioned investors, the Russia crisis has elevated the challenge of sanctioned assets, noted Paul Carr, senior manager and conducting officer at Capital Group Luxembourg who was commenting on challenges for liquid-asset managers. “Having companies which are listed on their local market, but not tradable for others represents a relatively unique situation,” he said, adding that these scenarios would become more common if Taiwan-China tensions increase. Again, boards need to ensure thorough due diligence, robust documentation, and clear policies.

The session was enlivened with questions and comments from the audience, with these experiences fuelling the panel’s discussion further. Graham Cook the director of the insurance broker Talisman concluded with an overview of how directors can protect their wealth and reputation from the risk of macroeconomic fallout. 

Directors and VAT - What’s coming next ?: Pictures
22 February - Chambre de Commerce