As Asian authorities – most notably those in China – seek a solution on how to regulate private equity markets, there is no shortage of guidance from Western countries on the subject. Moreover, private equity firms and investors seem to be taking increasing note of international best practice, although they often customise guidelines and standards for their own purposes.
The Institutional Limited Partners Association (ILPA), a Toronto-based organisation serving institutional investors in private equity, last week released an updated version of its Private Equity Principles and the first of its five standardised reporting templates.
The association seeks to drive asset class best practice and support long-term partnerships between limited partners (LPs) and general partners (GPs); it first published the guidelines in September 2009.
New components in the updated Principles include: an appendix on carry-clawback best-practice guidelines (given the complexity of this subject); increased clarity and description of the three existing guiding Principles (alignment of interest, governance and transparency); and expanded context around the purposes of key guidelines.
The latest set of principles seek to fine-tune certain aspects of the previous set of principles, which have been substantially negotiated among LPs and GPs, says Phill Smith, a partner in the funds practice at law firm Mayer Brown JSM in Hong Kong.
“At the outset, it must be borne in mind that ILPA’s membership is made up wholly of LPs, so its recommendations naturally are biased towards LPs’ interests,” he notes. “Having said that, it is clear in the current market, where many funds already have uncalled capital commitments, that new funds raising capital need to be acutely aware of what is needed to get LPs on board these days.”
Smith says the ILPA principles serve a very useful purpose in setting a high industry benchmark for the benefit and protection of the LP community. “But, as ILPA recognises, no single set of terms can provide for the broad flexibility of market circumstances,” he points out. “Industry standards will continue to change and be adapted to suit different market conditions.”
The Asian market is not a homogenous market, adds Smith. In the region there are markets that are more sophisticated and hence market practices are more aligned with those of Europe and the US, he says, while others have their own market norms which reflect the characteristics of their local GPs and LPs.
Over time, different Asian markets may develop their own set of widely accepted norms instead of conforming to a set of universally accepted standards, argues Smith.
Still, he notes a growing awareness of international best practices among Mayer Brown's Asia-based clients. He increasingly sees Asian clients, especially those undertaking international fundraising in a number of markets, to take into account ILPA principles and, in the case of real estate funds, guidelines from Inrev (Investors in Non-Listed Real Estate Vehicles), in their fund terms.
At the end of 2009, Anrev entered a cooperation agreement with Inrev, its sister organisation in Europe, to endorse the Inrev guidelines in Asia. The Inrev guidelines provide guidance to non-listed real estate fund managers on how they should present information on non-listed real estate funds in a consistent and transparent manner.
“Where our clients prefer to diverge [from international standards],” says Smith, “it is not uncommon for potential investors to require a comparison chart showing the extent to which the proposed documentation measures up to ILPA principles or Inrev guidelines.”
Those clients who seek to raise funds in more localised markets among a more localised group of (private) investors may prefer to privately negotiate more tailored terms, he adds.
Meanwhile, ILPA has released with the guidelines the first of its five standardised reporting templates, which covers the format for capital calls and distributions. Templates for annual and interim reports will follow.
Standardised reporting templates provide a useful guide and the templates recommended by ILPA would provide a level of transparency sufficient for most LPs, says Smith. But he expects larger investors, especially institutional investors, to continue to push for their own reporting requirements.
In other new components of the guidelines, ILPA provides various alternatives for claw-backs of distributions from GPs where overpayments are made in a fund’s early years. Where joint and several liability of all members of the GP is not forthcoming, a guarantee of the claw-back amount by a substantial parent company or an individual GP member or sub-set of GP members may be accepted.
Mayer Brown agrees with ILPA’s reversal of its recommendation that GPs should bear the cost of tax incurred on any carry amounts distributed and then returned. Instead of assuming the highest hypothetical marginal tax rate in a designated location, says Smith, the rate should be based on the actual tax situation of the individual GP member.
The guidelines also introduce a change in respect of the Limited Partner Advisory Committee. The ability to vote on matters using written consent, particularly for time-sensitive matters, is a useful practical addition, says Smith. “But, more importantly, we agree that each member should pay greater attention to analysing and declaring their own potential conflicts of interests.”