The quest for clarity

Fees and transparency have always been subjects for discussion in private markets, but the past few years has seen a greater push towards standardisation and improved reporting. So how is this changing practice in Asian markets?

Understanding the costs involved in private market fund investing and getting to grips with the value of portfolio holdings has not always been an easy task for LPs. Meanwhile, GPs have often struggled to keep up with the rising demand for information from a range of different investors – a task made more challenging as the amount of assets under management and the number of funds and strategies each GP manages has increased. Yet as the industry has matured and as several external events have had an inevitable impact on portfolio companies, most would agree that transparency between GPs and LPs has improved, although there is still some way to go in some areas.

Private markets in Asia are, of course, younger than in more developed economies, yet with GPs attracting capital from a global investor base, they are having to catch up fast on best practice, drawing lessons from other parts of the world and through discussions with LPs.

So where is the industry at today?

And what comes next?

Here are some of the key transparency themes and developments to date and some to watch out for.

Regulators are driving improvements to transparency.

“We have come a long way on transparency in the past decade,” says Jennifer Choi, Acting CEO of the Institutional Limited Partners Association (ILPA). “That’s not universally true, but we’ve seen progress in the quality of disclosure around fees in particular.” The early driver for this stems from statements made by, and actions taken by, the US Securities and Exchange Commission. This, says Choi, has shone a light on funds’ allocation of fees and expenses.

ILPA’s fee reporting template is moving practice along – although there are regional gaps.

With over half of LPs creating custom templates for fee and expense information, ILPA set about creating a more standardised approach that would meet LP needs while also reducing the burden on GPs – and the ILPA reporting template was launched in 2016. “We saw a good response to this initiative,” says Choi. “The industry worked with us to shape the template, get ahead of regulators and provide what LPs were looking for.”

Developments since then have been encouraging, although it’s clear some GPs are struggling to catch up. “The picture is not universal,” explains Choi. “We saw the fastest progress among the large buy-out institutions because they have deep back office capability, technology, processes and infrastructure to systematise fee and expenses transparency. There has been a lag in Asia, however, where the adoption of the ILPA template is slightly lower than in the US and Europe. That is related to the size and maturity of the industry and to the requests that LPs have of GPs in the region.”

Greater LP-GP communication is moving the dial on fees and expenses charged.

The two and 20 model may still be prevalent, but GPs are now having to account for where they are spending their fees and expenses. “The global financial crisis, combined with governance issues among some GPs has led to more discussions at the outset between LPs and GPs,” says Sandeep Aneja, Managing Partner and Founder of Kaizen Private Equity. “It has become more customary for GPs to present and agree budgets with LPs and there are a lot more conversations about extraordinary items.”

LPs with more financial firepower are also increasingly asking for fee reductions. “Investors almost always demand lower fees when they have a chance,” says Henry Lin, Founder and CEO of Linnovate Partners. “They are definitely becoming more strict around fees, which are now in the 1.5% to 2% range, as opposed to the set 2% we used to see.”

Covid has improved transparency for good.

When Covid hit, GPs were quick to respond and understand the impact it was having and could have on portfolio companies. Many LPs report that communication through this period was largely effective and helpful. “Covid has helped transparency,” says Choi. “GPs were especially strong on the quality of early disclosure and most were proactive on sharing updates rather than waiting for LPs to contact them. A lot of those better practices have stuck. We haven’t reached the holy grail – which would be the end-to-end transmission of what is going on in the portfolio, but Covid has normalised being more transparent.”

Technology is increasingly doing the heavy lifting.

And this has only been accelerated by the pandemic. “Technology is playing a crucial role in providing the information LPs need,” says Lin. “Just five years ago, a lot of investor reporting was done manually and the technology was far less asset-focused. Today, databases and other technologies designed for the industry have become available and automation is taking the load. We’ve also seen a new breed of technology-enabled services that allow GPs to outsource to their own specification and help them comply with the latest regulations and reporting requirements. That said, regulation and technology is already place in the US; it’s less so in Asia.”

The need for ESG reporting is gathering momentum.

This is adding further complexity and cost to the requirements GPs face as LPs are requesting ever more detail around ESG practice and improvements. The European Union’s Sustainable Finance Disclosure Regulation, combined with similar moves elsewhere, plus societal pressure on understanding the social and environmental impact of the finance industry, are all pushing GPs to provide more – and more detailed – information.

“ESG is some of the most difficult information to provide,” says a seasoned private equity firm CFO. “That’s because of the complexity but also because it’s relatively new. We are now trying to measure this at portfolio company level and also among our service providers to answer what we can.”

It is also leading to discussion around fees, particularly among smaller managers where resources are more limited. “Large platforms have the capability and resources to absorb the cost of ESG monitoring and reporting,” says Alison Nankivell, Senior Vice President, Fund Investments and Global Scaling at the Business Development Bank of Canada. “But smaller GPs may not be able to do that. Fees will become an increasing issue here and there has to be a discussion around this. There may well be reasonable situations where ESG costs are channelled through as fund expenses.”

LPs are increasingly viewing costs in the round.

As the industry matures across Asia and GPs raise larger and more funds, LPs are questioning the level of fees charged. “Fees will be lower in ten years than they are today,” says Choi. “Where you have faster fundraising cycles, you’re paying on predecessor and successor funds and best practice should be to step fees down and that doesn’t always happen. At the same time, fund sizes are increasing dramatically, but we’re not always seeing a fee reduction or organisational changes that would warrant that extra income. We’re also seeing items that were once covered by the management fee charged as partnership expenses.”

This is leading LPs to take a more holistic approach to what it costs to invest in funds. “This isn’t about fees,” adds Choi. “It’s about what aggregate costs are necessary to generate the return. Some will come out in the waterfall, but LPs are now examining more closely what overall costs are because there is a lot of complexity as to how costs are calculated.”