ILPA principles are emerging winners

Many of the participating DFIs, including the Asian Development Bank and CDC Group, are already significant investors in, or supporters of, private equity across the region, and some actually helped draft the principles. Their views represent much of the thinking that GPs and fund formation professionals will have to deal with in Asia Pacific in future.

DFIs are fairly emphatic that the ILPA principles are going to make a difference to the industry, in Asia as elsewhere. According to Mark Kenderdine-Davies, General Counsel at CDC, the principles “will have a significant impact on the structure and terms of funds which will be brought to market in future to invest in developing countries.” Tony Bakels
Manager for Private Equity at the Netherlands Development Finance Company (FMO), also feels that they “will help to promote best practice and unified terms.” At least one of the prominent Asian limited partners formally endorsing the ILPA principles affirmed that: “they will play a baseline role in emerging markets, where there is a not a standard ‘market’ practice the way there is in the US and Europe yet.”

Specific impact of the principles

The principles – or rather, the specifics covered in Appendix A (‘Private Equity Preferred Terms’) and B (‘Limited Partner Advisory Committee’), as much as the general guidelines and recommendations in the principles themselves – already appear to be having an impact. The ILPA certainly took care to ensure that its general principles could be immediately applied through actual terms and conditions, and funds have a fairly strict regime of protocols to adhere to, that cover the main areas of concern on alignment of interest, governance and transparency.

Partly, this reflects legacy issues in Asia Pacific that may be part of a general lag in knowledge transfer – including some delayed transfer of best practice. “We have seen emerging market fund managers trying to raise funds on terms which may have been achievable five years ago in the US, but which have had, in our view, no place in emerging markets for years,” Kenderdine-Davies remarks. Batels adds that “The guidelines address some of the key issues of fund investments, such as alignment of interest between GP and LP, governance and transparency.”

Kenderdine-Davies lists some of the more significant abuses he has seen in emerging markets funds. “Funds, for example, without ‘no-fault-divorce’ arrangements. Or funds with ‘deal by deal’ distribution waterfalls, and weak ‘80/20 economic deal’ protection arrangements, or which allow their managers to develop significant revenue streams from transaction fees, etc. Also, funds with opaque governance arrangements and limited transparency.”

In fairness to emerging markets GPs, AVCJ’s other sources do report that many developed-market funds have been guilty of one or more of the same offenses. Sources have also reported highly – even shockingly – aggressive responses from some GPs worldwide to LP questioning of these practices, although signs are now that the worst excesses of such behavior have passed with the chastening impact of 2008. And the endorsing Asian LP also maintains that the principles will serve as the foundation for initial discussions and the legal framework cementing the relationship between LPs and GPs.

Development finance involvement

DFAs, as a broad class of emerging markets investor, were certainly represented in the formulation of the ILPA principles, but the institutions disclaim any unique agenda or special interest in preparing the final draft. Bakels emphasizes that the principles were “developed through the efforts, contributions and collaboration of many institutional private equity investors and the ILPA. It does not have a specific DFI angle, but aims to develop best practice for the industry.”

Kenderdine-Davies feels that the DFAs broadly were not the major lobby in the formation of the principles. “It's fair to say that the principles were developed by North American institutional investors. The DFAs have been followers in the main – but I expect more to embrace the principles in future.” The concerted endorsement by DFAs in itself may trigger broader adoption, he adds. Asia’s LP source confirms that many of the largest investors in Asia, including GIC, Alpinvest, and CalPERS, are also party to the ILPA principles, and are using them as one basis for their own discussions with LPs.

DFAs and other LP participants are also clearly anxious that the ILPA principles should not be represented as a GP-bashing exercise, but ultimately to the entire industry’s benefit. “We want to encourage significant private equity inflows into our target markets to fund private sector businesses,” affirms Kenderdine-Davies. “The more aligned the fund terms, the easier the fundraising, in what we all recognize continues to be a challenging capital-raising environment.” And he adds, “lengthy fund negotiations benefit no one but fund lawyers.”

And the DFAs are keen to see the new principles give LPs comfort in committing to emerging markets. “Application of best practice will undoubtedly give comfort to (new) investors to the industry,” Bakels feels. And Kenderdine-Davies concludes, “Let’s learn from the errors of the past, realign interests, and work together to bring significant private equity capital back into developing economies.”

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