Investment Funds: The impact of COVID-19 on liquid and illiquid funds and their managers
1. Liquid funds
Due to the capital markets conditions caused by COVID-19, liquid funds may need to activate their gating provisions in order to limit redemptions, in accordance with the terms of the fund’s prospectus.
Suspension of NAV calculations, redemptions, subscriptions and conversions
In some cases, fund managers may need to suspend NAV calculations as well as redemptions, subscriptions and conversions. They can do so where the fund's articles of association specify the conditions for a suspension. Such conditions usually include exceptional circumstances. The current market disruption caused by the COVID-19 outbreak most likely qualifies as such.
The fund must inform the CSSF of the suspension without delay. If the fund markets its units in other EU Member States, the competent authorities of those states will need to be informed as well.
Cash exposure to a single counterparty
UCITS funds divesting or considering divesting their portfolios should respect the maximum cash exposure to any single bank, be it a custodian, sub-custodian or prime broker. The current limit is set at 20% of the fund's net asset value. Any violation of the applicable rules must be reported to the CSSF.
2. Illiquid funds
Funds in the investment stage may experience investor default. Depending on the provisions of the fund’s documentation, the potential consequences of default on other investors and the fund will need to be investigated.
Impact on bridge financing and leverage restrictions
Investor default may also lead to an inability to refinance bridge loans in a timely manner. The possibility to rely on force majeure or similar clauses will depend on the law governing the bridge documentation and the terms of the loan agreement.
For documentation governed by Luxembourg law, please see “Contracts and Commercial Litigation: COVID-19 as an unforeseeable event and/or a material adverse change”.
In addition, the potential consequences for the legal restrictions applicable to leverage may need to be assessed.
Exit delays and fund extension
Funds in the divestment stage may experience delays in disposing of certain assets.
Managers may also need to consider extending the life of the fund. To the extent the fund’s documentation needs to be amended in this respect, managers should reach out to their investors and the CSSF without delay.
Material adverse events
Illiquid funds, such as private equity and loan-originating funds, should consider whether COVID-19 could constitute a material adverse effect (“MAE”) under agreements or deals that have yet to close. For transactions still in the negotiation stage, managers of illiquid funds may wish to consider building in specific thresholds to establish the point at which the COVID-19 impact on the target company will be deemed to constitute an MAE.
Valuation & liquidity management considerations
For reporting purposes, fund managers will need to consider how to handle valuations in these tumultuous times. In particular, those with illiquid assets under management should plan for and seek to mitigate uncertainty in the valuation process.
Fund managers with (partially) open-ended illiquid portfolios should also assess how they will address redemptions.
Mention of a subsequent event in the financial statements
Fund managers may need to include a note in their financial statements, describing the impact of COVID-19 on the fund as a major subsequent event, where applicable.
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