The rapid and unprecedented spread of the novel coronavirus (Coronavirus) which started in December last year and soon became every economy’s waking nightmare has dealt a severe blow to businesses worldwide and posed a serious challenge to asset managers across the globe. Funds and their managers are battling various obstacles including accelerating fund outflows, substantial share price falls and operational challenges to their client-facing work as both international and domestic travel becomes increasingly difficult.
It is currently too early to quantify the true market and economic fallout from this outbreak and it remains to be seen how much more damage, both in terms of loss of lives and economic loss will occur as a result of this outbreak. However, the fund managers should consider adopting certain key measures that may be worthwhile in order to mitigate the damage and losses at the level of the fund as well as their portfolio.
Listed below are some of the key steps that should make it to every manager’s to-do list in the wake of the spread of Coronavirus:
1. Business continuity planning: As fund managers begin to fully come to terms with the business interruptions associated with the Coronavirus outbreak, it becomes increasingly important for them to implement a carefully structured business continuity plan. It will be imperative to the fund manager to adopt the highest degree of care in their fiduciary role towards the fund and assuage the worries and anxieties of their investors by sending them adequate communications regarding the adoption of such business continuation policies.
2. Revisiting the investor agreements for key clauses: It may be advisable for fund managers to revisit the key person clause in the primary document containing the rights of the investors and the obligations of the fund managers such as the fund’s shareholders’ agreements or the limited partner agreements. As a mitigating measure, fund managers may consider having the key persons work from virtual offices with limited or no physical contact with other personnel of the fund manager. Fund managers may also need to confirm whether the fund’s agreements require any mandatory in-presence/physical meetings of governance bodies of the fund which may become an impossibility in the current scenario and accordingly inform and/or obtain consent of investors to hold video-conference meetings instead.
3. Investor Reports: Fund managers may consider updating the investors on the anticipated impact of the outbreak on the fund’s portfolio. This may mean different things to different funds. For funds with an investment focus in China and/or Asia, this may mean informing the investors of how the market slowdown may impact the fund’s performance in the short-term. While the real and complete impact of the outbreak is yet to be assessed, the industry is aligned that it would have a negative impact on the market returns. Further, fund managers may need to inform their investors of any anticipated delays in reporting such as possible delay of the environmental social and governance (ESG) reporting. Typically, ESG compliances may require the fund to send its ESG trained personnel to physically visit the portfolio entities on a frequent basis. However, due to restrictions on site visits such investor reportings may be delayed.
4. Valuations and redemptions: With the quarter-end and financial year-end approaching, managers should give some thought to the valuation mechanism in this period of uncertainty. It may be worthwhile for managers to mitigate uncertainty in the valuation process. Funds engaged in exchange-traded instruments may have to be prepared to address partial or complete trading suspensions, increased volatility and fluctuating liquidity. Managers of vehicles that offer periodic liquidity/exit should also assess how they will address full redemptions.
5. Regulatory Reporting and Compliances: It may be safe for managers to assume that standard regulatory filing deadlines will remain in effect. Given that any delay in making regulatory filings and compliances may mean hefty penalties and regulatory action, managers should have in place a proper system of checks and balances to ensure that such filings and compliances are made in time. This may be more relevant to offshore fund managers as while in the Indian context, filings with SEBI and RBI may not be disrupted, under the U.S. laws, if a manager is to claim a hardship exemption, the preparation for the same needs to be undertaken sufficiently in advance.
6. LP/Investor Meet-Ups: Managers who had scheduled their regular investor and/or year-end limited partners’ meetings and conferences may have to move to a system of webinars and/or postpone the same depending upon how long the impact of the outbreak lasts. It may be safe for managers to assume that it will be difficult if not impossible to hold physical meetings and conferences in the coming month to the travel bans and accordingly inform the investors in advance to avoid any last minute cancellations.
7. Material Adverse Effect: Managers of private equity funds and direct lending funds should consider whether the outbreak may result in a material adverse effect under the definitive documents of their portfolio investments that are yet to be consummated. For transactions that are still ongoing, managers should consider whether they want to negotiate and incorporate any particular thresholds to determine at what stage the impact of Coronavirus on the portfolio company will constitute a material adverse effect. This will have a direct impact on the projected timelines for the closure of portfolio investments.
8. Risk Factor Disclosure: While force majeure risk factors including those caused by war, famine and disease are typically part of the investment risks disclosed to investors in the marketing documents, managers may consider whether specific disclosures respect to the risks associated with the Coronavirus should be incorporated in the placement memoranda. This is particularly true for funds which may not get the anticipated exits on account of the outbreak.
9. Delayed Timelines: Travel restrictions as well as inability of prospective investors to provide all KYC and other documents in time may mean that funds which were scheduled to hold final closings by the end of March or April may now need to extend their final closings in accordance with their fund documents. Further, timelines for regulatory approvals (including approvals from SEBI for launch of new funds) may take more time than originally envisaged as the workforce within the offices of various regulators cope with the potential lock down. Accordingly, it may be wise for managers to immediately revisit their launch plans especially activities which are dependent on timely grant of regulatory approvals.
10. Tax Impact of decision-making patterns: As a result of the travel restrictions imposed by the governments of various countries, personnel of various funds may be prevented from travelling to the required jurisdiction as per their tax residency. This may change their tax residency which in turn will require the fund managers to re-asses the substance requirements that may be in place for each of these funds. Further, in cases where personnel who are stranded in India and unable to return to their home jurisdictions or where personnel who are in overseas jurisdictions are unable to take decisions due to isolation / quarantine or other reasons associated with the Coronavirus, decisions may need to be taken in India which may give rise to considerations on the ‘Permanent Establishment’ and ‘Place of Effective Management’ under the Indian tax laws. Managers should consider these aspects along with their tax advisors at the relevant stage where it appears that key decisions are being forced to be taken from India.
- Siddharth Shah (Partner) and Gaurita Udiyawar (Principal Associate).
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This was also published by VCCircle on 17 March 2020