20th March 2020
The pace of change over the past two weeks has been dizzying. I was speaking to a friend last night who owns a chain of nurseries. A couple of weeks ago he had a business making a seven-figure profit before tax and like most of us was looking forward to his summer holiday. Last night he was facing financial ruin with 150 staff made redundant at the end of the month. This is subject to the nebulous prospect of a Government loan which hopefully he and many others will get some sort of clarity on next week.
In the asset management industry, most of us are slightly more fortunate in that we have recurring revenues. The most urgent task has been to secure basic business functionality in an environment which has been changing daily. We have been closely monitoring our Asian business, which has been rotating staff since January and accordingly we ran all our BCP testing in late February and ironed out the niggles early March. Only just in time, however, and it forced us to take a view on some extremely unhelpful "working from home" restrictions issued by various regulators.
There seem to be three stages to this. Denial, panic and then the new normal. I believe we are about to enter the third phase and, notwithstanding the enormous personal and professional difficulties many of us will go through, business will carry on. That means rather than postponing, there may need to be new ways for LPs to due diligence funds, for GPs to due diligence investments and for staff to operate in a safe environment, not just personally but to plug all the gaps that have been exposed to cyber criminals. The latter is a very real threat and includes the prospect of heightened phishing or ransomware attacks, or of counterparty impersonation (LPs or suppliers).
It’s now very difficult to get opinions on any advice relating to value or financial statements. During the week the Financial Reporting Council (FRC) issued guidance to auditors to delay audits if necessary, to gather further evidence on going concern and other material uncertainties. We are trying to narrow their focus to only those financial statements which warrant scrutiny. However, clearly there may be wider implications in relation to, for example, bank covenants where unqualified audit opinions are vital. Valuation uncertainty has had a significant impact on open ended funds, where those with 20% or more of illiquid assets with material uncertainty are under pressure to suspend issues and redemptions. Clearly this is also influencing pipeline deals.
In fairness, some of these fears from the FRC may be real. I spoke with one portfolio company CEO who said that the business's cash flow had been kept to a minimum, i.e. a few months cashflow, and that the immediate actions had been to tell the landlord that they weren’t getting any rent, the council that they weren’t getting any rates and all 800 employees that they were down to 80% salary. They are too big for SME support so the 80% will rapidly become 50% unless new conversations with the Bank of England (their offer of "come and talk to us") prove equally futile. Things have moved so quickly I suspect people have been caught by surprise and there will be many similar examples.
Funds which are near to a closing seem to be proceeding but funds at the beginning of a fund-raising cycle are mostly being postponed. Meetings with investors have been all but abandoned and, if this continues for several months, questions remain whether LPs and GPs will have to find new ways to engage on the basis they won’t meet face to face.
Feedback on the impact on due diligence of assets is mixed. Some GPs remain happy with more generic assets to rely on local advisors and desktop due diligence. Suffice to say, some deals that are close to completion will likely pull through but deal making generally is being postponed until there is better visibility.
Finally, there is some upside. On the real estate side, investment in logistics is a good example of an "in demand asset class". On the private equity side, any funds providing liquidity to the market are likely to be able to get traction such as secondaries, mezzanine debt and recap funds.
First though we need to protect our own businesses. That means very strong cash management, an eye on cyber threats and a rapid assimilation of the new normal way of working.
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