Research Trends and Conclusions: Private Funds 2012
With the benefit of over 14 years of research and tens of thousands of votes from clients and private practitioners, Who’s Who Legal takes a closer look at developing trends in the private funds legal marketplace worldwide.
The funds industry has begun to shake off the effects of the economic downturn and optimism is growing among lawyers in this sector. After a series of difficult years with little activity in fundraising, 2011 has shown signs of improvement on all fronts. However, as Tom Bell from Simpson Thacher & Bartlett LLP in New York heard one lawyer put it, ‘when you’ve been at a standstill, going 15 mph feels fast’. The reality is that activity levels are still significantly down on their pre-crisis levels with first time funds finding it extremely difficult to break into the market, a situation exacerbated by the increasing amounts of regulation to comply with.
Despite this gloomy outlook, the vast majority of lawyers that we spoke to were quick to point out an uptick in their workload over the past 6-12 months, a considerable feat when the economy remains volatile with Euro and US debt crises unnerving investors.
FUND FORMATION
The rise in the number of new funds forming over the past year can be attributed to a number of factors. Firstly, the growth has been stimulated by better economic conditions for the most part of the year. In addition there has been more certainty over the regulatory landscape, and resounding views among fund managers of ‘having put their plans on hold for long enough’. The greater part of fund raising has been in the region exceeding $1 billion, with a harsh climate remaining for those in sub-$100 million bracket and funds are still much smaller in size than they were prior to the economic crisis. For established funds with strong track records the conditions are favourable and the managers are beginning to take the balance of power back into their own hands. In fact, according to some lawyers the demand for high-end products far exceeds the products available. Emerging markets are a valuable source of investment and the list of potential sources increases year on year with Asia and Latin America particularly popular according to the lawyers that we interviewed.
The disparity between established funds with managers holding good track records and those starting anew is distinct. For small start-up funds the challenges are abundant and their critical need for capital and liquidity can be seen by these fund managers offering more managed accounts, laxer terms and bespoke side letters to investors.
While previously the practice of sovereign wealth funds and high net worth individuals with high levels of liquidity, negotiations on terms of investments have been seen more frequently since the economic crisis. There is a definite trend of investors wanting disclosure and transparency to better protect their investments and ensure the safety of their assets. One concern stemming from this is that there might be a case of investors becoming accustomed to better terms which in time might impact upon what established funds are able to offer in the longer term. Fund managers can only hope that with the recovery of the economy they will see even more power return to their hands, although it is almost certain that increased levels of transparency and disclosure will remain an accepted part of their practice.
In the hedge funds arena, lawyers have been increasingly instructed by their clients to advise in the addition of new classes, rather than the start up of new funds. This represents the different levels of leverage of the client base and the different needs of clients some wanting short lock-ups and more liquidity. Moreover it emphasises that clients are becoming more demanding and more educated about what type of product will suit their needs.
REGULATION
The economic crisis has had a lasting effect on the funds industry in the form of regulation. Although regulation was mentioned in almost every interview, as it was last year, the feedback this time was that uncertainty surrounding new regulation has declined as the authorities intentions have been made clearer. In particular, now that the Alternative Investment Funds Manager Directive in Europe has reached Level 2, fund managers and lawyers assured of the main content have started to see a pick up in activity. The impact of legislation can be divided into two sections: the impact on fund managers and the impact on fund practitioners.
For fund managers, regulation has increased the cost of starting a fund and raised the entry level threshold once again, making it harder for smaller funds to reach a successful first closing. The Volcker rule prohibiting proprietary trading has triggered spin outs from banks and prompted managers to set up their own funds as seen with Goldman Sachs and Scott Hahn former managing director and CIO of Morgan Stanley setting up his own fund. While the current economic climate might not favour start-ups the expectation is that there will be many more of these in the coming years, a potential source of work for lawyers on the fund formation side. A further consequence of regulation is innovation and creativity in the funds industry with more Ucits platforms being launched.
Private funds lawyers are seeing a knock on effect of the increased cost of regulation on fund managers pressuring them to lower fees and be more competitive. The reverse of this is that with such complex work required by fund managers from their lawyers, there is a ‘flight to quality’ with the top lawyers being instructed to take on work, despite the cost. The lawyer’s role has changed considerably with the onset of increased regulation, those we spoke to described the necessity of keeping on top of all the changes and how this has become a substantial part of their daily work. The day to day impact is that of more due diligence and compliance work being required. There is divided opinion on increased regulatory work among lawyers, some seeing it as a source of extra income and marketing themselves as regulatory lawyers while others view it as an add-on to a service already offered that isn’t generating extra income for the firm.
AREAS OF ACTIVITY
With constraints on the available capital, lawyers are being instructed less often to form new funds and increasingly to add new classes to existing funds. To spread the risk in an unstable economy the vast majority of funds are multi-strategy and global in nature, this not only reduces the impact of economic volatility in Europe and Northern America but it takes advantage of the emerging markets and the opportunities they provide. While the big funds are reportedly coming back and raising more capital, activity was seen in ‘quirky’ funds such as clean technology, energy and renewables. Infrastructure remained a seemingly ‘safe’ option to investors and distressed debt investments have seen solid returns.
The area of most interest and speculation is emerging market funds, although interestingly they do not make up a huge portion of lawyers work; a common percentage of time spent for emerging market work was around 10-15 per cent according to the lawyers that we interviewed. The traditional off-shore funds of Cayman and even Ireland and Luxembourg prove more popular. Perhaps the reason that the emerging markets gather so much attention is the potential they harbour for future investments and their ability to rebuff the economic crisis that has swept the rest of the globe.
In Brazil, the main funds are private equity, real estate and infrastructure with consumer supply services in the hot seat at the moment with the growing middle class. Lawyers noted that they are seeing the funds in this region diversify year on year.
While activity in the emerging markets has reportedly grown over 100 per cent, it is important to remember the starting figure and not overplay the revenue that is being received by law firms for their work in these regions. Despite this warning, the emerging markets look strong with the IMF predicting that by 2014 emerging markets will have overtaken developed economies in terms of share of global GDP. The demand for legal work will correspondingly increase and with investment capital available, work in these regions looks set to multiply.
LEGAL MARKETPLACE
Our research reflects a trend towards geographical diversification of lawyers and their firms, with the aim of ensuring clients are provided with a seamless service and so that lawyers have better access to fund managers and investors around the globe. This is reflected in the increasing number of jurisdictions listed in our books over the past four editions (see chart 1).
US law firms have made a resolute commitment to the London market, scooping up some of the leading individuals in the industry to establish or bolster their own private funds practices offering both US and English law capabilities, an attractive proposition to clients. With funds needing a greater level of guidance due to the increase in regulations and looking for their outside counsel to provide advice across multiple jurisdictions, London is conveniently positioned for US firms to take advantage of the rising level of legal work and to increase their market share of European funds work. Following last year’s shake up in the legal marketplace with the move of Jason Glover to Simpson Thacher & Bartlett LLP, this summer has seen US firms snapping up some of the finest lawyers London has to offer.
Weil Gotshal & Manges LLP added four lawyers to its private funds team in London, including Ed Gander, while Proskauer Rose LLP chose to bolster its London team with the addition of Nigel Van Zyl and Kate Simpson. Skadden, Arps, Slate, Meagher & Flom LLP & Affiliates selected Stephen Sims to launch its London based investment management practice.
A second trend seen among US law firms is their collective efforts to offer Hong Kong law capabilities. This step shows the steadfast allegiance of firms to the market and their long term commitment to the region as it continues to grow at a rapid pace. In September, Irish funds boutique Dillon Eustace announced its intention of opening a Hong Kong office and Simpson Thacher & Bartlett LLP launched their practice in April.
As law firms aim to increase their global capabilities they are also focusing on Africa, with Clifford Chance, Allen & Overy and Norton Rose announcing in the summer of 2011 their intentions to open offices in Casablanca, we expect by the end of next year to begin to see lawyers being listed under these jurisdictions.
Despite the trends discussed above, our research shows that the key locations for private funds legal work remain London, North America and the Cayman Islands followed closely by Hong Kong as reflected in chart 2 showing the number of inclusions in the key jurisdictions over the past four years.
Looking to the future, it is difficult for lawyers to predict what the next year will bring and the question triggers a chuckle of ‘if only I knew’. Despite the still difficult economic climate, the lawyers that we interviewed revealed that it was not having a significant impact on their clients’ plans at this stage. If fund managers press ahead with plans, then the industry looks set to continue its upward trend at a steady pace and the lawyers we spoke to were optimistic that in the next year they would start to see more consolidation of funds and more spin-outs from proprietary trading arms of banks creating fund formation work. The increasing amount of regulation in the sector appears to be a permanent change to the industry and consequently private funds lawyers will be required to keep up to date on changes to ensure they can advise their clients. Overall, the private funds industry looks to be on the mend. Emerging markets offer exciting opportunities to unlock potential new investment and the creativity in the industry, a reaction to the onset of regulation and economic turbulence, will make the industry an even more interesting and diverse place to work for lawyers.