Fund financing has been one of the strongest growth stories in the funds industry over the past decade. As sustainability has become a vital dimension of finance and as new uncertainties arise in financial markets, which trends will shape the future of fund finance?

Rising allocations to alternative assets, low global interest rates and an increasing demand from managers for sophisticated and flexible solutions have led to growth, not just in the sheer scale of fund financing but also in its sophistication.

Today, rapidly changing macroeconomic conditions, highlighted by rising interest rates and the recent bout of turbulence across financial markets, have posed fresh challenges and herald a new environment for investment and finance. But while market turbulence has dampened the pace of growth, fundraising remains high by historic standards, and the demand for more sophisticated financing solutions is, if anything, expected to strengthen.

To understand the scale and pace of these emerging trends and the effect of recent market events, Funds Europe spoke to experts across the funds sector, from advisers to legal experts, asset managers and fund financiers themselves, to hear their insights on this fast-changing landscape.

Key trends and factors

The global economy is at an inflection point. Central bank rates are rising across the developed world while geopolitical uncertainty continues to cast a shadow over investment; the cost of funding, FX rates and even sanctions were raised as issues by many of our interviewees. But, despite the uncertainties, the view was unanimous that fund finance would weather the turbulence.

Nevertheless, these uncertainties provide the backdrop to fund financing trends over the coming months and beyond.

Aside from the macroeconomic environment, three key trends emerged from our in-depth interviews; some already established but set to accelerate and develop, others nascent and yet to show their full ramifications.

• Sustainability

Green funds and an environmental dimension to investment have been features of the funds sector for at least a decade, but in the past few years, the focus on sustainability has intensified. Both finance providers and sponsors are increasingly keen to link finance explicitly to ESG targets. This in turn is raising concerns and challenges around the risks of greenwashing and the rigour and metrics required.

• Innovation and complexity

Net asset value (NAV) financing has been increasing in recent years. NAV financing links finance to underlying assets rather than funds deals. But NAV is just one aspect of innovation in the market. Many of the experts we spoke to attested to a general increase in innovation and complexity in financing and expected those trends to continue, including the emergence of financing structures previously unthought of.

• New capital and new entrants

Fund financing has been dominated by bank lenders, but the attractive risk-return profile and the desire among non-bank investors to diversify into alternative assets is drawing new entrants to the market from smaller banks to insurers and other institutional investors. Demand for fund finance is inexorably linked to the overall scale of the fund market, initial fundraising is booming, and mega-funds are now commonplace. Major fundraisings in 2022 include Advent International (US$25 billion), KKR (US$19 billion) and Blackstone (US$30 billion).

Each of these trends has many aspects but combined, they amount to continued growth in private equity funds and in the demand for credit financing, rising complexity in the structures of that finance and the need for sophisticated solutions.

Sustainability

Sustainability is no longer an afterthought in fund financing. Questions around ESG, the potential for explicit sustainability-linked finance and the metrics required to build ESG into the heart of the process have become a core issue in fund finance.

As Georgina McCreadie, assistant director, funds advisory at Deloitte, explains: “ESG is only continuing to grow as an area of attention for PE managers. We are seeing this translate into a growing interest and focus on ESG and sustainable linked financing for funds. Managers are increasingly looking for ESG to be one of the initial discussion points when considering how to structure their subscription facilities and will see it as an important capability when reviewing lenders’ offerings.”

Much of the impetus for pushing and maintaining ESG issues high on the fund financing agenda is coming from lenders themselves, who have made environmental issues in particular a priority. McCreadie points out that bank lenders are likely to refer fund financing deals not only to their credit committees but also, and with equal emphasis, to their own ESG committees. And McCreadie points to rising demand from LPs for an ESG dimension to their investments.

Lynn Alzin, partner in the finance and capital markets practice of Luxembourg business law firm Arendt & Medernach, agrees. “What’s driving the increase in ESG is greater investor engagement,” she says. “Investors are becoming more engaged in general, which is obviously then driving the pressure on funds to line up their ESG objectives and have that at the heart of their strategy.”