Asset managers turn focus to clawback risk
Asset managers are increasingly concerned about clawback risk in the private market sector, amid the possibility of delayed investment realisations in the year ahead.
The Citco company of groups has reported a 35 per cent increase in overall enquiries and active support on clawback risk last year. In response, Citco has published a new guide on the drawbacks of clawbacks, which offers advice on mitigating private markets clawback risk.
The advice includes using non-time weighted preferred return calculations; European-style expense recoupment provisions; and carried interest escrow requirements.
Citco also looked at a variety of scenario models which could be incorporated into the capital distribution process in order to mitigate the risk of a future clawback event.
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“It is important to note here that the process of mitigating clawback risk does not disadvantage LPs in any way,” said Tim Eberle, head of waterfall services at Citco.
“In fact, the opposite is true: having a defined process for clawback mitigation provides both GPs and LPs with an enhanced framework for transparently managing waterfall distributions – saving both parties the complication of enforcing clawbacks post-tax, thereby preserving the GP-LP relationship.
“Also, given the SEC’s private fund reporting rules requirement to enhance reporting to LPs on GP and LP clawbacks, these pre-emptive measures can only be seen as a positive outcome.”
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Citco’s analysis was based on the American waterfall distribution model, which allows managers to be paid before investors receive their preferred return and capital. These investors can then claw back the manager fees if the fund underperforms.
“In the current climate of geopolitical tensions and rising interest rates, private markets managers are facing their most difficult portfolio investment liquidation and realisation market in decades, forcing many GPs to significantly delay the realisation of their portfolio investments, whether through sale or IPO,” the Citco report noted.
“While there are already news and market reports around the distinct challenges and opportunities for the private markets in 2024, the risks of LPs clawbacks in waterfall distribution have not been properly addressed.”
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