Overview of the Fund Finance market in Singapore 2021

Overview

Singapore, like most countries, had a tumultuous year in 2020. COVID-19  affected Singapore (and Asia, generally) in February, earlier than most of the rest  of  the  world.  The subsequent slowdown of primary industries in Singapore, such as business services, transportation & storage and construction, led to a significant downturn to the economy.

The Singapore Ministry of Trade and Industry reported¹ on 23 November 2020 that in the third quarter of 2020, the Singapore economy contracted by 5.8% on a year-on-year basis.  Total employment levels in Singapore have also decreased; in the second quarter of 2020 alone, total employment in Singapore fell by 113,500 – Singapore’s largest quarterly decline on record.  Uncertainty surrounding other global events, such as the US election, further affected market confidence at a global level.

As the number of cases spiked across the world in the first half of 2020 and governments scrambled to isolate cities and communities, the fund management industry in Singapore did not escape unscathed.  Even though the industry saw a flurry of activities around the Singapore variable capital company (“VCC”), fundraising activities in general slowed to a halt as investors  adopted a “wait-and-see” position whilst many fund managers, especially those who took control positions in their assets, were busy fighting fire at portfolio level.

On the finance side, loan volumes in Singapore and Asia generally declined.  Syndicated lending in the first nine months of 2020 hit an eight-year low.²  However, rather interestingly, lenders and investors in capital call facilities did not see a significant number of defaults in existing loans as a result of the pandemic.  The resilience can be attributed in part to the fact that in the market, a number of Singapore fund structures financed by banks tend to be those backed by large institutional investors.

With low default rates despite the onset of a credit crunch due to the pandemic, some stakeholders commented that this pandemic has re-emphasised the strength of capital call loan products.  This is likely to result in even more lenders taking an interest in such products going forward. 

However, it was generally observed that unlike other markets such as the US, there was not a material increase in pricing for capital call facilities in Singapore/Asia.  This is likely due to the competitive and largely borrower-led nature of the Singapore fund finance market

This chapter examines the current state of the fund formation and fund finance markets in Singapore, the key developments over the past year, and areas to watch in 2021.

Fund formation - the VCC

The Variable Capital Companies Act 2018 came into force on 14 January 2020, formally introducing the VCC into the Singapore funds landscape.  The VCC has been seen as a potential game-changer in the fund management industry and a re-domiciliation feature has been incorporated to facilitate existing foreign funds to switch to the VCC.  With the VCC, the Singapore government hopes to attract more funds to be domiciled and managed from Singapore, thereby creating more opportunities for the players in the funds ecosystem in the country and strengthening Singapore’s position as the Asian hub for fund domiciliation and management.

To encourage industry adoption of the VCC framework in Singapore, the Monetary Authority of Singapore (“MAS”) has launched the Variable Capital Companies Grant Scheme, which will help defray costs involved in incorporating or registering a VCC by co-funding up to 70% of eligible expenses paid to Singapore-based service providers for a period of up to three years. The grant is capped at S$150,000 for each application, with a maximum of three VCCs per fund manager.

Since its launch, the VCC has been well received by the funds community as evinced from the high adoption rate of over 160 VCCs being incorporated to date.  As expected, the VCC has found favour with fund managers operating differentinvestment strategies such as hedge funds, venture capital funds and private equity funds.  It has also drawn many wealth management players, keen to establish fund platforms for their high-net-worth clients, and family offices.

Key features of the Singapore VCC and its benefits as a funds vehicle:

• The Singapore VCC is incorporated under the Singapore VCC Act instead of the Companies Act.  This enables the Singapore VCC to function as a corporate structure tailored specifically for investment funds.
• A Singapore VCC will have the flexibility to issue and redeem shares without having to seek shareholders’ approval.
  
  • This allows investors to exit their investments in the investment fund when they wish to, and pay dividends using its capital.
  • This is in contrast to the company structure that has restrictions on capital reduction and can only pay dividends out of profits
• The Singapore VCC may be established as a standalone fund or as an umbrella fund with multiple sub-funds.
  • The umbrella with a sub-funds structure creates economies of scale.
  • Each sub-fund can share a common board of directors and use the same service providers, including the same fund manager, custodian, auditor and administrative agent.
• As a safeguard for Singapore VCC shareholders and to enhance creditor protection, the assets and liabilities of each sub-fund will be ring-fenced from other sub-funds.
• The Singapore VCC will allow for a wider scope of accounting standards to be used in preparing financial statements, which helps to serve the needs of global investors. Apart from Singapore accounting standards and recommended accounting principles, International Financial Reporting Standards (“IFRS”) and US Generally Accepted Accounting Principles (“US GAAP”) can be used by Singapore VCCs.

Fund finance

Snapshot of Singapore market and structures

As noted above, the fund finance market in Singapore remains largely borrower-led and relationship-driven. There also continues to be a prevalence of large, institutional investors in Singapore funds. Loans to Singapore funds are typically upward-looking, capital call facilities, and asset-based lending is less common. Capital call loans in Singapore have historically been bilateral. However, as more international lenders take an interest in lending to Singapore funds (due in part to the introduction of the VCC driving  fund formation activity), syndicated structures are appearing more often than they had previously. The majority of facilities remain denominated in US$, with interest rates linked to LIBOR – although this will necessarily change over the course of the next year.

Loan and security structures remain largely unchanged from previous years, and the usual Singapore law considerations continue to apply to fund finance transactions, as summarised below.

• Governing law: The governing law for Asian capital call facilities can vary and often depends on the identity and jurisdiction of the banks, funds and investors.  English law remains a popular choice for governing law in this region, as freedom of contract is widely regarded as a  key  principle  upheld  by  the  English  courts. The principle emphasises the importance of upholding the parties’ commercial bargain. However, there is also a growing number of new transactions that are opting for Singapore law as the governing law of the facility documents, and Singapore courts as the forum for dispute resolution – these transactions tend to involve Singapore funds with general partners and investment managers incorporated in Singapore, as well as Singapore or Asia-based lenders.
• Provision of security or guarantee to offshore lenders: Unlike more heavily regulated countries like China and India, there are fewer restrictions on offshore lending structures. Singapore companies are generally not restricted from providing security or guarantees in favour of foreign lenders.  However, legal considerations relating to financial assistance, interested party transactions, corporate benefit, priorities and procedures, and formalities relating to the granting of security and guarantee, generally apply.
• Formalities: As a general principle, under Singapore law a legal assignment must be in writing, signed by the assignor, absolute and notified in writing to any persons against whom the assignor could enforce the assigned rights.  If any of these formalities are not complied with, it is an equitable assignment.  An equitable assignment is less desirable from  an  assignee’s  perspective,  as  the  assignee  can  usually  only  bring  an  action against the contract counterparty in its own name if it has a legal assignment.  With an equitable assignment, the assignee will usually be required to join in proceedings with the assignor.  This may be problematic if the assignor is no longer available or interested in participating.
• Registration: In addition, a registrable charge created by a Singapore company has to be registered under section 131 of the Companies Act (cap 50, 2006 Rev Ed) with the Accounting and Corporate Regulatory Authority of Singapore (“ACRA”) within 30 days from the date the instrument of charge was created.  A registrable charge that is not registered within the time limit is void against the liquidator and other creditors of the company.
• Priority: Similar to other common law jurisdictions, the rules determining the priority of charges under Singapore law are fairly complex. As a general principle, the relevant time for determining priority between charges is the time of creation of the charges. A prior equitable charge will be defeated by a subsequent bona fid legal chargee for value who had no actual or constructive notice of the prior charge. With regard to an assignment over call rights, the priority of an assignment will generally follow the order in which an assignment is made. However, a subsequent assignee will have priority over a prior assignee, without notice of the prior assignment if the subsequent assignee is the first to give notice of their assignment to the counterparty.  It is therefore critical in an assignment over call rights to ensure that the notice of assignment is duly served on the relevant counterparty on creation of the assignment.
• Ipso facto: A more recent consideration for capital call facilities (and loans to Singapore entities  generally)  is  the  introduction  of  Singapore’s  “ipso facto”  legislation, which came into effect on 30 July 2020 (“IRDA”).³ Section 440 of the IRDA restricts a person from:
  • terminating or amending, or claiming an accelerated payment or forfeiture of the term under, any agreement (including a security agreement) with a company; or
  • terminating or modifying any right or obligation under any agreement (including a security agreement) with a company,
    
    

  by reason only that the proceedings are commenced or that the company is insolvent. The IRDA does set out exceptions to this general principle; however, notably, syndicated and bilateral loan agreements are not among those excluded. Since the IRDA came into effect, lenders have started to mitigate this risk by requiring new provisions to be contained in guarantees that give lenders the right to call on guarantees immediately upon the occurrence of any event described in section 440 of the IRDA in relation to the borrower.

Key developments in 2020

Green and sustainable learning

Green and sustainable lending continues to be a focus and a priority for the Singapore government, with further developments of the MAS’s green finance action plan being announced. Following the announcement of its US$2 billion green investments programme in November 2019,⁴ the MAS announced in November 2020 the launch of the world’s first grant scheme to support green and sustainability-linked loans, which will take effect in January 2021.⁵ The grant scheme is intended to facilitate access by borrowers to green and sustainable loans by covering expenses such as engaging external advisors to develop frameworks and targets, as well as to encourage banks to develop their own expertise in these areas.

The MAS grant scheme is predicted to drive further growth in the green and sustainable lending space across loan markets generally. While green loans have not historically been associated with fund finance, this has become an area of interest for lenders and borrowers alike since ING Bank announced that it had introduced the world’s first “sustainability improvement fund financing” for a Singapore-based private equity fund, Quadria Capital, in October 2019. The new Singapore incentives are likely to make green and sustainable structures an even more attractive option for both lenders and borrowers in the competitive fund finance market.

Shifts in market practice

As distinct from many other forms of corporate loans, the due diligence process is crucial in fund finance transactions. As lenders’ security is often based solely on the contractual rights of the general partner and the obligations of the investors to meet capital calls under the Limited Partnership Agreement and other fund documents, lenders need to review the fund documents in careful detail. 

This is of particular importance for the increased number of international lenders who are now entering the Singapore fund finance market as a result of more funds being domiciled in Singapore and Asia. Lenders should note that there are deviations between provisions that such lenders might expect in a Limited Partnership Agreement or a Facility Agreement in the US or Europe, and what is typical for funds in Singapore or Asia generally. For example, while it is usual practice in the US and Europe for Investor Letters to be provided to cover certain risks or gaps identified by a lender in a Limited Partnership Agreement or Side Letter, these tend to be strongly resisted in the Singapore and Asia markets. It is important to involve lawyers at an early stage to flag these key issues before term sheets and financing documentation are finalised.

Another area of focus from lenders has been the issue of sovereign immunity of investors. The prevalence of large, institutional government-linked investors in Singapore domiciled funds has meant that sovereign immunity is an issue that is commonly raised as part of the due diligence and documentation process, particularly as fund documentation often does not contain a waiver of such immunity by investors. 

The approach of  lenders in other  markets in such circumstances would typically be to obtain a waiver (either express or implied) of such sovereign immunity, or failing that, a commercial acknowledgment from the relevant investor that despite its right to claim sovereign immunity, this will not limit the relevant investor’s obligation to meet capital calls under the fund documents.  However, given the relative difficult in obtaining Investor Letters noted above, transactions in Asia may need to involve a more detailed analysis into when a particular investor might be entitled to claim sovereign immunity, whether this poses a risk to the lenders and alternative ways to mitigate that risk.  Such analysis would depend on the jurisdiction of the investor itself, as well as the jurisdiction of the fund; however, in some jurisdictions (such as Singapore), even entities that are entitled to sovereign immunity may not be entitled to claim such immunity for private and commercial acts.

The year ahead

As many have come to appreciate in 2020 more than ever before, it is difficult to predict what the future may hold.  The political, health and financial stability of influential nations across the globe is no longer a constant that can be relied on.  However, although we are not out of the woods yet, the world is in a better place today than six months ago as people understand the virus better, and success of early trials of the vaccines has also given the world a shot in the arm.  Fundraising activities have slowly resumed and there is more optimism in the Singapore fund management industry that 2021 will see a stronger recovery.  Interesting developments to look out for will be:

• VCC: the positive reception of the Singapore VCC in 2020 bodes well for the VCC regime in seeking to strengthen Singapore’s position as the Asian hub for fund domiciliation and management and enhancing its international competitiveness.  Even then, the MAS has already commenced work to fine-tune the regime, which will likely see the introduction of VCC 2.0 in about one or two years’ time.
• ESG stimulus: The MAS stimulus package for green and sustainable loans, combined with more detailed guidelines on green and sustainable lending, is expected to result in a further increase in green and sustainable loans for the finance market generally, including capital call facilities.  This is likely to result in an increased focus by lenders on the details of the investments made by the funds to which they are lending, both when the loan is asset-based or when it is an upwards-looking capital call structure.
• Market practice: Due to the growing interest from international lenders in lending to Singapore funds, it will be interesting to see whether the market practice in Singapore, and Asia more generally, starts to move closer towards the European and US market norms, or alternatively how lenders decide to react to and address risks that are unique to the Singapore and Asia market.
• Phasing out of IBOR rates: At the time of writing this chapter, there is not yet a settled market approach or drafting recommended by the Asia Pacific Loan Market Association to reflect substitute risk-free rates for Singapore dollars (although exposure drafts of US$ Facility Agreements have been published and are under discussion).  Despite this, lenders in Singapore will need to stop documenting IBOR-linked loans that will mature past the end of 2021, as soon as possible in the coming year.  The Singapore loan market, including the fund finance market, is likely to see substantial activity in 2021 as existing facilities are amended and terms of new facilities are adjusted to reflect the new market standards.

1.  “Economic Survey of Singapore, Third Quarter 2020”, Ministry of Trade and Industry Singapore, November 2020, https://www.mti.gov.sg/-/media/MTI/Resources/Economic-Survey-of-Singapore/2020/Economic-Survey-of-Singapore-Third-Quarter-2020/FullReport_3Q20.pdf.
2.  “1-3Q  2020  Review:  Asia  Pacific Syndicated  Loan  Volume  Drops 15% to US$298.2bln”, Refiniti, 30 September 2020.
3.  Insolvency, Restructuring and Dissolution Act (No. 40 of 2018) of Singapore, section 440. 
4.  https://www.mas.gov.sg/news/media-releases/2019/new-us$2-billion-investments-programme-to-support-growth-of-green-finance-in-singapore
5.  https://www.mas.gov.sg/news/media-releases/2020/mas-launches-worlds-first-grant-scheme-to-support-green-and-sustainability-linked-loans.