There is correspondingly less commentary on the inevitable corollary: the end. What we call the beginning is often the end. And to make an end is to make a beginning (T.S. Eliot).
Funds come to an end for a multitude of reasons. On one hand, underperformance, fixed termination dates or illiquidity may necessitate closure. On the other, more ominous factors can be at play such as a market collapse, adverse litigation, regulatory action, perhaps fraud.
This article approaches fund closure primarily from a solvent wind down perspective with thoughts on insolvent situations.
Wind down
Investment managers focus on how to generate returns for investors, while steering their fund through an increasingly complex regulatory and compliance landscape. When it’s time to wind down, managers and fiduciaries face an array of challenges. Foresight and planning are crucial to preserve investors’ capital and ensure a smooth closure process.
How then does a fund begin to wind down?
Planning
After the decision is reached to close a fund, the manager and/or directors will devise a detailed wind down plan with input from all main departments including investment management, investor relations, tax and legal. This plan will define key staff required during the wind down process, risks (with a corresponding mitigation strategy) and timeline.
Often, a fund will turn to a professional adviser/specialist wind down manager or liquidator to handle the final stages of a wind down, which allows for the effective transition of all core streamlined fund operations away from the incumbent manager together with certain supporting functions such as tax and fund accounting.
After consultation, and considering the fund’s constitutional and governing documents, the wind down plan will culminate in step-by-step milestones to see the fund ready for formal closure.
Operations
An assessment will be made of the fund and its operations, with a particular focus on how best to return capital to investors, while maximising value and minimising costs. A vital aspect of effective fund management in a wind down is the ability to control costs by establishing the “must have” versus the “nice to have” for the fund. Dated legacy functionalities across IT and third party service providers should be evaluated based on the new needs of the fund with new, pragmatic, cost-conscious fee structures determined.
Institutional knowledge
Retention of key staff is often difficult as well as costly. Ahead of any departures, data, including the detail of operational processes, must be safeguarded. Compliance and procedure manuals, investor information, valuation models, NAV breakdowns, cash summaries and tax related data are integral to a wind down, especially if engaging a wind down manager or liquidator.
Management of assets
In order to aid an orderly wind down, most investment managers, in conjunction with the fund’s board of directors, will suspend subscriptions and redemptions and then make compulsory redemptions to investors. These actions will prevent a rush of redemptions and mitigate liquidity challenges which, if not properly managed, can cause solvency risks.
Coordinating with investors
Investors are at the heart of every fund and effectively communicating with and managing investors’ expectations is a priority. The timeline for a wind down and final distributions will be impacted by the nature and complexity of a fund’s portfolio. Timing should be clearly communicated to investors who will be eager to know when they will receive their final distributions, statements and tax documentation.
Other aspects
During planning, sufficient time should be allocated to attend to the final audit, tax return, and resolution of any outstanding issues including regulatory and compliance matters. Additionally, all contracts with third party service providers are reviewed to identify appropriate termination procedures. Throughout the wind down, a fund must keep up with its regulatory, compliance, KYC and AML requirements whilst adhering to local and international regulations.
Performing the wind down
This will focus on achieving the wind down plan, realising liquid and illiquid assets and winding down the fund’s operations. In funds with highly fragmented investor populations, and depending on the wind down time horizon, there is likely a significant range of appetites for near term liquidity versus hold to maturity.
Liquid assets
Liquid positions are by their nature relatively easy to close out. However, consideration should be given to any particularly large holdings and market sensitivities with thinly traded equities to avoid adverse price movement. A common value maximisation strategy is to sell positions in tranches over a number of weeks.
Illiquid assets
Illiquid assets are more challenging, particularly where there are litigious matters or insolvent investments, which can cause an extended wind down period.
Liaising with the managers of funds holding illiquid assets to understand timescales involved and the barriers to monetising investments will yield useful information that informs the wind down strategy. To control costs, legal, tax and accounting fees associated with illiquid investments require timely oversight.
To avoid a protracted wind down, a manager might explore selling illiquid assets on the secondary market. This will be at a discount and there is balance to be struck between ongoing costs, realisable value and holding risk.
Specialist wind down managers offer liquidity auctions with price discovery, a process that commences with collating volume and pricing expectation of the vendor group. This is then offered to qualified bidders through a competitive bid process. Ultimately, the successful bidder(s) will be those offering to acquire the most volume at the highest price point. Importantly, all vendors who have offered their positions at this price or less will receive the same prices; that is, the price of the winning bid.
As the underlying investments are realised, capital is returned to investors. Liabilities of the fund are discharged, final investor statements distributed, counterparty contracts terminated, and necessary tax and accounting matters settled.
Formal closure
In the final stage, the fund will be formally wound down within the applicable legal and regulatory framework. For certain funds, this will involve deregistration, the cancellation or revocation of regulatory licences and a solvent liquidation process that concludes with the fund’s dissolution.
Insolvency
When a fund is insolvent, for example, an inability to pay redeemed creditors, counterparty obligations or margin calls in leveraged situations, a formal insolvency process is necessary.
Briefly, for US onshore funds, a Chapter 7 bankruptcy entails the appointment of a bankruptcy trustee who liquidates the debtor’s assets and pays creditors in accordance with the provisions of the US Bankruptcy Code. Alternatively, a Chapter 11 reorganisation provides a restructuring solution with oversight from the court or bankruptcy trustee by facilitating an adjustment of debts, by reduction, extension of time or through a more comprehensive renegotiation.
Offshore funds, colloquially those incorporated in Cayman, the BVI or Bermuda, broadly follow a similar insolvency regime based on English common law. A court appointed liquidator will realise assets, pay creditors in accordance with the prescribed priority and investigate the activities of the fund to maximise asset realisations for the benefit of creditors.
In any jurisdiction, insolvency processes may take years, this especially applies in litigious or contentious scenarios. Investors are likely to receive distributions at substantial discounts to NAV. It is recommended for fund stakeholders to seek legal and professional advice in such cases to seek to protect their position insofar as is possible.
The author is the managing director of PricewaterhouseCoopers (BVI) Limited and a Licensed Insolvency Practitioner in the British Virgin Islands. He regularly winds down funds in both solvent and insolvent situations acting as court appointed liquidator where necessary.
