State of Treasury Management 2024 for Private Markets

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We now sit seven quarters removed from when the U.S. Federal Reserve and other central banks began raising interest rates to combat inflation, and it has become clear that “higher for longer” is now the expectation and assumption for the foreseeable future among the investment management industry.

And while the Fed’s rate hikes were on everyone’s mind in 2023, the regional bank crisis in March and April shook financial sponsors especially hard, given SVB and FRB’s heavy focus serving private capital markets.

Economic headwinds and the regional banking crisis took their toll as fundraising across the board slowed down significantly. Although PEI found that average PE exposure reached 10.41% last year (up over 4% over 5 years and almost a full percentage point from the year prior), according to PERE, only $92.8 billion was raised across 139 funds in Q1-Q3 2023, which is on track to close with the industry’s lowest total since 2012.

Exits appear to be recovering at a slow pace. And the collective outlook from the industry appears cautious at best. According to data from EY’s Private Equity Pulse for Q3 2023, “exit markets have shown similar signs of recovery in recent months, albeit at a slightly slower pace than acquisitions. In the third quarter of this year, PE firms announced 68 exits via M&A, up from 47 in the first quarter of the year, and up from 57 in Q2.” Surveyed PE professionals in the report were split evenly on the near-term outlook for exits in terms of seeing an increase or decrease in the year ahead.

In the wake of these conditions, growing interest in private credit will continue to garner headlines in 2024. Despite financial behemoths in the private market world making big bets on private credit fund launches last year, overall debt fund fundraising in 2023 came in at the lowest totals since 2016, according to data from Private Debt Investor, indicating that while there’s a lot of hype, we’re still early in the trend with a lot of room for optimism. For example, BlackRock is forecasting private credit to grow to a $3.5 trillion market in the next five years.

Impact on Treasury and Operations

Higher interest rates, a slowdown in fundraising, and a recovering exit landscape are putting pressure on private equity COOs and CFOs who are having to cope with increased complexity across credit facilities, debt obligations, and an expanding and diversifying LP base. A renewed focus on liquidity strategies has amped up the need for creative but risk-controlled financing solutions.

These factors are pushing many fund sponsors to focus on putting best practices into place in the back office of their finance departments. Many firms are coming to the realization that they need to be more buttoned up when it comes to their financial operations, and their treasury and liquidity management functions, in particular.

At the core of this initiative is an intense focus on planning ahead for immediate-, medium-, and long-term cash requirements. Firms are considering implementing strategies such as cash laddering/cash segmentation to balance yield, liquidity, and risk. Additional considerations include scrutiny on where to park idle cash, whether that be with a bank or swept into various types of money market funds.

Spotlight: Bank management and the importance of "Just in Time" liquidity

In the wake of SVB and the regional banking crisis, the norm has shifted in terms of how private fund managers approach their banking relationships. Whereas in the past, a firm may have only had one banking relationship, it’s now common to use 3-4 banks, adding more complexity to manage when it comes.

Regardless of a fund’s strategy or expected outcome, practices that improve transparency and give a real-time view of cash, credit rates and availability, and investor capital are being sought by private fund managers. It is amid this difficult climate that the notion of “just-in-time” liquidity is more relevant for private equity funds.

As part of this effort, they are looking to better manage cash flows to avoid unnecessary idle cash balances. In examples we’ve seen across the industry, fund managers have swept excess cash directly into a money market fund or account.

Jonathan Spirgel, Managing Director of Cash & Liquidity at Hazeltree, summed up this point in a November 2023 article in Treasury Management International:

“Good treasury management, irrespective of industry, means understanding where your sources are, and the use being made of the cash at a moment’s notice…at Hazeltree, we’ve had many clients recently saying they want two banks for every account for every legal entity.”

Spotlight: Middle market firms seek more sophistication and best practices

The largest fund sponsors tend to be more complex and have embraced the formalization of many aspects of their operations. However, what we’re seeing now is that middle-market firms and even many of the smaller shops are becoming more like their upmarket counterparts from a middle- and back-office perspective, with large-scale operations and expanding investor networks.

There are a number of forces that are contributing to this evolution among middle- and small-market firms. The regional banking crisis, for example, pushed many to diversify banking relationships, which by default added operational complexity.

When dealing with the data of an individual bank, it is possible to manage it effectively. However, funds face a connectivity challenge because many banks have not invested in improving their data connectivity ecosystem for clients. As a result, you have to rely on email statements and manually send wires through a bank portal, while also keeping track of everything on your own spreadsheets. On top of this, agreements are often in PDF format, and there is other unstructured data to deal with. This process is inefficient and risky because multiple banks mean multiple logins to portals, and multiple Excel downloads.

In addition, LPs continue to demand more transparency from their GPs, regardless of what size they are. And regulators are in their corner as evidenced by the SEC’s private fund rule that was finalized in August 2023.

For these firms to manage this increase in operational complexity, technology is taking on a more important role for shops that already run lean.

Typically, middle-market firms have the majority of their workforce focused on fundraising and investor relations, whereby they might not have as many FTEs dedicated to the treasury function. At a point in the maturation process, there comes a realization that Outlook and spreadsheets can only get you so far.

When a firm decides to diversify its banking relationships, it can be challenging to manage multiple counterparties with different processes and data formats. This can lead to inefficiencies and increase the risk of errors. To mitigate these risks, it's essential to have a technology solution in place that can normalize data and manage subline facilities efficiently. This will ensure that the firm can continue to operate smoothly and reduce the likelihood of human error.

What We Expect in 2024

Economic outlook

The expectation is for interest rates to remain at current levels for the next two to three quarters, with potential rate cuts coming at the end of 2024. However, even if the Fed does cut rates, those cuts will likely be minimal. The impact of the presidential election in the U.S. cannot be forgotten in this, as well. Wall Street appears to be divided in terms of how aggressive cost-cutting will be.

Industry trends

Democratization of access to private markets contributes to the increasing complexity of managing LPs and, therefore, liquidity.

In the wake of SVB and the regional banking crisis, the norm has shifted in terms of how private fund managers approach their banking relationships. Whereas in the past, a firm may have only had one banking relationship, it’s now common to use 3-4 banks, adding more complexity to manage when it comes.

A sign of this is the expected growth of secondary markets. While secondary offerings provide liquidity and exit strategies for investors, it also adds a whole new level of complexity for PE firms in managing LPs as they shift in and out of funds. Secondary funds have raised more capital in Q1-Q3 2023 than in any other similar period to date, according to data from Secondaries Investor. According to Hamilton Lane, the secondaries market has grown from $20 billion in 2008 to more than $100 Billion in 2022.

The explosion in private credit is another trend we expect to continue into 2024 and beyond as banks maintain tighter lending standards. Eventually, we could easily see a world in which this trend gives way to a maturation of the loan-matching marketplace, whereby loan agents match private credit borrowers with fund lenders. This is an emerging trend that will no doubt require technology to ensure the health of the marketplace as it scales.

Regulatory reform and fallout from the SEC’s private funds rule is also an area we will be keeping a close eye on. With the rule only recently adopted in August 2023, the SEC is already seeing pushback in the courts. We will be watching to see how litigation plays out. Still, the impact of the regulation permeates throughout all departments of a firm in one way or another, with finance and operations at the forefront from a reporting and auditing standpoint. Yet another nudge for firms to get the back offices in order.

Where Hazeltree is investing

In 2024, we’re focused on investing in our platform on a number of fronts to serve our clients better.

One area we’re particularly excited about is formalizing capital account management over the lifetime of a fund, with a focus on simplifying complexities related to liquidity. This includes adding new workflow tools to set up and manage individual calls, for example.

Another area of note is adding capabilities/functionality to our flagship debt capabilities, including the rollout of a new “Debt Wizard” for creating requisite transactions like drawdowns, interest, and fees. In addition, we’re actively working on delivering new capabilities to enable the ability to estimate the borrow base on a subscription line of credit.