Q&A: JCRA’s Benoit de Bénazé

Oscar Geen: Risk management is not a concept that is traditionally associated with private equity, but as the asset class matures, we have heard the term used more frequently. Have you noticed an increase in business from private equity firms and what specific areas do you help them with?

Benoit de Bénazé: Yes, we have definitely seen an increase in business from private equity firms in recent years. A lot of people associate risk management advisers with the larger end of the market, but we have been advising an increasing number of mid-market investors as well. Fund-level hedging in particular is becoming increasingly popular due to GPs investing in currencies other than the fund currency. We see the same trend at the individual asset level if it is an international business – or one with ambitions to grow in that direction.

OG: It must be quite expensive for private equity firms in the lower mid-market. How do they justify that expense?

BdB: Often they will appoint us as an adviser quite early on in the due diligence process. They might not end up actually hedging, but they want to know what the risk is and how expensive it would be to insure against it. That way they can tell their LPs that they have carried out a sufficient amount of due diligence and made an informed decision.

OG: If they do decide to go ahead and hedge, what are the different solutions you would recommend?

BdB: At fund level, deal-contingent hedging is the preferred solution to cover any risk from signing to closing. There is less consensus on hedging the FX risk of the equity during the hold period. At the level of the individual asset, the most basic thing you can do is to analyse the revenues of the business and make sure they are offset by debt to the degree possible. For example, a business such as Acuris has revenues in sterling, euros, dollars etc. and we would look to match that in the debt package, to act as a type of natural hedge. Then we can also advise on the hedging instruments banks offer to mitigate the risk. We are not a bank so the advice is independent and we have the freedom to shop around to ensure our clients get the best price.

OG: At individual asset level, how difficult is it to get accurate information and what happens if it changes?

BdB: We were recently contacted by a firm that we had worked with a couple of months earlier. After the transaction completed, we were able to take a closer look and it turned out that much of the key information we had been given about the asset’s currency exposure was incorrect. The management team overlooked the company structure and some intra-group transactions were reported incorrectly. Obviously, we are reliant on the information that the client provides. In this case, though, it meant that the currency mix of the debt they had put in place did not match the revenues. But we were able to take another look, offer a new assessment of their exposures, and advise on the best options to mitigate the risk going forward.

OG: When hedging with derivatives, how would this be financed? Are LPs happy for that kind of investment to be drawn from the fund?

BdB: It depends on the instrument and the level at which it is being used. At individual asset level, CFOs/treasurers are often very conscious of currency risk and may take hedging measures themselves. Here, the costs would be borne by the company. At portfolio level, there is no consensus. Particularly where the hedge is for a short period of time and against a specific risk, it would be more likely that they would use a capital call facility than notify their LPs and draw down from the fund. The hedging activity of dollar funds with sterling and euro assets is high at the moment, as hedging improves IRR in the current market.

OG: When you say a short time, do you mean GPs could insure against currency fluctuation in the aftermath of a big event such as Brexit for example?

BdB: Yes, exactly. And many have, to some extent. But it is important to be aware that this can be very expensive. In general, LPs in a fund that has UK exposure will be aware of this risk and may be comfortable with it due to diversification elsewhere in their portfolio. Even in this case, though, it is vital for the private equity fund to be able to quantify this risk before investing. That due diligence work has been a big part of the increase in business we have seen as a result of Brexit.

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