Bringing transparency to waterfall calculations

For limited partners, administrator waterfall verification services deliver assurance and transparency – which in turn benefits managers, too

As capital flows into private equity, private debt and real estate funds, investors are continuing to ask for more transparency. While this trend places an additional burden on investment managers, the calls by institutional limited partners (LPs) for improved disclosure into fees, expenses and waterfall calculations presents a new opportunity for fund administrators, which have previously focused primarily on the needs of investment managers or general partners (GP).

GPs and LPs turn to verification

New regulations open the door for fresh partnerships between LPs and third-party administrators, specifically through waterfall verification and recalculation services. 

Under a waterfall verification/recalculation service model, a GP that does not outsource its accounting and reporting functions would engage an administrator either to independently verify or recalculate its waterfall calculations (ensuring that the methodology and results align with the fund’s governing documents). The verification model is also possible when an LP appoints an administrator to provide waterfall verification/recalculation services across its portfolio of investments. 

Partnering with an administrator benefits both the GP and its LP clients. From the LP’s perspective, this provides assurance that carried interest is being computed accurately and in line with partnership agreements, and also provides the transparency necessary for LPs to comply with rules and regulations. 

From the GP’s perspective, leveraging the administrator’s technology and expertise reduces the risk of miscalculating carried interest. Furthermore, independent review and verification provides comfort to their LP clients, reducing investor queries and the need to expand the GP’s administration function.

While LPs will almost certainly drive demand for waterfall services, they will only succeed if GPs willingly play their part. Unlike a traditional full administration offering in which the administrator verifies the waterfall calculation’s inputs, a bespoke verification/recalculation model largely requires the investment manager to take responsibility for providing all relevant inputs. 

Administrators can play a further role in the standardisation of these inputs (including, but not limited to, standardised data templates, standardised output reporting and possible integration with external GP accounting platforms), allowing the whole process to become scalable across an LP’s portfolio, while also giving the GP consistency in terms of data requests and requirements. 

Citco looks to develop best practice

As LPs increasingly demand waterfall verification services (and other verification services, such as management fee and NAV verification), we believe that both GPs and fund administrators would benefit from understanding what constitutes best practice. We also think that independent waterfall verification and recalculation will become an important tool for LPs, and have clear ideas about how it can be both robust and practicable.

22nd February 2018