April 12. 2023

Subscription Finance: Alternative Currency Capital Commitments


Executive Summary

It has become increasingly common for private equity funds to accept capital commitments in multiple currencies within the same fund (or group of parallel funds), but having capital commitments denominated in multiple currencies included in a subscription credit facility (“Facility”) borrowing base creates unique structural issues related to foreign exchange risk. In this Legal Update, we provide an overview of how lenders can mitigate these potential risks.


When Facility obligations and the underlying borrowing base/collateral are denominated in the same currency, there is no risk that fluctuations in currency exchange rates could create a shortfall between the uncalled capital commitments and the Facility obligations. However, when loans are advanced in one currency (such as US dollars), but the obligations are secured by uncalled capital commitments denominated in another currency (such as euros), Facility lenders face foreign currency exchange rate (“FX”) risk. If the exchange rate has fluctuated unfavorably when it comes time for repayment and a capital call is made on the investors, the uncalled capital commitments securing repayment of the Facility obligations may be insufficient even though the uncalled capital commitments are fully called and funded.

The fund finance market has generally addressed this concern by requiring foreign currency borrowings to be measured against the borrowing base on a US dollar-equivalent basis, including on regular revaluation dates, and to maintain an FX reserve that further reduces the borrowing base to protect against intra-revaluation date movements.

Although the standard market approach addresses FX borrowings, some lenders have struggled with how to address the FX risk when a private equity fund’s capital commitments are denominated in multiple currencies. In these situations, FX fluctuations may benefit or harm the Facility lenders depending on the constantly changing ratio of capital commitments and outstanding Facility obligations in each relevant currency and on the exchange rates between these currencies.

What Lenders Need to Know About How to Mitigate Foreign Currency Exchange Rate Risks

This FX risk can be mitigated in a few different ways.

Excluding Investors

The most straightforward approach from a documentation standpoint is to simply exclude investors with capital commitments denominated in an alternative currency from the borrowing base, but that approach may be too restrictive on the borrowing base in many cases. Accordingly, this approach is usually used when the alternative currency capital commitments would already be excluded from the borrowing base or the additional borrowing base benefit received is not needed or not worth the complexity of using a more nuanced approach.

Applying a Haircut

An alternative approach used by many lenders is to simply apply a haircut to the alternative currency capital commitments via an FX haircut (much like the traditional FX reserve used for borrowings). While this approach provides borrowing base credit and is relatively straightforward from a documentation perspective, it can also be overly limiting as the FX reserve and the FX haircut will result in double counting. For example, in a US dollar-denominated facility that has both US dollar and euro borrowings and capital commitments, the borrowing base would be reduced for the FX reserve associated with the euro borrowings (which is based off the premise that the collateral is all denominated entirely in US dollars) and would be further reduced by the FX haircut for the euro capital commitments.


To address the double counting concerns associated with applying an FX haircut, in certain circumstances facilities are structured via a cross-netting approach. Under this approach, the borrowing base reduction factors in that FX risk for borrowings is offset by capital commitments in the same currency. There are a few variations on how the cross-netting formula works. Most of these variations address how the cross-netting takes into account applicable advance rates and concentration limits, such as whether the formula is currency specific and whether it is based on the aggregate effective advance rate or determined on an investor-by-investor basis applying the specific advance rate and concentration limits with respect to each investor. While the cross-netting approach can be useful, the calculations and reporting requirements associated with it are more burdensome than other approaches. For this reason, the cross-netting approach is usually only used when there is an expectation that there will be significant amounts of both alternative currency capital commitments and borrowings in that currency.

Going Forward

As more private equity funds are open to accepting alternative currency capital commitments, lenders should be well versed on ways to address the FX risk without being overly punitive. The approach chosen, however, should reflect the operational realities and needs of the specific private equity fund(s) considering the complexity of addressing the issue can result in the need for more operational resources and increased compliance risk.

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