US Fund Managers: How To Accommodate EUR Commitments To Your USD Fund – New York Office Snippet

We increasingly encounter questions from US fund managers (USFM) about accommodating EUR commitments to their USD-denominated funds. Such EUR commitments often arise in the context of commitments to a Luxembourg SCSp (the Fund) with a US oriented investment strategy. The SCSp is the default fund vehicle used by USFMs to access the EU investor market. EUR commitments are usually driven by EUR-denominated allocation limits to which EU based investors may be subject.

To accommodate such EUR commitments, the USFM can offer a separate EUR feeder or currency-specific classes of interests in the Fund. In both of those options, the Fund bears the currency exchange (FX) risk in the sense that it does not have predictability of the total drawdown cash to be received in USD from the EUR investors due to fluctuation of the EUR/USD FX rate between the date of the EUR commitments and the drawdowns. The Fund can hedge that FX risk, which comes at a cost that is borne by the Fund and is usually allocated to the EUR investors. Both solutions entail additional structuring and operational costs and are therefore only economically viable above a certain threshold, which is often not met.

An alternative means of accommodating investors who prefer committing in EUR is to permit EUR-denominated commitments directly to the Fund (without creating currency-specific classes of interests in the Fund). The aggregate EUR commitment amount is converted into USD based on the FX rate on the commitment date (the USD Shadow Commitment) and the proportionate drawdowns of the (USD and EUR) investors is determined based on the USD Shadow Commitment. This prevents fluctuations in the drawdown proportions due to movements in the FX rate.

The Fund then calls capital from all investors in proportion to their remaining USD (Shadow) Commitments. The resulting amount is then drawn in EUR and converted into USD at Fund level.

If the USD strengthens against the EUR (more EUR needed to fund the USD Shadow Commitment), the aggregate EUR amount required to meet the Fund’s USD cash needs may exceed the EUR commitment. The EUR investors are normally excused for the excess in such a situation and the Fund’s firepower is then less than the USD Shadow Commitment amount. To mitigate this risk, EUR investors and the Fund may agree in a side letter to increase their EUR commitments by a buffer amount if such situation arises. The buffer is typically calculated as a percentage of the EUR commitments or of distributions already made by the Fund when the buffer kicks in. If the USD weakens against the EUR these concerns obviously do not arise.