A subscription credit facility, also frequently referred to as a capital call facility (a  “Subscription Facility”), is a loan made by a bank or other credit institution (a “Lender”) to a  private equity fund (a “Fund”).1 What distinguishes a Subscription Facility from other secured  lending arrangements is the collateral package, which is comprised not of the underlying investment  assets of the Fund but, instead, of the unfunded capital commitments (“Capital Commitments”) of the  limited partners of the Fund (the “Investors”) to make capital contributions (“Capital  Contributions”) when called from time to time by the Fund’s general partner (the “General Partner”).

As the Subscription Facility market continues to grow and mature,2 Lenders willing to include the widest range of Investors within the borrowing  availability (the “Borrowing Base”) may enjoy a competitive advantage against Lenders that have a  relatively more narrow set of Investors they will advance against, all things being equal. One way to potentially expand the borrowing capacity under  a Subscription Facility is for a Lender to  advance against more of the governmental Investors in the Fund and, in particular, governmental  Investors that are public retirement systems (each a “System”).3

Historically, full Borrowing Base credit (typically a 90% advance rate) is given to Investors that  are Systems with (a) a senior unsecured debt rating  (or its equivalent) of BBB+ or better by  Standard & Poor’s Financial Services LLC or Baa1 or better by Moody’s Investors Service, Inc., and (b) a minimum funding ratio4 above a specified threshold  (typically 90% if the Investor’s rating is BBB+/Baa1 (or equivalent) and no minimum for Investors  with higher credit ratings). These rating and funding ratio criteria are often referred to as the “Applicable Requirement” in a Subscription Facility.  Where it can be established that a state, county, municipality or other governmental subdivision is  ultimately responsible for the obligations of a System, a Lender can reasonably look past the  System’s own credit profile and, instead, to the credit rating and quality of the responsible  governmental entity in determin- ing if the Applicable Requirement has been satisfied, or whether the System Investor otherwise merits inclusion in the Borrowing Base, perhaps  at a lower advance rate (typically 60–65% of the unfunded Capital Commitment). Thus, establishing a  credit linkage between a System and a creditwor- thy responsible governmental entity may provide a  way for a Lender to get comfortable advancing against the unfunded Capital Commitment of a System  Investor that would otherwise not satisfy the Applicable Requirement on its own. Below we outline a  few alternate approaches and factors that a Lender may use to assess whether an adequate credit linkage exists between a System and a responsible governmental entity.

Overview of Public Retirement Systems

Systems are created and administered under the laws of a  state (the “Plan Sponsor”) to provide pension and other retirement benefits to employees of governmental units such as states, cities and counties. Systems typically hold substantial reserves available for investment in a diverse array of financial products and often rely on  significant investment returns to supplement the participating employee and employer contributions  used to fund retirement benefits for the System’s participants.

A System can be organized to provide benefits for employees of a single governmental unit or  employ- ees of multiple governmental units. A single-employer system is a System that provides  benefits for employees of only one governmental entity, often the Plan Sponsor. Some common  examples of a single-employer System are those that provide benefits to retired state judges or  state legislators. In such a System, the relevant state would be the only employer of the  individuals covered by the System. A multi-employer system is a System that covers the employees of  more than one governmen- tal entity.5 An example of a multi-employer System is a System that  provides retirement benefits to a state’s public safety personnel. Such a System may cover  employees of many different governmental entities, such as state university police departments,  county sheriffs’ departments and city fire departments.

The retirement benefits offered by a System may be structured in a variety of ways. Here, we will  focus on Systems that are organized as defined-benefits Systems, where the employees covered by the  System will contribute a statutorily determined percentage of their income during the term of their  employment in return for a defined level of benefits during their retirement. Many states have  constitu- tional protections safeguarding the pension benefits accrued by public employees during their careers.6 These constitutional provisions can prevent Plan Sponsors from reducing the level of benefits promised to public workers, causing Plan Sponsors to focus on ways to increase the  System’s assets rather than reduce pension liabilities to ensure the financial health of the  System.

Credit Linkage to Plan Sponsors

By demonstrating that a creditworthy governmental entity is ultimately responsible for the funding  obligations of a System, a credit linkage analysis provides valuable underwriting information and  may facilitate inclusion of a System in the Borrowing Base. Because the statutory regimes used to  govern Systems are varied and often complex, a credit linkage review calls for a thorough analysis  by counsel of multiple sources of state and local law, including state constitutions, statutes,  ordinances and case law, as well as statements and financial reports issued by both the Plan  Sponsor and the System. There are a number of ways that a Lender can attempt to link the credit  rating of a System  and its Plan Sponsor, some of which are quite direct while others are more  attenuated. It is important to note, however, that the degree of connectivity between a System and  its Plan Sponsor required to establish a sufficient credit linkage to permit inclusion of a System  Investor’s unfunded Capital Commitments in the Borrowing Base will differ based on the preferences  of the relevant Lender. We will focus on two of the more popular methods used to dem- onstrate such a credit link in more detail below.


Perhaps the most straightforward way to establish a credit linkage is to research and locate a  source of law that expressly provides that the Plan Sponsor is responsible for the liabilities of  the System. In the best case scenario, such a law would expressly designate all of the System’s  liabilities as direct obligations of the Plan Sponsor. In such a situation, a Lender can take  comfort that the rated Plan Sponsor is ultimately responsible for funding the investment-related obligations of the System. The laws in this area, however, are seldom so clear, and a careful legal analysis will need to be  undertaken to assess the extent to which the Plan Sponsor actually assumes the System’s  liabilities. For example, the laws may provide that the Plan Sponsor assumes operational and  administrative liabilities of the System but be silent as to investment liabilities or benefit  obligations. This type of limited assumption of liability would likely not include the assumption of the System’s obligation to fund Capital  Contributions to a Fund. Thus, a Lender may not be comfortable advancing against a System Investor  in reliance on such a limited assumption of liability and may need to undertake a different  analysis to establish whether an adequate credit link exists to include such an Investor in the  Borrowing Base.


When clear statutory or case law evidence does not exist to establish credit linkage, another  method that can be used involves conducting an analysis of the sources of the System’s assets to  ascertain the extent to which the Plan Sponsor is responsible for providing funds to the System  vis-à-vis other participating employers. If the System primarily receives its fund- ing (i.e., its  assets) from the Plan Sponsor, it may be reasonable for a Lender to consider the credit worthi-  ness of the Plan Sponsor as a primary factor in deciding whether or not it will advance against a  System Investor. The purpose of this funding analysis is to determine the percentage of a System’s  assets that is coming from the Plan Sponsor in relation to other sources, thus illustrating for  each entity its level of responsibility for funding a System’s liabilities.

A System is often funded primarily by the three following sources: (i) employee contributions  deducted from each participating employee’s salary, (ii) employer contributions required to be made under the law and (iii) investment gains earned  through investment of the System’s reserves.7 According to data gathered in 2010 by the US Census Bureau, from 1995–2010, 68 percent of public pension fund receipts came from investment earnings, 11 percent came from employee contribu-  tions and about 21 percent came from employer contributions.8 Employer contributions are the only  System assets that are funded directly from the coffers of Plan Sponsors; as such, the key task in  conducting a funding responsibility analysis is to review applicable laws to determine the required  annual employer contributions for each participat- ing employer.

Once the amount each participating employer is required to contribute annually to a System has been  determined, the next step in a funding analy- sis is to establish the percentage of employer  contributions coming into the System that has historically come from each participating employer  (including the Plan Sponsor) by reviewing the System’s financial, actuarial and other information.  This information will help a Lender assess the degree to which the Plan Sponsor has been respon-  sible for providing funds to the System that, when extrapolated, may give the Lender enough comfort  that the Plan Sponsor will provide adequate assets to the System to fund Capital Contributions  going forward so as to enable the Lender to include the System Investor in the Borrowing Base.

With respect to a single-employer System, the sole employer (i.e., the Plan Sponsor) would be the  only governmental unit responsible for providing funds to the System, making a credit linkage  easier to establish. When analyzing a multi-employer system, however, it can become significantly  more challeng- ing to establish a credit linkage between the System and its Plan Sponsor.

In some cases, the Plan Sponsor of a multi-employer System assumes responsibility for funding the  employer contributions of some or all of the other participating employers. For example, the  Illinois Teachers’ Retirement System is a multi-employer System consisting of approximately 1,000  govern- mental units, where approximately 95 percent of the employer-provided funding for the Illinois Teachers’ Retirement System is the responsibility of the State of Illinois.9 More typically, with respect to multi-employer Systems, each governmental unit participating as an  employer in the System is only responsible for making a required employer contribution for its own  employ- ees. In this scenario, a funding analysis requires locating and reviewing the financial,  actuarial and other information related to the System to determine the extent to which the Plan  Sponsor is responsible  for funding the System relative to other participating employers in order  to establish the extent to which the Plan Sponsor is supporting the System.

An additional layer of complexity is added when a Lender is considering advancing against a public  pension fund that holds assets of multiple Systems. This situation can arise when a state that  sponsors multiple Systems seeks out ways to reduce the administrative burden of operating multiple  Systems by creating, for example, a common pension fund that collects, pools and invests moneys  received from several different Systems (a “Common Fund”).10 When such a Common Fund is established  to facilitate investment activities, the funds of each System may be invested jointly, while the  gains and losses of the Common Fund are allocated among each System on a pro rata basis. In this  scenario, again, a funding analysis calls for locating and reviewing the financial, actuarial and  other infor- mation related to the Common Fund and each System participating in the Common Fund to  determine the extent the Plan Sponsor is respon- sible for funding the assets of each System and,  ultimately, the Common Fund relative to other participating employers.


In deciding whether to advance against a System, in addition to a credit linkage analysis, there  are other potential factors that a Lender may wish to consider and discuss with its counsel. For  example, a Plan Sponsor of a System may have enacted a statutory regime that helps ensure that sufficient funds will be made available to the System for it to meet  its liabilities.11 In such a case, a Lender may become more confident in the overall  creditworthiness of the System and may become comfortable advancing against a System (perhaps at a  lower advance rate and/or with tight concentration limits) despite the lack of credit linkage to  the Plan Sponsor.

Lenders should also be aware of a Plan Sponsor’s ability to adjust the accrued liabilities of the  System. As mentioned above, in many instances, System benefits are protected by state constitu-  tional provisions. Certain states, such as Arizona, Illinois, Michigan and New Jersey, have pending  cases relating to recently enacted pension reforms touching on this issue. These cases may have  impli- cations for the ability of Plan Sponsors in those states to limit their benefit liabilities  as a means of managing the fiscal health of a System. As such, Lenders participating in the Subscription  Facility market will want to consult with counsel familiar with these issues as they look to  advance funds against Capital Commitments made by Investors  that are Systems. Finally, it is  important to note that, when a Lender is advancing against a governmental entity, it should  consider the extent to which the entity may be able to use sovereign immunity defenses to impede  enforcement of its contractual obligations in federal and/or state court.12


As the Subscription Facility market becomes increas- ingly competitive, a Lender’s ability to  provide Borrowing Base credit for a greater number of a Fund’s Investors is one way for a Lender to  distin- guish itself from its competition. By analyzing the legal regime and publicly available  financial and other information about a System and its sources of funding, a Lender may be able to  establish sufficient credit linkage between a System Investor and a more creditworthy Plan Sponsor,  facilitating inclusion of such an Investor in the Borrowing Base.