The State of Secondaries

[Rory] Hello, and welcome to "The State of Secondaries," a webcast series from Nasdaq Fund Secondaries. I'm Rory Mabin, and I lead the institutional side of our team here at Nasdaq. In this series, we sit down with leaders across private markets to discuss key themes shaping today's landscape. Joining me today from Aon is Jerald Khoo, Managing Director and Head of Private Markets Liquidity Solutions. Jerald will share insights on how Aon is helping private market investors unlock liquidity through innovative insurance backed solutions that are transforming the way sponsors approach secondaries and continuation fund vehicle transactions. Jerald, welcome, and thank you so much for joining us today.

[Jerald] Thanks for having me.

[Rory] Thanks. It's a pleasure. We've been looking forward to this episode. So in today's episode, we'll explore how insurance capital is being deployed to solve some of the most prevalent challenges in private markets today, namely liquidity, and how Aon's new Private Market Liquidity Solutions, or the PMLS group, the platform is creating new avenues for capital efficiency and risk management. So let's just start by talking a little bit about your background and the kind of clients that you're typically working with.

[Jerald] Sure, happy to. So for those who may be unfamiliar, Aon Transaction Solutions is a specialized practice within Aon that offers and provides clients with risk, as well as advisory management services, with respect to supporting their business transactions. My role there as one of the Senior Brokers is really to think and advise clients is to how best to use insurance capital in order to alleviate the risk that they may be undergoing in their transactions.

[Rory] Yeah, I think that makes a lot of sense and is obviously incredibly kind of timely, very innovative in the context of private markets today. So let's talk a little bit more about that specifically. So from a transaction insurance standpoint, how is Aon addressing the liquidity challenge like at the moment today in private markets?

[Jerald] Sure, so the liquidity challenges that we're seeing in the market, I think we're focused on is pretty much the same, I think, across the board and other market participants are keen on as well. We're seeing prolonged exit timelines. We're seeing investor DPIs down. We're seeing financing conditions that have been tightened, as well as sponsors that have been, you know, less able to really effectively raise new capital in recent times. So all of these, we see, has led market participants to really focus on creative solutions to address such illiquidity needs. We're seeing alternative investment structures, like secondaries, and how that's been a huge uptake in recent years. And also, an increasing focus by sponsors to looking at how to ring-fence tail end fund liability. So we launch Aon's Private Markets Liquidity Solutions platform, really, is with a goal of being another tool in a toolkit for such participants or such investors who are looking at alternative ways to address illiquidity concerns. Our goal at the start was to effectively harness insurance capital to enhance the returns to investors, and at the same time, allowing fund sponsors to optimize their fund performance and minimize their contingent liabilities. We see this, you know, pretty often and oftenly used in particular on secondary transactions. And it's a broad ranging scope of application that we've seen in recent times as well from GP-led continuation vehicles to traditional LP trades, and across the spectrum of different industries from private equity, credit, infra, real estate, venture, you name it.

[Rory] Yeah, I think that really makes sense. And if you could kind of compare and contrast, right? Talk us through what makes this offering dynamic and innovative, relative to sort of the broader insurance industry.

[Jerald] Sure, so transaction insurance predominantly was used on buyout or typical, traditional M&A processes. And what we've seen in the industry is that a lot of players in the space have been evaluating, using that lens to evaluate even alternative investments and really leading to square peg and round hole situations. Are you using a buyout lens to evaluate things like secondaries? And this has led to things, like onerous underwriting processes, timelines that don't necessarily reflect the realities or expectations of these alternative liquidity solutions. As well as premium pricing, candidly, on the policies that are insurance, policies that are being placed that just wasn't fit for the moment for parties to do this at at scale. So what we wanted to look at and develop was the suite of flexible solutions, really catered to private markets that was increasingly, as we said, focused on liquidity solutions transactions.

[Rory] Yes, that's right. And, you know, for those who kind of know me well, people will say that I'm sort of like the how person, right? So I'm keenly focused on, okay, like let's talk about the concept also, but more importantly, how does this actually work? So let's dig a little bit deeper into that, into the mechanics. How does transaction insurance actually work to enhance liquidity?

[Jerald] Sure, so I would just maybe to use examples to touch on some of the key offerings that we have in the transactions insurance space with respect to liquidity. I think the first one is, I've mentioned a couple of times already is with respect to secondaries transactions. Whether it's a GP-led continuation vehicle or a direct traditional LP trade, you typically have selling parties that are making a suite of representations over the underlying assets to the buyer investors that are coming in. And the buyers on the other hand, there's an expectation that the sellers would be backstopping these representations to the extent there are any potential breaches there. So that has generally been the case, but we're seeing an increasing use of an alternative structure is to use reps and warranties insurance or transaction insurance to replace a traditional seller backstop, whether that be in the form of an indemnity or some other form of escrow or holdback. And this has several advantages. From the selling LPs, from a selling investor's point of view, you're able to achieve a truly clean exit, because instead of having to agree to any indemnification or even an escrow holdback, you're able to walk away from the deal with a hundred percent of the proceeds distributed at closing. So it really helps that capital distribution upfront. From a buyer's perspective, you're still able to get your investment protected even without the traditional seller indemnification. Say there's an issue that comes up, it gets discovered after the transaction closes, maybe a tax exposure that just wasn't taken into account at the time of the deal signing. In the event, you know, that happens, and you have a policy in place, a successful claims payout could help the investor, not just protect the investment, but also protect how the overall rate of return looks like for that piece. And then, for GP-leds in particular, if you have a financial sponsor that's involved, the benefits really are, it helps them to shift balance sheet risk and improve their balance sheet risk for themselves by moving off any need for post-closing retention, a post-closing sort of recourse to be factored into their reserves. So we can really see a whole suite of benefits kind of across the board here. And I think that really leads to an alignment of interests between or among all the parties. And what we've seen is that it really reduces deal friction. A couple of things I'll just add on the secondaries front, one of the innovations we've been working on at Aon is what we were dubbing election period coverage. So this is an Aon proprietary facility that provides up to $15 million of coverage for interim breaches that come up during the election period on secondaries. So, such breaches are usually excluded from regular, traditional transaction insurance coverage. But this is something that our team has been working on for the better part of last year and formally deploying it as of Q4. So this is something we're looking really excited about and also look to continue as we head into this year.

[Rory] Brand new, hot off the press, I love that. And so, the idea is that it is specifically focused on covering any breaches that occur kind of in a continuation vehicle process or tender offer process during the time that sellers or LPs are coming to elect. Is that about right?

[Jerald] That's right.

[Rory] Yes, it's really cool. And there's so much innovation going on in this space and where, as transactions continue to be so nuanced and continuing to evolve, I think something like this, really, it makes a lot of sense in the time that we're in.

[Jerald] Yeah, I totally agree. And I know we've talked a lot about secondaries and transactions, but maybe just moving a little bit off of that and thinking about sort of liquidity as as a whole. As I mentioned, we're seeing a lot of fund sponsors looking really deeply into how to ring-fence their tail end fund liabilities. And that's also another solution that we've brought out to market, which is the fund wind down insurance, which essentially allows a party to ring-fence your tail end fund liabilities, allows quicker final distributions, so quicker capital distributions to your investors without there being onerous requirements for keeping funds in escrow, especially if they're looking to just wind down the fund at the end of its life. That makes a lot of sense, especially when those sponsors are also currently in the market trying to fundraise, the thing that they're focused on more than anything is getting that capital back to their investors.

[Rory] So, you know, from your perspective personally, how are insurers evolving their approach to private market risk?

[Jerald] So I think it's an interesting question. I think we see sort of different facets of that evolution. I think there is, at the very high level, an increased ability to underwrite liquidity solution transactions, stepping away from the traditional M&A model. And that's something that we're seeing an increased appetite from insurers, just to, you know, underwrite these sort of transactions. You know, a couple of years ago, the number of underwriters that we have in the space that were really looking at these in a very deep manner was, you know, less than three. Right now, we're up to, you know, more than 10. So that's kind of more than tripling of carriers that are available capital that's available in the space for clients who are pursuing such transactions. And I think there's really just a greater level of education that has been in the space, not just within our industry, but I think the broader private markets as a whole looking at deals like secondaries or considering alternative transactions. I think, whereas folks may have been focused on how it's inherently a conflicted transaction and how controversial it may seem to be. I think really digging into it, you understand or you're starting to understand more about the disclosure regimes, the requirements, and the internal processes that deal parties are really being very mindful of in order to transact and pursue that liquidity

[Rory] Yeah, and get a good outcome for all of the parties. And, you know, again, I think the evolution, the innovation in this space is really a good indicator that we're not stopping or slowing down anytime soon.

[Jerald] Yeah, I think that's right. And I think what's really key and underpinning sort of the evolution is for the effective insurers who are actually seeing themselves more as partners to these, you know, financial sponsors or investors. Not so much as just capital providers, but also really wanting to partner them as in this new phase, right, in this growth period as to how they can, you know, truly unlock further liquidity for our clients.

[Rory] Yeah, I think all of that makes sense, and it's a great segue. I always like to end segments kind of talking about the future, with an eye toward what comes next. So, you know, if we're looking ahead, what do you see, or how do you see the use of insurance in private markets evolving? Let's talk about five years from now, let's talk about 10 years from now, and what does that look like?

[Jerald] So I think at the very start, there will be, or I expect that there will be an increased participation from the insurance markets, as well as increased ability to really work on these bespoke transaction solutions. So I think that what we have seen in the last four or five years or so will continue in the next five, 10 years. In terms of how, so that's kind of on the insurance or capital providing side. I think the evolution when it comes to sponsors and investors, I think there will be a shift or there has started to be a shift in the way transaction insurance is used and viewed on such deals, in addition to just being looked at as sort of a defensive posture or used as something to protect against a downside. More and more of our clients that we speak to are also thinking about it as another method of a portfolio management tool and how insurance capital could be used to, you know, achieve their state of goals, whether it's liquidity, or whether it's to wind down a fund, or some other, you know, other commercial goals. And I think the shift that has started will continue over the next five to 10 years, where deal teams and parties will start to use insurance, as I mentioned, not only in the sort of to protect against the negative scenario, but also, about how I can use it to unlock potential upside going forward.

[Rory] Yeah, I think all of that makes sense. What is your prediction? Are there going to be more providers in this space 10 years from now? Is there going to reach sort of like a critical mass, and then, there's like a fair amount of, you know, condensation and consolidation of groups? Are there 50 different providers in a decade? What do you think?

[Jerald] Yeah, well great question. I think we're still some ways away from there being critical mass, especially when it comes to these alternatives or even secondarie insurance coverage. What I mentioned earlier about how transaction insurance has really been rooted mainly on traditional buyouts processes. We have about doubled the number of carriers that are providing capacity on traditional buyouts, compared to those that are willing to look at secondary. So I think there's still some movement there. In terms of where this all goes, I don't, to your point, I think there will come a time where there will be that critical mass, but I think we may also start to see some sort of specialization as within the carriers, whether it be industry type, or whether it be, you know, geographic regions, or deal sizes. I think that would be something that we want to keep an eye on as well. Even as the market gets, you know, larger and larger, there may be different segments that are starting to form and different ways in which an insurance carrier may want to set themselves apart as being the subject matter expert in a specific segment.

[Rory] That makes a lot of sense. And look, that's what we're seeing in the secondary space today, right? Kind of dedicated pools of capital with specialization that are kind of coming into the space. So with so much development happening in the world of PE these days, it's been interesting to hear about how Aon is playing a role in shaping the future of liquidity in private markets through insurance backed solutions. If viewers would like to learn more about Aon's Private Market Liquidity Solutions, click the link below or contact the Transaction Solutions Team directly. And thank you to our audience for tuning into the "State of Secondaries." We'll see you next time.