Five Questions With Yukako Kawata, Partner, Davis Polk & Wardwell

1 – You focus on fund formation for private equity firms and other alternative strategies. What are the most important issues facing firms fundraising today?

The LPs are very focused on conflict issues and they really do want to know and understand what transactions the sponsor would enter into with portfolio companies. LPs are also very focused on valuations…. Other issues revolve around governance provisions. There the emphasis has been focused on key person provisions and provisions related to the removal of the fund sponsor, with or without cause. The other issue that has been around for a long time but over the last couple of years has taken on a life of its own relates to side letters and the use of side letters.

2 – As more U.S.-based funds increase their overseas allocations, what legal issues are increasingly being raised?

The key issues that are being raised would be issues like making sure there is sufficient flexibility in terms of how investments are structured by the funds—especially when they go offshore because of the different tax and regulatory implications. Tax issues are areas where funds have found they need to focus on early and resolve. LPs investing in funds are also very focused on those kinds of issues and focused on things like the kind of tax undertaking that the fund sponsor is prepared to give, such as assistance in filing returns, seeking tax credits, what sort of reporting requirements are imposed, et cetera.

3 – What do you make of the convergence in the alternatives space?

It could be viewed as good or bad depending on who you are. Some people will say that having hedge funds [target private equity investments] increases competition for deals. Having another large group of potential investors competing may be viewed as a bad thing. On the other hand, hedge funds source deals in a way that’s different from the private equity firms and some firms have found deal opportunities by teaming up with hedge funds. You also find that private equity firms themselves are beginning to explore the possibility of behaving in a more hedge fund-like manner, such as investing in more liquid things. The convergence is happening on both sides.

4 – Do you think hedge funds will eventually be more stringently regulated?

Hedge fund regulation is an exceedingly hot topic nowadays, especially given that the U.S. Court of Appeals recently vacated the hedge fund rule that the SEC had adopted. That rule would require hedge fund managers to register as investment advisors. Since then the industry has been sitting there waiting what the SEC will do. People have been watching this very carefully.

5 – Where do you see this going?

[SEC] Chairman Cox testified in front of the Senate Committee on Banking Housing and Urban Affairs about the regulation of hedge funds. He didn’t say one way or the other what the SEC was going to try to do. In terms of trying to seek a rehearing, he did indicate a couple of things that the staff at the SEC are going to focus on. In his testimony he made it very clear…that he did not think that whatever was done should be intrusive on the operations of the fund and should not require the disclosure by hedge funds of their portfolios. He emphasized the fact that hedge funds had a role to play in benefiting the market. His concern seemed to be that the investors in the hedge funds were indeed meeting a minimum level of sophistication so that the purchasers could not be retail investors.