Apollo Global Management's role as liquidity provider to a proposed ETF has sparked concern that it might allow Apollo to influence pricing of the fund’s private credit holdings to its advantage.
Apollo Global Securities, an Apollo subsidiary, will serve as a liquidity provider to the SPDR SSGA Apollo IG Public & Private Credit ETF, according to a Sept. 10 filing with the Securities and Exchange Commission.
“There is a danger that, absent additional transparency and strong controls, Apollo could use its position as liquidity provider for the ETF to influence, potentially for its own advantage, pricing for those and similar illiquid assets that are held elsewhere,” said Andrew Feller, a former SEC enforcement attorney who recently joined law firm Kohn, Kohn & Colapinto as senior special counsel.
The filing says Apollo has agreed to provide the ETF “with firm executable quotations for each asset-backed and corporate finance instrument sourced by Apollo (each, an “AOS Investment”) held by the Fund and has further agreed to purchase from the Fund any AOS Investment held by the Fund, subject to a daily limit, at a price at or above the quotations given by Apollo.”
Challenging to value
The “illiquid nature” of private credit assets makes valuing them challenging, an April International Monetary Fund report said.
Micah Hauptman, director of investor protection at the Consumer Federation of America, also cited pricing-related concerns in an Oct. 4 letter to the SEC regarding the proposed ETF. The letter referenced the adopting release for SEC final rule Good Faith Determinations of Fair Value, issued in December 2020.
Under Section 2(a)(41) of the Investment Company Act of 1940, fund assets that don’t have readily available market quotations must be fair-valued by a fund’s board or its designee, subject to board oversight, the letter said.
Determining whether a market quotation is readily available “is based on active market conditions for identical investments,” Hauptman’s letter said.
“These requirements are intended to ensure that ‘fair value determinations will be more likely to reflect a price that could be obtained in arm’s length transactions with less bias,’” the letter said, quoting from the adopting release.
'Raises concerns'
However, based on the filing for the SPDR SSGA Apollo IG Public & Private Credit ETF, “it appears that Apollo will play a central role in determining asset prices through its firm bids on AOS Investments,” the letter said.
“This raises concerns that Apollo’s liquidity provision could distort the valuation process,” Hauptman added.
For instance, during times of market turmoil or lower liquidity, “Apollo would have an incentive to offer lower bids to repurchase assets at a discount,” the letter said.
That would put the fund in the tough position of deciding whether to accept those bids in order to ensure sufficient liquidity or reject them and potentially be unable to meet its redemption obligations, Hauptman said.
“This process would undermine the independent valuation process required by the Act, raising concerns that valuation determinations by the board or its designee could become pro forma, which would be inconsistent with the Act,” the letter said.
For the valuation process to work properly, “if the fund’s board or its designee, acting in good faith, determines a different value for the fund’s holdings than Apollo, and liquidity is needed, Apollo should be required to repurchase those holdings at the values determined by the fund, rather than at the prices Apollo is willing to pay,” Hauptman’s letter said.
When it comes to the proposed ETF, “there is a lot that we don’t know,” said Hauptman, who served as counsel to SEC Commissioner Caroline A. Crenshaw before rejoining the Consumer Federation of America in 2022, in an interview.
“We don’t know what the liquidity agreement says,” he said.
Still, the filing raises “some serious questions,” Hauptman said.
“I sent the letter to the SEC staff … because I’m hoping that it provides additional support for them to review the filing closely,” he said, adding, however, that having worked at the SEC, “I doubt I’m raising questions that they haven’t already thought of.”
An Apollo spokesman declined to comment “while the SEC review process is ongoing.” A State Street Global Advisors spokesman reiterated an earlier statement saying that, “For regulatory reasons, we cannot discuss fund filings pending SEC review.”
Inherent conflict
When it comes to funds in general, “there is an inherent conflict in valuation,” said Carolyn McPhillips, president of the Mutual Fund Directors Forum, an association for independent directors of mutual funds, ETFs, closed-end funds and other registered investment companies.
“The adviser, for example, has a potential conflict in how it values the security because the adviser is going to get paid based on the assets of the fund, which are determined by the value of the underlying assets,” McPhillips said. Consequently, “the adviser may have an incentive to inflate the value,” she said.
“So, the 1940 Act has a structure in place, and that’s why you have fund boards, because they are providing independent oversight to this entire process,” McPhillips said.
According to the filing for the SPDR SSGA Apollo IG Public & Private Credit ETF, the board designated the fund’s adviser, an SSGA subsidiary, as the “valuation designee” for the fund.
In the proposed private credit ETF, for which a liquidity provider will give executable quotations for the portfolio, “the adviser is still going to have a valuation committee that is going to look at these prices,” McPhillips said, adding that the committee presumably will have information on what the fund paid initially to acquire those securities.
“There’s models that you can use for pricing … you can look at similar types of securities,” she said.
For the SPDR SSGA Apollo IG Public & Private Credit ETF, finding comparable securities is likely to be “very hard” given the “unicorn types of securities” found in private credit, she said. Outside pricing services that work with other types of funds that hold similar hard-to-value instruments could also be used, she added.
“So, you may not be comparing apples to apples, but you might get an idea of sort of what else is going on in the market,” she said. “So, you can have objective third-party resources as well.”
Were McPhillips to be on the board overseeing the proposed ETF, “I would definitely want to know what checks and balances are in place to make sure that we don’t have one entity saying, ‘this is the price’ and ... no controls around that,” she said.
“I would really have conversations with the adviser about how they are using Apollo to inform decisions on the valuation of these securities,” McPhillips said, adding that she would want to know how the adviser is getting confidence that controls are in place to ensure that fund shareholders are being treated fairly.
She said she would also want to know that the adviser had enough expertise with private credit as an asset class to be able to evaluate the pricing information.
“As long as the board can get comfortable with that, the board’s job is not to tell the adviser what kind of funds it should be offering,” McPhillips said. “The board’s job is to make sure that the adviser has the appropriate expertise to service the fund in a way that’s fair to its shareholders.”
