Structuring Collateralized Fund Obligation Transactions: Key Issues and Considerations

Description

Over the past several years, CFOs reached new heights in issuance volume. Although CFOs have been somewhat under the radar, they are gaining market acceptance and momentum among asset managers, owners, and investors. The CFO is a transformational technology for vehicles designed to finance limited partnership interests in private funds and other assets.

While CFOs can take various forms, they are created when a bankruptcy-remote special purpose entity (the CFO issuer) acquires a diversified portfolio of underlying fund interests, including private equity funds, hedge funds, private credit funds, infrastructure and real estate debt and equity, and other similar investments. To finance that acquisition, the CFO issuer issues tranches of rated notes and equity, which are secured by the underlying fund interests owned by the CFO issuer or its subsidiary. More senior tranches benefit from credit enhancement features, and when necessary, interest and principal payments that would otherwise be allocated to junior tranches are redirected to the senior tranches.

The structure of CFOs resembles a hybrid of a net asset value (NAV) facility and a collateralized debt obligation (CDO). CFOs utilize the tranche and collateral structure of CDOs while incorporating the loan-to-value metrics found in NAV facilities. Due to the restrictions on transfer of limited partner interests, the underlying fund interests are typically held by a subsidiary of the CFO issuer. In this type of structure, an investment company--the CFO issuer--acquires a stake in a pool of private equity funds through its subsidiary. The CFO issuer also acquires interests in other portfolio assets, such as money market funds and other liquid products.

One of the attractive features of a CFO is that it can be tailored to meet many different needs and situations. However, there are two primary structuring challenges: (1) the timing of dividends and other distributions paid to investors on these investments are difficult to predict and (2) most private equity investments require an investor to commit to making capital contributions when called.

Listen as our authoritative panel discusses the nuances of structuring CFOs, including the asset-based lending nature of the rated notes that underpin these deals and the complexity of cash flows, liquidity needs, and legal considerations.