Collateralized Fund Obligations – GLI Pink Book 2025
Over the past few years, collateralised fund obligations (“CFOs”) have become increasingly popular for financing equity interests in private funds and other assets, offering an alternative liquidity solution to traditional portfolio secondary sales. In the latest edition of Global Legal Insight’s 2025 Fund Finance Laws and Regulations, also known as the ‘Pink Book’ in the fund finance community, Dechert’s Global Finance team has published a chapter titled ‘Collateralized Loan Obligations’.
Key Takeaways
- Comprehensive Overview of CFOs: The chapter sets out what CFOs are, outlines their basic structure and terms of a CFO transaction, and discusses relevant regulatory considerations.
- Comparative Analysis: It compares differences between CFOs to rated funds and NAV facilities, highlighting key differences.
- Market Dynamics: The chapter analyses the factors driving recent market growth and concludes by highlighting the overall benefits and advantages that CFOs offer, anticipating that they will continue to gain momentum in 2025 as a viable alternative investment solution.
Authors: Global Finance Dechert partners, Christopher P. Duerden, Lindsay Trapp, Anthony Lombardi, and counsel Caroline M. Lee, who served as co-authors on this chapter.
The authors wish to thank Jay Alicandri, partner and co-head of the Corporate and Securities Group at Dechert LLP, Mary Bear, consulting attorney in the Global Finance Practice at Dechert LLP, Blake Ellis and Michael Mulvey, associates in the Global Finance Practice at Dechert LLP, Richard Pugh, partner in the Global Finance Practice at Dechert LLP, and John Timperio, partner and co-head of the Finance and Real Estate Group at Dechert LLP for their assistance in the preparation of this chapter.
This article was first published in GLI - Fund Finance 2025. We acknowledge and thank Global Legal Group for their permission to share it.
Extra Insights
Watch GLI's video interview here, featuring Lindsay Trapp and Chris Duerden as they discuss collateralized fund obligations.
Introduction
Over the past several years, collateralized fund obligations (“CFOs”) have seen an explosion in popularity as a means of financing equity interests in private funds and other assets and providing an alternative liquidity solution to the more standard portfolio secondary sale. CFOs first came to market in the early 2000, although its use has been hitherto relatively marginal. The recent growth of interest in CFOs has been driven primarily due to: (i) the strong desire of certain classes of investors (e.g., insurance companies, sovereign wealth funds and other regulated investors) to gain exposure to non-traditional asset classes such as private equity and secondaries funds in a structured and capital efficient rated format; (ii) the fund sponsor’s growing need for alternative liquidity options while offering attractive investment opportunities for a wide variety of investors; (iii) the ability to diversify collateral with a variety of different financial assets with varying risk profile, such as private equity funds, pension funds, credit opportunity funds, buy-out funds, infrastructure funds, real estate funds, private credit funds, co-investments, asset-based securitizations (“ABS”) and residuals in collateralized loan obligations (“CLOs”) and other securitizations; and (iv) the growing (but still inefficient) private equity secondaries market which can make sales of LP interests unattractive.
CFOs, despite their bespoke complex structure, can be tailored to the needs of investors and fund sponsors. Financing fund interests (as defined below) via a CFO offers a long-term capital markets solution with more so favorable cost of funding than certain shorter-term financings executed in the private, bilateral/club market, such as net-asset-value (“NAV”) facilities. In the case of the regulated investors (e.g., insurance companies) subject to risk-based capital requirements, holding rated notes issued by a CFO offers better capital treatment than holding fund interests individually and directly. This is primarily due to the fact that CFOs generally (though not always) benefit from broad and diverse fund interests, which are supported by structural credit enhancement features, such as overcollateralization and liquidity support, which enable them to issue a majority of their capital structure in the form of investment grade rated debt.
What is a CFO?
A CFO is a structured transaction which involves the securitization of private fund interests (such as limited partnership (“LP”) interests) and other assets. In a typical CFO, fund interests are transferred to an asset holding company which is in turn held by an issuing entity (CFO issuer) which issues notes and equity interests to investors. These notes and equity interests are backed by the payment streams received from the fund interests. Although CFO transactions often involve assets other than fund interests, this practice note will generally refer to assets of a CFO as simply “fund interests”.
Notwithstanding the foregoing, there is no one “standard” CFO. As noted, they are tailored to accommodate the needs of the investors and/or fund sponsor. Given such no-one-size-fits-all feature, CFOs can be structured with assets that do not fit neatly into any of the more traditional channels and be designed in a way that takes into account the specific regulatory, capital and/or tax requirements of CFO Issuer (as defined below) and investors. While it can be complicated, its bespoke no-one-size-fits-all structure offers flexibility, which in turn creates appeal to many market participants.
Basic Structure of a CFO
In a typical CFO, a bankruptcy-remote special purpose entity (“CFO Issuer”) purchases and holds a diversified portfolio of fund interests, which is financed by issuing one or more rated notes and a single class of unrated equity, which may take the form of subordinated notes or an LP interest. Since the terms of most fund interests may prohibit them from being pledged to secure a financing without the consent of the general partner (“GP”) or investment manager of the relevant fund, the fund interests are held in a subsidiary of CFO Issuer (“Asset Holdco”). The assets of the Asset Holdco are not subject to a pledge or a security interest, but equity interests of the Asset Holdco are pledged to secure the repayment of the notes and other obligations of CFO Issuer, and the Asset Holdco may guarantee the obligations issued by CFO Issuer.
The most senior tranche will have the highest rating on its notes. Each successive tranche will be more junior to, and have notes that are lower rated than, the immediately prior tranche. The most subordinated tranche will be an equity tranche. The returns on subordinated or equity tranches, in turn, can vary in line with gains or losses on the underlying investments. This tranched capital structure allows the investors in CFO to determine their preferred risk/return investments.
Each tranche (other than the junior most tranche) has a seniority or priority over the other tranches, with “tighter” loan-to-value (“LTV”) or similar collateral quality tests, which, if not satisfied, will result in the diversion of available cash to pay down the principal balance of the rated tranches of each class of notes in their order of seniority until such LTV or collateral quality tests are satisfied, with the equity last in line in the so-called “waterfall” of repayment.
The proceeds of CFO offering are used to finance the underlying fund investments, provide liquidity to the underlying funds, purchase more fund investments and/or for any other permitted purposes.