In a previous article, we discussed the role of the AIFM of a Luxembourg alternative investment fund (AIF) in a fund financing transaction. In this article, we will focus on another key player in the investment funds ecosystem and discuss the extent to which depositaries of Luxembourg AIFs are involved in fund financing transactions.

As the entity in charge and responsible for the safekeeping of the assets of the AIF, the role of the depositary in the context of a fund financing transaction shall differ depending on the provisions of the AIF’s constitutive documents and/or the terms of the depositary agreement entered into between the depositary and the AIF (the Fund Documentation).

Depositary’s Consent or Notification

In certain circumstances, the Fund Documentation may require the AIF to seek the prior consent or non-objection of its depositary before entering into a transaction under which the AIF shall borrow, grant guarantee or security over its assets or otherwise cause leverage.

In other circumstances, the consent of the depositary may not be required but there may be an obligation to notify it, in advance or thereafter, of the entering into by the AIF of such a transaction.

Where such a requirement exists, the AIF would in principle not be able to validly enter into the contemplated transaction unless it has obtained the depositary’s prior written consent or non-objection, or sent the depositary a written notification in due course.

The above may also be applicable when the financing is not entered into directly by the AIF itself but at the level of a direct or indirect subsidiary of the AIF, and it is worth checking in such a case if the Fund Documentation and in particular the AIF’s depositary agreement contains look-through provisions, pursuant to which the leverage, borrowing or related guarantee or security arrangements by the underlying investment vehicles of the AIF are also in scope of the above prior consent, non-objection or notification requirements.

There is no prescribed form for such a consent or notification, which generally consists of a letter describing the contemplated transaction, its main financing terms and any guarantee or security interests granted over the assets of the AIF and which is signed or countersigned by the depositary to confirm its consent, non‑objection or acknowledgment.

Waiver of First-Ranking Pledge

It is not unusual that assets of the AIF are pledged in favor of the AIF’s depositary under the terms of the depositary agreement, preventing the AIF from granting a valid and enforceable first-ranking pledge over the same assets in favor of the lenders to secure the obligations under the contemplated fund financing transaction. In such a case, the AIF will have to obtain an express confirmation from the depositary that it waives its first-ranking pledge before the AIF can grant a first-ranking security over such assets in the context of the fund financing. Alternatively, a consent from the depositary that its existing pledge remains in place as a second-ranking pledge subject to the lenders’ first-ranking security interest would also generally work from the perspective of the lenders and may be the depositary’s preferred option.

Conclusion

The level of involvement of the depositary in a fund financing transaction is ultimately to be determined on a case-by-case basis. It is therefore recommended to agree and clearly define in advance, i.e., at the time the depositary agreement is negotiated what the role of the depositary will be in future fund financing transactions.