April 2, 2025

Collateralized Fund Obligations: Understanding the Diligence, Documentation, and Rating Agency Process

Authors: Kiel A. Bowen, Todd N. Bundrant, Mark C. Dempsey, Michael P. Gaffney, Lawrence R. Hamilton, Jennifer T. Hartnett, Ann Richardson Knox, Arthur S. Rublin, Ryan Suda, Sagi Tamir, Andrew L. Hogan
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Because collateralized fund obligations (“CFOs”) can be customized to the unique needs of both funds and investors, those needs will impact the process and timing of the transaction. This Legal Update, the latest in a series on CFOs, provides information relevant to funds and investors on the negotiation, diligence, and closing process of a CFO transaction.

Background

CFOs are investment vehicles that consist of portfolio investments (“Investments”) pooled together into a bankruptcy-remote special purpose entity (“Asset HoldCo”) that is owned by another bankruptcy-remote special purpose entity (“CFO Issuer”) which issues tranches of rated notes and equity (collectively, “Securities”) to third-party investors (the “Securityholders”). These rated notes are secured by the equity interest in the Asset HoldCo. CFOs provide a mechanism for portfolio managers, portfolio investors, secondary funds, and funds of funds (each, an “Investor”) to incorporate alternative financing vehicles into their investment portfolio.

What You Need to Know

Negotiation and Design Phase

CFOs are typically designed through discussions and negotiations between the sponsor, the investors and the investment bank acting as arranger or initial purchaser for the transaction, informed by input from the rating agency. The sponsor, in some cases together with other transaction parties, will identify an investment portfolio of hedge, private equity, growth, and/or similar funds (or will design the portfolio criteria, if there will not be an identified portfolio at closing).

Diligence

The rating agency as well as the investors and other parties to the CFO will undertake diligence procedures of the proposed Investments and the underlying assets. Accordingly, the negotiation, structure, design, and diligence process can be lengthy even before the CFO begins marketing. Diligence can be further complicated when the CFO consists of an unidentified pool of assets. In this case, the CFO manager can add new funds post-closing, and because those assets are unknown...

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