Recently, there has been a noticeable uptick in participating retail investors and insurance company investors within the alternative investment space. This increase is evidenced by expanding platforms (who, having been granted exposure to leading alternative asset managers) swiftly marketing their wares in the retail space, and in turn delivering a single subscription agreement, backed by this nascent wave of investors. Lucky for alternative asset managers, insurance company investors have followed suit via debt capital commitments (as opposed to traditional equity capital commitments).

Historically, insurance company investors have played a limited role in the fund finance market as a result of prohibitively burdensome regulatory constraints and risk-based capital requirements. Specifically, there was uncertainty as to whether such debt capital commitments would be enforceable under Section 365(c)(2) of the US Bankruptcy Code if an applicable fund was ever subject to bankruptcy proceedings. However, it is now apparent that a workable solution has proved beneficial for both insurance investors and alternative asset managers in the form of a ‘rated feeder.’ While the structure here doesn’t necessarily need to be a ‘feeder’– it appears that the rated feeder is the preferred structuring solution. Once an alternative asset manager has a prospective insurance investor engaged in committing capital to ongoing fundraising efforts in the form of debt interests rather than equity interests, there are a number of things that will need to happen, starting with engaging with a rating agency at the earliest opportunity. 

Of course, if an alternative investment manager is in fundraising mode, it is unlikely that the fund will have made many (if any) investments. The rating agency will work with the alternative asset manager based on its historical investments, along with a hypothetical basket of assets based on the fund strategy, and begin the rating process based on this. Importantly, the equity portion of the feeder can be adjusted. The ability to create a bigger equity slice for the feeder will support the strength of the rated debt and therefore rating outcome. As will having various tranches, as different ratings can apply across tranches, the most secure tranche obtaining the highest rating and so on. This is becoming more prevalent in the fund finance market.

Rated note feeders will usually issue debt (in the form of notes) to its investors under a note purchase agreement (or other equivalent document which brings the key arrangements together and sets out the rights and obligations of the parties) and the debt issued under this instrument will then be rated by a rating agency.

If a subscription-line lender, which typically provides debt at the fund level secured against the capital commitments of fund investors, wants to include investors who come through the rated note feeder into the borrowing base of the subscription line facility, it will need to ensure that upon the occurrence of an enforcement event, that it has the ability to step into the shoes of the rated note feeder and issue notes to the investors of the feeder. The debt issued under the feeder’s note purchase agreement will need to be subordinate to any debt provided by a subscription line provider – effectively a waiver (sometimes via investor consent letter) by the investor of any prior or competing rights it may have with the subscription line lender.

As funds seek to access a wider range of investors and the Insurance company investors in particular, we expect an increase in the number of funds that will rely on rated note feeder funds as the means of drawing down investor commitments. The jurisdiction of establishment of the fund and the drafting of the constitutional documents of the feeder fund and the note purchase agreement will all be important factors in determining whether a subscription-line lender will be able to take account of such an investor in its borrowing base.