Private Equity Sponsors Leverage Collateralized Fund Obligations Amid Regulatory Shifts

Last week, Vista Equity Partners tapped Goldman Sachs to arrange a roughly $1 billion collateralized fund obligation (CFO) backed by stakes in its private capital funds. It’s the latest deal in a growing trend where sponsors are leveraging bespoke securitizations to raise cash backed by their illiquid portfolios.

These securitizations rely on cash flows from fund interests in buyout, credit, and other private strategies, sliced into tranches, typically with a first-loss equity position retained by the sponsor.

For GPs, CFOs can be used as a fundraising tool for new funds and can provide liquidity for existing fund interests.

According to credit outlet Octus, the large size of the transactions makes them a cost-efficient fundraising instrument.

“You tend not to do regular fund financing at the scale of the CFOs,” said a source cited by the outlet who has worked on several CFOs this year.

“The ability to blend the underlying secondary positions into a large pool and raise capital against it means that you can get a better cost of funding than you would otherwise have.”

The instruments are built—and rated—based on an assortment of portfolio construction considerations: strategy mix, vintage, manager dispersion, and geographic spread.

Fitch’s criteria, for example, discourage above 25 percent exposure to any single GP or 10 percent to any single fund and apply additional stress to riskier strategies, younger vintages, and emerging-market concentrations.

The number of inbound pitches and active mandates points toward a trend with some staying power, rather than an isolated jump based on temporary market conditions.

“Not a week goes by for me without getting a new CFO proposal, so I expect the market to continue to grow,” said Greg Fayvilevich, global head of Fitch Ratings’ fund and asset management group, in an interview with Bloomberg.

On the demand side, appetite for such securitizations has also hit an inflection point.

Insurers are the primary buyers, for whom CFOs offer an opportunity to add private capital exposure, which is attractive relative to the low yields available in public markets.

Now, a pair of recent regulatory changes has made it easier for them to allocate cash to these instruments.

In January, new capital rules from The National Association of Insurance Commissioners’ took effect that clarified treatment for these securities, allowing carriers to grow their exposure.

At the same time, UK-based insurance firms, historically cut off from assets like collateralized loan obligations (of which the CFO is a variant), can now purchase certain types of CFOs following reforms to the UK’s Solvency II guidelines.

Previously, the Solvency II framework rewarded insurers for holding assets with “fixed” cash flows that closely match their liabilities, effectively barring most conventional securitizations. Under the new reforms, language was loosened to also include assets with “predictable” cash flows.

Because a CFO securitizes illiquid fund interests, where cash flows are tied to irregular events like exits or dividends, the traditional CFO still doesn’t meet the criteria. But, reports Octus, “several asset managers are working on CFOs designed to be capital efficient for U.K. insurance companies.”

“There is a lot of work being done to create structures that would be matching adjustment-eligible,” Pierre Maugüé, partner at Debevoise & Plimpton in London, tells Octus. “It’s the big project of 2025.”