| Collaterised Fund Obligation 101 |
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| 09/01/2005 | |
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David Barwise, partner, and Josh Parbhu, associate at the White & Case law firm answer this week's 101 on collaterised fund obligation 1-What is a Collaterised Fund Obligation? A Collaterised Fund Obligation is an obligation which is issued by a Special Purpose Vehicle (SPV) domiciled in a tax-efficient jurisdiction. Such obligations are rated and unrated securities, in the form of notes, backed by a pool of assets and its income stream. The rated notes will range from AAA to B, with the unrated notes known as equity or subordinated securities. The purchasers of these securities will then be paid a fixed sum on their maturity, as well as interest payments on set dates. Typically, the underlying assets in a CFO will either be interests in hedge funds or private equity funds. 2-What is the objective of such a strategy for an institutional investor? There are a number of benefits of investing in a CFO compared to investing directly into an asset class: offering exposure to a diversified investment portfolio, both by geography and industry, in one single investment; offering access to funds in which an investor might not otherwise be able to participate; access to the yield potential of higher-risk asset classes such as private equity and hedge funds, with limitation of this risk; potential regulatory capital relief; and the fact that bespoke risk profiles can be created to match individual investor demands. There are also numerous benefits for the issuer, many of which vary from issuer to issuer, dependent on the asset class to be securitised and the situation of the individual institution, but the primary generic benefit for the issuers in a CFO is that that the securitisation provides them with a new, stable source of capital with which to fund their operations. 3-Why has there been only a handful of CFO deals in Europe until now? What is the 2005 outlook for CFO transactions? Generally speaking, CFOs are very much at the cutting edge of the structured finance market and as a relatively new and unfamiliar product, appetite in the financial community to date has been limited. However, the capital markets and the funds industry are converging slowly, and as familiarity grows among issuers, investors and advisers, the number of CFO transactions that come to market is likely to grow. In addition, asset-specific challenges have previously limited the opportunities to bring CFOs to market. For example, private equity assets have historically been considered unsuitable for securitisation because of their unpredictable cash flows and the volatility of their market value. However, recent developments in the structuring of such transactions have enabled this hurdle to be overcome. The last few years have seen around five major CFOs in Europe that have been publicly rated and sold, averaging approximately one per year. Given the complexity of such transactions it is unlikely that we will see a substantial number of CFO transactions going forward, but we would expect steady incremental growth, equating to perhaps two or three CFO issues in Europe in the next 12 months. |
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