Demand for fund finance continues to grow, but the market is changing. Banks remain central to this need, yet regulatory requirements can constrain their ability to deploy capital. At the same time, insurers, pension funds, asset managers and private credit investors are playing a bigger role in the market, and many require independent credit ratings before they can participate.
For sponsors, this creates a clear opportunity. A rated facility can help attract a broader lending pool, support larger facility sizes and, in some cases, improve pricing or capital efficiency. Having worked with rating agencies since 2018 and brought more than 45 lenders into capital call facilities, Investec has seen first-hand how ratings can work in practice.
Why ratings matter in fund finance
In the past, fund finance – whether through subscription lines or bespoke facilities such as continuation vehicles (CVs), net asset value (NAV) lending or management company financing – typically operated outside the world of credit ratings. Lenders and sponsors tended to rely on relationships and market insight to structure deals with a single bank or syndicate, and the deal would be ‘rated’ using the bank’s internal models to assess the level of credit risk involved in the transaction.
However, as the role played by fund finance in supporting the growth of private equity markets has expanded, the formal use of credit ratings has also increased. Over recent years, leading global rating agencies have developed methodologies specifically covering fund finance transactions.
Recap: How credit ratings work
Regardless of whether they apply to publicly listed or private market assets, credit ratings are an independent and systematic assessment of the level of credit risk associated with a financial transaction. The rating agency considers factors ranging from a borrower’s existing debt load, its cash flow and liquidity as well as management and governance, and its overall business risk profile.
Ratings can be applied to individual debt issuances, such as government or corporate bonds, as well as to more complex finance structures such as assets created through securitisation. When rating private equity transactions such as CVs or NAV-based loans, agencies also assess portfolio concentration risk, exit options and the alignment of different investor groups. Subordinated subscription lines with higher advance rates have also achieved investment-grade ratings, demonstrating that ratings are supporting structure innovation.
The ratings agencies use the same credit rating methodologies and scales for publicly traded assets as for private assets. But while public ratings are available to all market participants, private ratings are typically shared only with permitted parties involved in the transaction, such as the borrower, arranger and relevant lenders. This can make private ratings attractive to sponsors who want the benefits of an independent credit assessment while preserving confidentiality.
In general, the different agencies tend to arrive at similar rating levels. However, having worked extensively with the major agencies since obtaining our first rating in 2018, we have identified certain nuances in the methodologies they employ.
A number of forces are driving the growth of credit ratings in private markets.
In fund finance, banks continue to play a dominant role. Although the fundraising environment has become more challenging in recent years, the growth in the availability of private capital has created extra demand among banks. At the same time, ongoing regulatory pressures can impose significant constraints on banks, at times limiting their ability to deploy capital. This is where credit ratings have an important part to play: the use of independently verified ratings on bank-backed fund finance can alleviate these constraints by addressing regulators’ concerns and improving banks’ capital positions.
A number of non-bank institutions such as insurers, asset managers and private credit funds have entered the fund finance market in order to take advantage of potential yield and diversification benefits. However, many of these institutions require ratings to invest, either due to their internal mandates or regulatory rules that govern their asset-allocation policies. In many cases, credit ratings are a pre-requisite for their involvement.
Fund finance has expanded from traditional subscription-line lending to encompass newer asset classes such as NAV lending. Credit ratings for such products can help to enhance investor confidence by providing external validation.
How borrowers can benefit from credit ratings
By taking advantage of private ratings, fund sponsors may be able to attract larger lines of credit with more consistent pricing: this can play an important role in enabling private capital funds to scale.
Based on publicly available information, Investec estimates that there are around 100 public fund finance ratings, representing billions in publicly rated debt. This provides a useful indication of the market’s growing scale, although the actual use of ratings is likely to be higher still, given that many fund finance ratings are private and therefore not visible to the wider market.
Ratings can also help sponsors achieve better outcomes: a bank may be able to provide a larger hold size on a rated facility, reducing the need to bring in additional investors as a part of a syndicate. Ratings can also enable institutional investors to participate over longer durations than the three- to five-year time horizons favoured by banks. This can help to expand general partners’ (GPs’) strategic options, for example by using long-term institutional debt to provide greater financing flexibility.
We are already seeing some evidence of this shift, which is moving fund finance closer to the established model of structured credit. There have been some securitisations of subscription loans, which either involve private ratings of all the loans in the pool or ratings of tranches of debt within the structure. On the fundraising side, we are also seeing tranche structures with investment grade-rated senior tranches that are attractive to institutional investors such as insurers.
We understand that preparing a rating involves additional disclosures and ongoing engagement with rating agencies, and some GPs may be cautious about such requirements. The current market is also highly competitive, with significant lender liquidity chasing fewer deals, which may make a rating feel less urgent. But liquidity can change quickly, and waiting until conditions tighten may limit the options available.
In our view, a rating should therefore be considered not only as a tool for today's financing, but as a way to future-proof it. Establishing a rating while markets are supportive can broaden the potential lender base, preserve access to institutional capital and put sponsors in the strongest possible position to secure liquidity and competitive terms if bank appetite or market conditions change. The key question is not simply whether a facility can be rated, but whether a rating can improve execution today while creating valuable financing flexibility for the future. We stand ready to help our clients navigate their needs.
Find out more about the rating process and how Investec can help you meet your fund finance needs
Nick Rusling
Fund Solutions
Important information:
This article is for general information purposes only and should not be used or relied upon as professional advice. It is advisable to contact a professional advisor if you need financial advice. The opinions featured are not to be considered the opinions of Investec.
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