What lenders need to know about financing Irish regulated funds

According to data published by Ireland’s Central Bank, qualifying investor alternative investment funds – funds that are restricted to investment by professional investors – had more than €843 billion in net assets as of March 2024.

Considering the growth in private equity investing and extent of investment by Irish funds in real assets, coupled with their need for credit, the borrowing by Irish funds is an important segment of the market for lenders to understand – but there are practical issues they should consider when an Irish fund is a borrower in a fund finance transaction.

Typical Irish fund structure

In fund financing transactions, lenders will typically deal with an Irish fund that is authorised as a qualifying investor alternative investment fund (QIAIF), which means an alternative investment fund that is subject to regulation under the Alternative Investment Fund Managers Directive.

In fund finance transactions involving Irish funds, it is important to consider aspects such as segregated liability and the role of the depositary.

Segregated liability

An Irish fund is normally established as an umbrella vehicle with more than one sub-fund. Each sub-fund constitutes a separate portfolio of investments that has segregated liability, which means that the assets and liabilities of one sub-fund belong exclusive to that sub-fund and cannot be used to discharge the liabilities of another sub-fund. Each sub-fund benefits from legislative ring-fencing of assets and liabilities and may be wound-up as a private limited company under Irish insolvency legislation.

Although a sub-fund may be considered a separate person or separate economic entity, a sub-fund does not have separate legal personality and therefore care should be taken when drafting finance agreements – particularly the parties clauses, the granting clauses, and the execution blocks – to ensure that the agreements properly identify the relevant sub-fund as the contracting party.

Role of the depositary

To protect investors from loss of their investments and in response to financial scandals such as the Madoff fraud, the AIFMD regulations require that assets of investment funds be held by a depositary for safekeeping, which is independent of the AIFM. In discharge of its safekeeping obligations, a depositary is required to hold in its custody assets that can be registered in a financial instruments account, such as equities or bonds, and to register these assets either in its name or indirectly in the name of its sub-custodian.

For assets that are not capable of being held in the depositary’s custody, such as real estate, shares of private companies, or unlisted securities, the depositary is required to verify the Irish fund’s ownership of these assets. The depositary also has a duty to ensure that all cash of the Irish fund is properly monitored, and that cash is held in an account opened in the name of, or on behalf of, the Irish fund. Accordingly, the creation of security over an Irish fund’s assets will need to be either granted by the depositary where investments are registered in its name, or facilitated by the depositary where the investments are subject to the depositary’s oversight and ownership verification.

Legal vehicles

The type of legal vehicle that an Irish fund is established as will have an impact on the structure of the financing transaction. The principal types of legal vehicle for an Irish Fund are:

• Irish collective asset-management vehicle (ICAV) – this is an Irish corporate vehicle that is customised for investment funds. It is governed by its board of directors and will invariably appoint an AIFM with responsibility for its overall management;
• an investment limited partnership (ILP) – an ILP is established under a partnership agreement between one or more general partners and one or more limited partners. An ILP is managed by its general partner who will generally delegate management authority to an AIFM. An ILP is regarded as tax transparent structure and is suitable for private equity investments;
• a unit trust – a unit trust is established by a trust deed between the AIFM and Irish fund depositary.

Taking security – practical considerations

When lending or taking security over an Irish fund, appropriate diligence should be carried out to verify the matters such as legal capacity, authority, borrowing limits, and internal approvals. In relation to Irish funds, diligence on the following matters should be undertaken:

Capacity

The constitutive document of the Irish fund, which could be its instrument of incorporation for an ICAV, partnership agreement for an ILP, or trust deed for a unit trust, should be reviewed. This is to ensure that the Irish fund possesses the capacity to engage in the financing transaction and grant security, and that no restrictions have been adopted concerning these matters. Typically, an Irish fund will have broad powers enabling it to borrow and secure all its investments and undertakings.

Borrowing limits

Although an Irish fund is not subject to restrictions on the extent to which it may borrow, it is required, for the benefit of its investors, to disclose in its offering memorandum the maximum amount of leverage it may undertake. Therefore, it is important to review if the Irish fund has adopted any borrowing restrictions.

Purpose restrictions

An Irish fund will be established with a defined investment objective and specific investment policies, which for example could focus on investing in commercial real estate. The purpose of the Irish fund’s borrowing should be checked to ensure consistency with its investment policies.

Investment structure

Investment by Irish funds in infrastructure, real estate, or private equity is often structured through a special purpose vehicle (SPV) nominee vehicle, which may be established in Ireland or overseas. At the outset of the financing transaction, a lender should verify the entire investment structure and, where an SPV is used, the lender should look to take full security over the SPV nominee vehicle. Depending on the place of incorporation of the SPV, the security over the SPV may require the assistance of foreign counsel.

Relevant approvals

An Irish fund is invariably managed by its AIFM which may be authorised to undertake borrowing transactions on the fund’s behalf. Furthermore, financing transactions may be subject to internal controls or approvals, such as the approval of borrowing and indebtedness by an investment committee of the Irish fund. Accordingly, the appropriate authorisation and approval of the transaction, if required by the AIFM or other body, should be addressed at the outset.

Authority

The person signing the transaction documents must have the authority to enter into facility agreement or security documents in question. In the case of an Irish fund, authority may lie with the ICAV, the AIFM, the general partner, or the depositary, or the directors of the SPV, depending on the circumstances.

Execution and delivery

Care should be taken to ensure that the financing transaction documents are properly executed by the Irish fund in accordance with its constitutive document. As mentioned above, Irish funds are often established as an umbrella structure and therefore the execution blocks should be checked to ensure that the Irish fund enters into the transaction for and on behalf of the relevant sub-fund.

Security arrangements

There is no one size fits all when it comes to the appropriate security package, however, security will typically include security over:

• the underlying assets of the Irish fund’s portfolio;
• the SPV through which investment in underlying investment portfolio is made;
• security over the Irish fund’s bank accounts, and;
• security over the Irish fund’s right to call its capital contributions from investors.

There are a variety of issues to consider in respect of security arrangements:

Fixed charge over the Irish fund’s property

The Irish fund, as borrower, will normally grant a first priority charge over its property including the securities and/or cash account recorded in the books of the depositary. The entity granting the security should be verified. Normally, this will be the ICAV itself, or the general partner for an ILP, or the AIFM and the depositary for a unit trust. The governing law of the charge/security should be verified. In most cases the governing law of the charge/security is the law of the jurisdiction where the secured assets are situated – such law will govern enforcement of the security. In complex fund structures with different cash and securities accounts, this might require multi-jurisdictional charge/pledge or account control agreements to be put in place.

Security over the SPV, if any

Where an Irish fund invests in property through an SPV, such as a private limited company or a partnership, security will normally be also granted over the Irish fund’s shares of the private limited company or interests in the partnership vehicle. If the SPV is a partnership, a lender should request security over the shares of the general partner to the SPV partnership, which would mean that on enforcement the lender will be able to exercise control over the general partner.

Charge over relevant bank accounts

The Irish fund’s bank accounts will typically be held with a credit institution that is not affiliated with the depositary. The charge or pledge over the Irish fund’s bank account should be taken under the laws of the jurisdiction where the bank account is situated. An Irish fund may have different bank accounts, such as a cash account which is maintained to meet its day-to-day expenses, a subscription account into which investor subscriptions and redemption monies are paid, and possibly a rent collection account that is used to collect rental payments or other income or receipts generated on the Irish fund’s investments.

Charge over an Irish fund’s shares or units

A lender may request a charge over shares/units issued by an Irish fund. The grant of charge or security over the shares/units of an Irish fund should be reviewed against the Irish fund’s constitutive document – such as the instrument of incorporation for an ICAV, or partnership agreement for an ILP – to determine the extent of control and the rights that the registration of the shares/units in the name of the lender will confer.

A lender may face difficulty in putting in place this type of security. The investors may comprise a broad base of investors and often it is not feasible to put in place a charge over the shares/units that are held by an international base of investors.

Furthermore, the utility of taking a charge over shares/units of an umbrella fund may be diminished because the charge, if granted over one sub-fund, may not confer control over the Irish fund as a whole. The time required to register the charge in the name of the lender or its security agent, combined with the time required to appoint replacement directors to the Irish fund and obtain their approval by the Central Bank, means that enforcement action under a share charge is not capable of being implemented within a short timeframe.

Subscription line facility

Lenders may provide a subscription line facility, sometimes referred to as capital call facility, to Irish funds. The security for a subscription line or capital call facility normally consists of a security over the Irish fund’s right to call on investors to make capital contributions under the subscription agreement and a charge over the subscription account into which the subscription monies are normally paid by investors. For subscription/capital call facilities, the lender will need to determine: who can make capital calls on investors – normally this will be the ICAV or the general partner in the case of an ILP; when capital calls are permitted to be requested from investors under the subscription agreement, and; what restrictions apply to the making of capital calls from investors.

Guarantees

In financing transactions, a lender may request a guarantee from a parent of the borrower or the borrower’s affiliate. However, as mentioned above, sub-funds within an umbrella fund structure have segregated liability, meaning that one sub-fund may not guarantee the indebtedness of another sub-fund. Furthermore, the rules of the Central Bank prohibit an Irish fund from acting as a guarantor to a third party. Although the Central Bank’s rules do not explicitly define the term “third party” or clarify the scope of the prohibition to “act as a guarantor,” it is generally understood that the prohibition restricts an Irish fund from providing credit support to investments that are not wholly owned by the Irish fund.

Depositary control and acknowledgement

A first priority charge over the Irish fund’s investments is normally coupled with a depositary control deed under which the depositary acknowledges that the Irish fund has charged its assets, and confirms that the lender or its security agent may exercise the sole and exclusive control over the Irish fund’s assets upon the notification of the occurrence of an event of default. As with all financing transactions, it is important to clarify at the outset who has the title to the property and control over its disposition. The depositary control arrangements will need to be tailored in each case to reflect how the Irish fund’s investments are held and managed.

Duty of care agreements

As mentioned above, an Irish fund is managed on a day-to-day basis by its AIFM. The AIFM will often appoint an investment manager with discretionary authority to manage the Irish fund’s portfolio of investments. In addition, the administrator is important to the operation of the Irish fund and it manages the investor subscription process and calculates the fund’s net assets. Normally, a lender will enter into duty of care agreements with the AIFM, investment manager, and administrator, under which each service provider acknowledges the lender’s security and undertakes not to vary the terms of the relevant agreements in any way that would be prejudicial to the lender’s security.

Summary points for lenders to consider

The security over the investments of an Irish fund should be appraised upon a bottom analysis that takes into account matters such as the type of Irish fund vehicle, the types of investments being secured, the location/jurisdiction where the investments are located, the entity in whose name the investments are registered, the presence of an SPV vehicle, if any, through which investments are made, and the authority of the relevant fund service providers to borrow and ground security. This can be a complex set of relationships to manage, so it is recommended that the entire investment structure be understood at the outset.

Based on our experience, we also recommend that future financing requirements are considered when the Irish fund is being designed. We also recommend that, from the very outset, there is close collaboration between the teams of fund formation specialists and fund finance specialists who are engaged in the structuring of the financing arrangements. This will help ensure that financing requirements are embedded into the fund structure from inception.

The growth of fund financing to Irish funds is expected to continue over the short to medium term. Fortunately, the laws of Ireland facilitate lenders in taking a comprehensive security package of an Irish fund.