Rated Note Feeder Funds: 5 Key Considerations for Insurer Investors

As insurance companies increasingly seek capital-efficient access to private credit strategies, Rated Note Feeder Funds (RNFs) have emerged as a compelling structure. These investment vehicles blend debt and equity features to optimise regulatory capital treatment. However, investing in RNFs requires careful scrutiny of their legal and operational architecture.

Navigating the Complexity of RNFs

RNFs function by pooling capital from a select group of institutional investors, predominantly insurers, and then funnelling it into a master private credit fund. This two-tiered structure is critical. The "feeder" fund issues two classes of securities: a senior, rated debt component (the "rated notes") and a junior, unrated equity component. The core benefit for insurers is that the rated notes, due to their investment-grade rating, attract a much lower regulatory capital charge compared to a direct investment in the underlying private credit assets under certain insurance regulatory regimes. This structure essentially allows insurers to gain exposure to high-yield private credit while maintaining a more favourable capital position on their balance sheet.

Below are five critical considerations for insurer investors evaluating such investments.

1. Credit Rating and Regulatory Alignment

The cornerstone of RNF appeal lies in their ability to secure a credit rating - typically investment grade - which can significantly reduce capital charges for insurers. It's essential that the rating is obtained from a recognised rating agency and remains valid throughout the life of the investment. A downgrade or withdrawal of the rating could immediately increase capital requirements, eroding the primary benefit of the investment.

Insurer investors should ensure that fallback mechanisms are in place should the rating be withdrawn or downgraded, including options to convert debt into equity in either the feeder fund or master fund, or exit the structure. Beyond the initial rating, investors must also scrutinise the rating methodology itself. What are the key assumptions? How sensitive is the rating to changes in the underlying fund's performance or leverage? A robust due diligence process will include stress-testing scenarios to understand how a downturn could impact the rating and, consequently, the insurer's regulatory capital. It's also vital to confirm that the rating agency is on the approved list of regulators to ensure the capital benefits are fully realised.

2. Commitment Structure and Drawdown Flexibility

RNFs usually operate on a dual commitment model, where insurance investors allocate capital in a fixed ratio between rated notes and equity interests. While this ratio is often set at inception (e.g., 75:25), it may be adjusted by the manager to preserve rating integrity or meet regulatory thresholds. This dual commitment creates a complex capital call dynamic. The manager will typically draw down capital for the rated notes first, followed by the equity portion as needed to cover losses or fund new investments.

Insurer investors should understand how drawdowns are triggered, the notice periods involved, and whether re-borrowing or conversion mechanisms could affect liquidity or capital treatment. A key area of inquiry should be the sequencing of capital calls. For instance, what happens if the manager calls on the equity commitment before fully drawing down the rated notes? Additionally, investors should clarify the process for "re-borrowing," where repaid principal from the rated notes can be called again by the manager. This feature can be a double-edged sword: it offers the manager more flexibility but may introduce uncertainty for the insurer's cash flow planning and solvency metrics.

3. Transferability and Stapling

Liquidity planning is crucial for insurers, and RNFs typically impose transfer restrictions. Notably, the rated notes and equity interests are often stapled, meaning they must be transferred together and only with the manager's consent. While intra-group transfers may be permitted, broader disposals could be constrained.

This has implications for portfolio rebalancing, exit strategies, and internal governance. The stapled nature of the investment means that a sale is a complex and often manual process. Unlike a publicly traded bond or ETF, there is no liquid secondary market. This lack of liquidity makes it difficult to rebalance portfolios or exit the investment quickly in a stressed market. The transfer restrictions are a key part of the fund's legal architecture, designed to ensure that the fund's capital structure and investor base remain stable. However, they place a high burden on the insurer to forecast its long-term needs accurately. Investors should negotiate for clear, pre-defined terms on transferability and understand the manager's typical response time and criteria for approving a transfer request.

4. Credit Facilities and Cross-Collateralisation Risk

Many RNFs are structured to support subscription credit facilities, which may be secured against investor commitments. While these facilities can enhance operational flexibility, they also introduce cross-collateralisation risk, particularly if shared with other funds managed by the same sponsor.

Insurers should seek transparency on the scope of such facilities and ensure that their commitments are not exposed to unrelated liabilities. The presence and terms of these facilities can introduce an additional layer of risk. For example, if the master fund defaults on its credit facility, the lender could seek recourse from the RNF's investors, potentially activating a capital call on a pro-rata basis. This risk is amplified if the facility is shared across multiple funds. Insurance investors should perform a deep dive into the legal documentation to understand the ranking of the credit facility, the circumstances under which it can be drawn, and any protective covenants that prevent its misuse. A clear delineation of the RNF's assets and liabilities from those of the sponsor's other funds is essential to mitigate this exposure.

5. Subordination and Limited Recourse

RNFs often feature subordinated notes, meaning payments to insurance investors may rank behind other obligations, such as credit facilities. Moreover, these structures typically include limited recourse provisions, restricting investor claims to the assets of the feeder fund itself. This can be beneficial from a risk containment perspective but may also limit recovery in distressed scenarios.

Insurance investors should assess how these features interact with their own solvency and risk frameworks. The subordination of the notes means that in a liquidation event, the noteholders are paid after senior creditors, such as the providers of the subscription credit facility. This structural feature is necessary to secure the investment-grade rating but puts the noteholders at a higher risk of loss if the underlying portfolio performs poorly. Similarly, the limited recourse provisions mean that an investor's exposure is capped at their committed capital; they cannot be held liable for the debts of the master fund or the sponsor. While this provides a degree of liability protection, it also means that in a worst-case scenario, the insurer may not be able to recover its full investment, even if the master fund has assets that could be used to satisfy its claims.

Conclusion

Rated Note Feeder Funds offer a sophisticated route into private credit for insurer investors, balancing yield potential with capital efficiency. However, their complexity demands a thorough understanding of the legal, regulatory, and operational dynamics. By focusing on rating integrity, recourse limitations, drawdown mechanics, transferability, and credit facility exposure, insurers can make informed decisions that align with their strategic and regulatory objectives.

The authors regularly carry out due diligence review of the legal documents for private credit funds and RNFs, in particular for institutional investors, including insurance investors, as well as advising fund sponsors. If you would like to discuss any of these key considerations or private credit funds or RNFs in greater detail, please reach out to the authors directly.