The holder cap is a fact about year three.

The lighter fund tiers in each centre cap the number of holders. The cap is read at formation, against the first close, and found comfortable: twelve institutions against a cap several times that. It is then forgotten, and it is the forgetting that costs, because the cap is counted on every day of the vehicle's life, and the register moves without the manager subscribing anybody. A cap that was comfortable at first close is the binding constraint in year three, on a day the manager did not choose, triggered by an event it did not control.

This note sets out how a register grows without a subscription, what a breach of the cap does to the vehicle, what constitutions usually do about it and why that is not enough, the provisions that hold, the placement dimension of every transfer, a worked illustration over a ten-year life, cases as types, what each party holds, the sequence and the questions managers ask.

How a register grows without a subscription

Three movements add holders, and none is in the manager's control.

A transfer splits a holding. An institution that sells part of a position to two buyers has turned one name on the register into three. A holder that is itself a fund of funds and distributes its interest in kind to its own investors on winding up has turned one name into twenty, each of whom must be classified, each of whom counts.

An estate or a restructuring converts one name into several. An individual holder dies and the holding passes to heirs, who may be several and who may not pass the tier's test. A family holding company is demerged and its interest divided among successor companies. A corporate holder is acquired and its interest transferred to the acquirer's subsidiaries for its own reasons. A sovereign reorganises its investment arm into four entities.

A feeder is dissolved. A feeder vehicle is one holder for the master's count, and when it is reorganised or wound up by its own sponsor, for its own reasons, and its participants arrive on the master's register directly, one holder becomes forty. The feeder's sponsor owes the master nothing and may give no notice.

What a breach does

A vehicle over the cap no longer meets the conditions of its tier. In both centres the consequence is that the regulator may require the vehicle to convert to a higher tier, with that tier's duties, documents and providers, or may treat the vehicle as having been a fund of a different kind for as long as the breach lasted, with the duties of that kind unperformed. The manager's permission is reviewed in that light, because operating a fund outside its tier's conditions is a conduct matter. The lender's facility usually carries a representation that the fund meets its tier's conditions, which is now untrue. And the holders, who subscribed to a qualified investor fund, hold units in something else.

What constitutions usually do

They refuse a transfer that would breach the cap. The refusal right is real and most constitutions have it. It is not a cure, for three reasons. It does nothing about estates, restructurings and feeder dissolutions, which are not transfers the manager consents to. It converts a holder who must sell into a holder in distress, and a distressed holder on a closed-ended vehicle is a problem the manager will be asked to solve, usually by finding the buyer itself, which raises the placement question in the state the buyer sits in. And it is operated at the worst moment: the transfer is on the table, the buyer is identified, the seller has a reason to leave, and the manager is the party saying no.

The provisions that hold

The better provisions are designed for the count rather than against it, and there are five of them.

Headroom. A number of holders reserved at first close, stated in the constitution, so that the cap is never reached by commitments alone. A vehicle with a cap of fifty and a register of thirty has headroom for twenty movements; one with a register of forty-eight has headroom for two. The manager decides the headroom as a design choice, and the register is sized to it.

A split rule. Transfers are permitted only where the number of transferees keeps the register within the headroom, with the manager's consent expressly conditioned on the count, so that the refusal is a constitutional mechanism rather than a discretion.

Aggregation. A rule counting holdings under common ownership or control as one holder, where the tier's own counting rule permits it, with evidence of common control required at the point of transfer and reviewed annually. A sovereign's four subsidiaries are one holder under such a rule; a family's three successor companies are one.

A feeder covenant. A feeder admitted to the register undertakes, in its subscription agreement, to give a stated notice before any dissolution or reorganisation that would bring its participants onto the register, and to replace itself with a nominee the tier counts as one, or to procure that its participants hold through such a nominee. The covenant binds the feeder's sponsor, who otherwise owes the master nothing.

A conversion path. A procedure written at formation for converting to the next tier up if the cap is reached despite the rest: the consents required, the documents to be re-papered, the regulator's process, the providers to be appointed and who bears the cost. A breach then becomes a known procedure rather than an emergency negotiated in front of the holder who triggered it.

By provision · by movement	Transfer splits	Estate or restructuring	Feeder dissolution
Refusal right alone	Refuses the transfer; seller in distress	No effect	No effect
Headroom	Absorbs within the reserve	Absorbs within the reserve	Absorbs small feeders only
Split rule	Limits transferees to the headroom	No effect	No effect
Aggregation	Counts common-control transferees as one	Counts successor entities as one	No effect on unrelated participants
Feeder covenant	No effect	No effect	Notice and a nominee keep the count at one
Conversion path	Last resort, as a procedure	Last resort, as a procedure	Last resort, as a procedure

The counting rules, read closely

Each centre's rules say how holders are counted, and the rule is read before any of the provisions above is drafted, because a provision that counts differently from the rule is a provision the regulator ignores.

The rules address nominees: whether a nominee holding for several persons is one holder or several, and in what circumstances. They address joint holders: whether two persons holding one unit jointly are one or two. They address feeders and other collective vehicles: whether a fund that holds units is one holder regardless of its own register, and whether that changes where the feeder was formed for the purpose of circumventing the cap. They address holdings under common control in some cases and not in others. And they fix the date of counting, which in both centres is continuous.

A manager who drafts an aggregation rule that the centre's counting rule does not recognise has drafted comfort for itself and nothing for the regulator. The aggregation rule that holds is the one that mirrors the counting rule's own treatment of common control, with the evidence the rule requires, and an aggregation the rule does not permit is not attempted.

Transfers between existing holders

The one transfer that never moves the count is a transfer from one existing holder to another, and a constitution designed for the cap makes that transfer the easy one. A pre-emption right for existing holders on any proposed transfer, on the same terms as the proposed buyer, gives a selling holder a buyer the count already includes and gives the manager a transfer it can consent to without a classification, a placement route or a headroom calculation. The pre-emption period is short enough that a seller with a buyer is not held for a quarter, and the price mechanism is the proposed buyer's price or a valuation, so that the existing holders cannot use the right to squeeze a seller.

The same logic applies to the holder who ceases to qualify. A compulsory transfer provision that offers the position first to the existing holders, at a valuation, keeps the count flat and the register qualified, and the holder who must leave leaves at a price the constitution sets rather than at a price a distressed sale produces.

The lender's reading of the count

A capital-call facility lender reads the register twice: once for the count, because its facility carries a representation that the fund meets its tier and an event of default if it does not, and once for the borrowing base, because each holder's undrawn commitment is graded for credit. The two readings pull in different directions. A feeder is one holder for the count and is graded on the lender's view of its participants, which is often nothing, so that a fund designed to keep its count low through feeders has a borrowing base the lender discounts. A sovereign's four subsidiaries are one holder under the aggregation rule and four borrowers for the lender, each of which has to sign the lender's acknowledgement.

The facility's transfer provisions also bind. A transfer of units that the constitution permits still needs the transferee to sign the lender's acknowledgement, or the commitment leaves the borrowing base and the facility may need to be reduced. A constitution drafted for the cap alone, without the lender's acknowledgement as a condition of every transfer, has a transfer provision the lender will ask to be amended at the first drawdown.

Designing the feeder relationship

A feeder is the largest single risk to the count, because its dissolution is decided by a party outside the fund, and the design of the feeder relationship is therefore the most important of the five provisions. The feeder's subscription agreement carries the covenant: notice of a stated length before any dissolution, reorganisation or distribution in kind that would bring its participants onto the register; an undertaking to replace itself with a nominee the tier counts as one, or to procure that its participants hold through such a nominee; and an acknowledgement that a breach of the covenant entitles the manager to refuse to register the participants and to treat the feeder's interest as held by the feeder's liquidator pending a compliant arrangement.

The feeder's own constitution is read for the same purpose. A feeder whose own rules permit its participants to require a distribution in kind of the master's units has a dissolution risk its sponsor cannot control, and the covenant has to reach the feeder's own documents. A feeder sponsored by the manager itself is the easiest case, because the manager controls both sides; a feeder sponsored by a bank or a platform is the hardest, because the sponsor's interests and the manager's diverge on the day the feeder is no longer useful to the sponsor.

Sizing the register to the cap

A method, as a type. Start with the cap the tier imposes. Subtract the headroom the manager will reserve, and the headroom is decided by the register's composition rather than by a round number: one reserved place for each holder that is an individual or a family entity, because those produce estates and demergers; one for each institution that has reorganised in the last decade, because institutions that have reorganised once reorganise again; three for each feeder that is not under the manager's control, because a feeder's dissolution is the largest single movement and a nominee absorbs only part of it; and two for transfers the manager cannot foresee. The remainder is the register the fund can admit at final close.

A cap of fifty, a register intended to include six family entities, four institutions with a history of reorganisation, two external feeders and a balance of institutions, produces a headroom of six plus four plus six plus two, which is eighteen, and a register of thirty-two. A manager who wants forty holders at final close with that composition has described the exempt tier, and the method has told it so before the vehicle is formed.

The method also tells the manager which provisions matter most for its particular register. A register of institutions with no individuals and no external feeders needs the aggregation rule and little else; a register with three external feeders needs the feeder covenant above everything; a register of families needs the provision for a holder who ceases to qualify and the pre-emption for existing holders. The headroom is reserved against the movements the register will actually produce, and the constitution is drafted to them.

The count is also a placement fact

A holder who arrives by transfer is a holder who was, in the eyes of most Gulf regimes, marketed to. The secondary sale of a foreign fund's units to a resident of the Kingdom, of Kuwait or of Qatar is an offer of those securities in that state, and the buyer's standing is tested under the same rules as a primary subscriber's. The Kingdom's regulations confine secondary transfers of privately placed securities to existing holders, to institutional and qualified clients, or to lots of two hundred thousand riyals or less. Kuwait's permission attaches to the scheme. Qatar's count of one hundred potential buyers grows with every person a seller approaches. A manager who has designed the count has usually also designed the transfer regime, because the two are one provision read from two sides: who may arrive, by what route, and how many.

Where it surfaces

At the transfer the manager consents to without counting, because the constitution's refusal right was a discretion the manager did not think to exercise on a transfer between two institutions it knew.

At the feeder's dissolution, announced by the sponsor's liquidator in a letter the manager did not expect, with a list of participants the manager has never classified and a date the count will move on.

At the lender's annual review, when the representation that the fund meets its tier is repeated in a compliance certificate the manager signs, and the count on the day is over the cap.

At the regulator's review, when the administrator's register is read day by day against the cap and the breach is dated to the day the feeder's participants arrived.

At the distribution in kind, when the asset is divided among a register that includes persons the tier never admitted and whose capacity to receive the asset was never tested.

In every case the discovery is made by a party other than the manager, at a moment the manager did not choose, and the cure is a procedure that should have existed and does not.

A ten-year life, as a type

A qualified investor fund is formed with a cap of fifty and a register of thirty at final close, with headroom of twenty, an aggregation rule and a feeder covenant. Year two: a sovereign reorganises its investment arm into four subsidiaries; under the aggregation rule the four count as one; the register stands at thirty. Year three: a family holding company is demerged into three; the three are under common control and count as one; thirty. Year four: a feeder with eighteen participants gives the year's notice its covenant requires and replaces itself with a nominee; thirty. Year five: an institution sells half its position to two buyers; the split rule permits it within the headroom; thirty-two. Year seven: an individual holder dies and the holding passes to three heirs, two of whom fail the tier's test; the constitution's provision for a holder who ceases to qualify operates, the heirs hold through a qualifying nominee or sell to an existing holder; thirty-two. Year nine: a distribution in kind at the end of the term to thirty-two holders, each of whom was classified at admission or at transfer.

The same vehicle drafted with a refusal right alone: year two, thirty-three; year three, thirty-five; year four, fifty-two and in breach; the conversion is negotiated with the regulator, the lender and the register at once, in front of the feeder's participants who triggered it.

Four cases, as types

A fund with a cap of fifty and forty-five holders at final close, drafted with a refusal right and nothing else. In year two a sovereign holder reorganises its investment arm into four subsidiaries and transfers its interest to them under a transfer the constitution permits, because it is not a transfer to a new person in the manager's reading. In year four a feeder with eighteen participants is wound up by its sponsor, a bank that has closed the product line, and the participants arrive on the register. The fund is over its cap. The lender's representation is untrue and the facility is in default pending a waiver; the regulator's review finds a fund outside its tier for the period; the conversion to the exempt tier is done under pressure, with a new administrator, a new memorandum, a depositary the exempt tier in that centre requires for the asset class, and a re-papering of fifty-two subscriptions, each of which needs a classification the manager never performed for the feeder's participants.

A fund whose constitution refuses transfers that breach the cap and has no pre-emption. A European holder under its own regulator's pressure to divest finds that the only permitted buyers are the existing holders, who know it must sell and who are not obliged to buy. The price reflects it. The manager, asked to help, finds an outside buyer in the Kingdom, and in finding it has offered a foreign fund's securities in the Kingdom without a distributor, which the distributor it uses for primary placements declines to paper retrospectively.

A fund whose feeder covenant required a year's notice and a replacement nominee. The feeder's sponsor, closing the product line, gives the notice; the manager forms a nominee company that the tier counts as one holder; the participants' interests are transferred to the nominee with each participant's classification recorded; the count does not move, and the lender, which had never counted the feeder in its borrowing base, now has a nominee whose participants it can grade.

A fund with headroom of twenty, an aggregation rule mirroring the centre's counting rule, a split rule, a feeder covenant, a pre-emption for existing holders and a conversion path, none of which is ever needed beyond the first four. The count is a number in the administrator's quarterly report, with the headroom remaining stated beside it, and the one holder that ceases to qualify in year seven is bought out by two existing holders under the pre-emption at a valuation the constitution fixed.

What each party holds

The manager holds the headroom decision, the consent on each transfer, the aggregation evidence and the conversion path.

Counsel holds the drafting of the five provisions to the tier's counting rule and the placement regimes, and the opinion on whether a particular movement breaches.

The administrator holds the count as a live number, reported with the headroom remaining, and refuses to register a transfer the constitution does not permit.

The lender holds the representation that the fund meets its tier and a default if it does not.

The feeder's sponsor holds the covenant and the notice.

The regulator holds the counting rule and the review.

The sequence

1. The cap is read against the intended register at final close, and the headroom is fixed.
2. The aggregation rule is drafted to the tier's counting rule, with the evidence it requires.
3. The split rule and the feeder covenant are drafted into the constitution and the subscription agreements.
4. The secondary-transfer rule of every state a buyer could sit in is read, and the manager's consent conditioned on it.
5. The conversion path is written as a procedure with consents, documents and cost.
6. The administrator reports the count and the headroom every period.

Questions a manager asks

Is the cap counted at first close or continuously. Continuously. A vehicle is within its tier on every day the count is at or below the cap and outside it on every day it is not, and the administrator's register is the evidence of the count on each day. A breach that lasted a week is a breach that lasted a week.

Does a nominee count as one holder. Under some counting rules and not others, and in some circumstances and not others: a nominee formed to circumvent the cap is looked through by rules that would otherwise count it as one. The answer is read from the tier's rules, with counsel's opinion in the file, before a nominee is relied on, and the nominee's own arrangement is drafted to the rule.

Can the manager simply refuse every transfer. It can, and the refusal converts every seller into a distressed holder and every estate, restructuring and feeder dissolution into a breach the refusal does not reach, because those are not transfers the manager consents to. A refusal right is a backstop, not a design.

What happens to a holder who ceases to qualify, by death, by change of status or by a change in the rules. The constitution provides for it or it does not. A compulsory transfer to a permitted holder at a valuation, a holding through a qualifying nominee, or a redemption where the tier permits it, each written at formation with the pre-emption for existing holders. A constitution without the provision has a holder it cannot keep and cannot remove, and a register it cannot evidence.

Does the cap reach the feeder's participants. Not while the feeder exists and the counting rule treats it as one. It reaches them the day the feeder does not exist, and the feeder covenant is the only protection the master has against a decision its sponsor takes for its own reasons.

Is conversion to a higher tier a realistic cure. It is a procedure with the regulator's process, the holders' consent, new documents and usually new providers, and it takes a quarter at best. Written at formation as a path, it is a procedure the manager runs; discovered at breach, it is a negotiation the manager loses, with a lender in default and a regulator reading the register.

Does the cap affect the exit. A distribution in kind goes to every holder on the register, and a register of fifty-two that should have been fifty is a distribution to two persons the tier never admitted. A continuation vehicle's rolling holders are counted against the new vehicle's cap on the day they roll. A secondary sale of the whole is a transfer to one buyer, which the cap does not reach, unless the buyer is itself several.

Terms used

Holder cap: the maximum number of holders a tier permits, counted daily.

Headroom: the reserve between the cap and the register fixed at formation.

Aggregation: counting holdings under common ownership or control as one holder, where the tier permits.

Split rule: a transfer provision permitting partial transfers only within the headroom.

Feeder covenant: a feeder's undertaking to give notice before dissolution and to replace itself with a nominee.

Conversion path: the constitutional procedure for moving to a higher tier.

Secondary transfer: the sale of existing units to a new holder, read by onshore regimes as a placement.

What to read

The funds rules of the centre on the tier's holder limit and its counting rule; the constitution's transfer, aggregation, feeder and conversion provisions; the subscription agreement's feeder covenant; the secondary-transfer rules of the Kingdom, Kuwait and Qatar. On this site, the vehicles and liquidity rooms under Structures and the worked structure on an investor class.