Private debt funds, and loan origination funds in particular, play an essential role in providing alternative sources of funding to certain categories of borrowers, such as SMEs. The EU Commission expects loan origination funds to become an ever more important source of financing to the real economy, and has consistently identified loan origination funds as an essential component of its plan for an effective Capital Markets Union (CMU).
Most loan origination funds operate as AIFs within the general AIFMD regulatory framework, which does not impose any specific requirements on loan origination funds. There is no harmonised regime for private debt AIFs or for loan origination activities carried out by AIFs in the European Union. Certain Member States, such as France and Ireland, have adopted a specific regime for loan origination funds. Others, such as Luxembourg, have issued specific regulatory guidance on how the general AIFMD organisational requirements should apply to AIFMs managing loan origination funds. Certain countries simply do not allow AIFs to engage in lending activities.
With the proposed amendments to the AIFMD, the EU Commission aims to harmonise the regulatory framework for loan origination AIFs within the EU. The proposal seeks to enable AIFs to originate loans in all Member States, to create a level playing field between different Member States and to reduce compliance costs. It also seeks to improve risk management, to monitor and prevent risks to financial stability and to protect investors.
EU Commission proposal
In order to recognise lending as a legitimate activity of AIFMs and allow AIFs to extend loans anywhere in the EU, including across borders, the proposal adds “originating loans” to the list of permitted activities for AIFMs. It also adds the servicing of securitisation special purpose entities (SSPEs) by AIFMs, acknowledging that SSPEs are commonly used to structure private debt funds.
The proposal then lists specific organisational requirements for AIFMs managing loan origination AIFs: to improve risk management, AIFMs must implement policies, procedures and processes for the granting of credit, for assessing credit risk and for administering and monitoring their credit portfolio. Specific stress-testing requirements are also expected to apply.
The proposal also adds certain requirements at the level of the loan originating AIF itself:
- to limit the risks associated with inter-connectedness to the broader financial system, a loan granted to a borrower that is a financial undertaking or collective investment undertaking cannot represent more than 20% of an AIF’s capital, subject to certain ramp-up provisions;
- to avoid certain conflicts of interest, AIFs cannot grant loans to their AIFM, a delegate of their AIFM, or to their depositary;
- to avoid moral hazard situations where loans are originated to be immediately sold off on the secondary market, AIFs must retain a 5% exposure to loans they have originated and subsequently sold on the secondary market; and
- to avoid liquidity transformation risks, AIFs which originate loans for more than 60% of their net asset value must be closed-ended.
The proposal also adds new transparency obligations. AIFMs managing loan origination funds will have to periodically disclose certain information to investors on the composition of the originated loan portfolio.
Finally, AIFMD reporting will be extended in order to provide regulators with more granular information on the loan origination activities of AIFMs.
Certain level 2 measures will be needed to complete and implement the new framework.
Today’s publication of the legislative proposal kicked off the legislative process. The EU Commission’s proposal is now under review by the EU Parliament and the Council of the EU. The text in its current version states that once it is adopted by the EU co-legislators, Member States will need to implement the adopted amendments within 24 months following their entry into force.
For further information, please reach out to your usual contact within the Fund Formation Group.
- To access the proposed directive amending the AIFMD and the UCITS Directive as regards delegation arrangements, liquidity risk management, supervisory reporting, provision of depositary and custody services and loan origination by alternative investment funds, click here_
- To access the annexes to the proposed directive amending the AIFMD and the UCITS Directive as regards delegation arrangements, liquidity risk management, supervisory reporting, provision of depositary and custody services and loan origination by alternative investment funds, click here_