Private debt funds, and loan origination funds in particular, play an essential role in providing alternative sources of financing to certain categories of borrowers, such as SMEs. The European Commission expects loan origination funds to become an increasingly important source of finance for the real economy, and has consistently identified loan origination funds as an essential part of its plan for a effective capital markets union (CMU).
Most loan origination funds operate as AIFs under the general regulatory framework of the AIFMD, which does not impose any specific requirements on loan origination funds. There is no harmonized regime for private debt AIFs or for loan origination activities carried out by AIFs in the European Union. Some 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 organizational requirements of the AIFMD should apply to loan origination fund managers. Some countries simply do not allow AIFs to engage in lending activities.
With the proposed changes to the AIFMD, the European Commission aims to harmonize the regulatory framework for loan origination AIFs within the EU. The proposal aims to enable AIFs to create loans in all Member States, to create a level playing field between different Member States and to reduce compliance costs. It also aims to improve risk management, monitor and prevent risks to financial stability and protect investors.
Proposal of the European Commission
In order to recognize lending as a legitimate activity of AIF managers and to allow AIFs to grant loans anywhere in the EU, including across borders, the proposal adds ‘home loans’ to the list of activities authorized for AIF managers. It also adds the service of Special Purpose Securitization Entities (SSPEs) by AIFMs, recognizing that SSPEs are commonly used to structure private debt funds.
The proposal then lists specific organizational requirements for AIF managers managing loan origination AIFs: to improve risk management, AIF managers should implement policies, procedures and processes for the management of loans. ‘granting credit, to assess credit risk and to administer and monitor their credit portfolio. Specific stress testing requirements should also apply.
The proposal also adds certain requirements at the level of the original loan from the AIF itself:
- to limit the risks associated with interconnection with the financial system in the broad sense, a loan granted to a borrower who is a financial institution or a collective investment undertaking may not represent more than 20% of the capital of an AIF, subject to certain ramp-up arrangements;
- to avoid certain conflicts of interest, AIFs cannot grant loans to their manager, to a delegate of their manager or to their depositary;
- to avoid moral hazard situations in which loans are created to be immediately sold on the secondary market, AIFs must maintain 5% exposure to the loans they created and then resold on the secondary market; and
- to avoid the risks of liquidity transformation, AIFs that issue loans for more than 60% of their net asset value must be of the closed type.
The proposal also adds new transparency obligations. Managers of loan origination funds will periodically disclose certain information to investors on the composition of the loan portfolio issued.
Finally, AIFMD reporting will be extended to provide regulators with more detailed information on AIFM loan origination activities.
Some level 2 measures will be needed to complete and implement the new framework.
Today’s publication of the legislative proposal launched the legislative process. The European Commission’s proposal is currently under consideration by the European Parliament and the Council of the EU. The text in its current version indicates that once adopted by the EU co-legislators, Member States will have to implement the adopted amendments within 24 months of their entry into force.
For more information, please contact your usual contact within the Fund Formation Group.
To access the proposal for a directive amending the AIFMD and the UCITS directive with regard to delegation agreements, liquidity risk management, prudential reporting, the provision of depositary and custody services and loan origination by alternative investment funds, click here_
To access the annexes of the proposal for a directive amending the AIFM directive and the UCITS directive with regard to delegation agreements, liquidity risk management, prudential reporting, the provision of depositary and custody services and origination of loans by alternative investment funds, click here_