Loan origination activities under the EU's second Alternative Investment Fund Management Directive, known as AIFMD2, present both opportunities and challenges for alternative investment funds, or AIFs, writes Geoffroy Hermanns, partner at Norton Rose Fullbright in Luxembourg. In this contribution as Knowledge Partner to Investment Officer Luxembourg, he also addresses the impact these AIF changes can have for Eltif funds used for loan origination.
The new regime applicable to funds providing loans introduced by AIFMD II can be divided into two sets of rules. The first set applies to any AIF which grants a loan either directly as an original lender or indirectly through a special-purpose vehicle or another party. The second set applies to AIFs which either have an investment strategy of mainly acting as a loan originator or have originated loans which represent at least 50% of the AIF net asset value.
1. New regulations applicable to AIFs providing loans:
A. Requirements applicable on all AIFs that originate loans:
Lending concentration restrictions:
AIFs may not lend more than 20% of their capital to any single borrower that is:
- A financial undertaking;
- An AIF; and
- An Undertakings for Collective Investments in Transferable Securities (Ucits).
The capital of the AIF being defined as “the aggregate capital contributions and the uncalled capital commitments, calculated on the basis of amounts investible after deduction of all fees, charges and expenses that are directly or indirectly borne by investors”.
Risk retention requirement:
All loans originated by AIFs after 15 April 2024 will be required to retain 5% of each loan that they originate during at least 8 years that may apply in certain jurisdictions.
B. Additional requirements for Loan-Originating AIFs:
Leverage cap:
- 175% for open-ended AIFs;
- 300% for closed-ended AIFs.
The leverage limit is to be expressed as the ratio between the AIF’s exposure calculated according to the commitment method (Net risk + borrowings + reinvestment of collateral) and its net asset value.
Preference for closed-ended loan-originating AIFs:
Loan-originating funds should generally be structured as closed-ended funds, unless the Alternative Investment Fund Manager (AIFM) can demonstrate to the competent supervisory authority that the managed open-ended AIF has an adequate liquidity management system that takes sufficient account of the AIF’s investment strategy and its redemption rules.
C. Prohibited activities:
Under AIFMD II, AIFs that originate loans are prohibited from granting loans to:
- the AIFM or the staff of the AIFM;
- their depositary and the depositary’s delegates;
- the AIFM’s delegates and their staff; and
- any entity in the AIFM’s group.
II. New regulations applicable to AIFMs managing loan origination AIFs:
A. Policies, procedures and processes for the granting of loans and credit risk management:
AIFMs must implement effective policies, procedures and processes for the granting of loans, for assessing credit risk and for administering and monitoring their credit portfolio. They must also keep those policies, procedures and processes up to date and effective and review them regularly (at least once a year).
B. Exemptions for shareholder loans:
Under AIFMD II, shareholder loans are defined as loans “granted by an AIF to an undertaking in which it holds directly or indirectly at least 5 % of the capital or voting rights, and which cannot be sold to third parties independently of the capital instruments held by the AIF in the same undertaking”.
Provided that the nominal value of shareholder loans does not exceed in aggregate 150% of the AIF’s capital, its AIFM is exempted from the leverage caps, the policies, procedures, processes and credit risk management, as referred above.
III. Easier access for companies to debt financing:
A. Introduction of the European Passport for loan origination activities:
AIFMs involved in loan origination can now operate on a cross-border basis within the EU. This provides all EU companies with access to a potential alternative funding source in a market where bank loans are increasingly restricted and expensive, notwithstanding any existing banking monopoly rules.
B. A new regime that competes with ELTIFs originating loans:
A European Long-Term Investment Fund, or ELTIF, used to be the only investment vehicle permitted to carry out loan origination activities on a cross-border basis through its European marketing passport. The granting of access to loan-originating AIFs to the European passport means the attractiveness of ELTIFs could be reduced, given their stricter legal framework.
Comparison between the two regimes:
|
|
AIFMD II |
ELTIF 2.0 |
|
Leverage limits |
For open-ended AIFs: 175% of the capital For closed-ended AIFs: 300% of the capital |
For ELTIFs marketed to retail investors: 50% of the net asset value For ELTIFs marketed to professional investors: 100% of the net asset value |
|
Diversification limits |
20% of the capital of the AIF to any loan granted (only when the borrower is a financial undertaking, an AIF or a UCITS) |
20% of the capital of the ELTIF to any loan granted (only for retail investors) |
To conclude, loan origination activities under AIFMD II present both opportunities and challenges for AIFs. While the updated framework aims to provide a more cohesive regulatory environment, ensuring compliance and navigating the evolving landscape of lending activities will require careful attention to regulatory requirements, risk management and market dynamics.
The impact of these new requirements is yet to be seen. It will be interesting to see how they are interpreted locally by financial regulators and whether they will interfere with the existing well-established loan origination providers.
Geoffroy Hermanns is a partner at Norton Rose Fullbright in Luxembourg. The law firm is a knowledge partner of Investment Officer Luxembourg.
