Private debt funds, and in particular lending funds, play an essential role in providing alternative sources of finance to certain categories of borrowers, such as SMEs. The EU Commission assumes that lending funds will become an increasingly important source of finance for the real economy and has consistently identified lending funds as an essential part of its plan for an effective Capital Markets Union (CMU).
Most lending funds act as AIFs under the general AIFMD regulatory framework, which does not impose any specific requirements on lending funds. There are no harmonized rules for private debt AIFs or AIF lending activities in the European Union. Certain Member States, such as France and Ireland, have specific rules for lending funds. Others, such as Luxembourg, have issued specific prudential guidance on how to apply the general organizational requirements of the AIFMD to AIFMs managing lending funds. Certain countries simply do not allow AIFs to lend.
With the proposed changes to the AIFMD, the EU Commission wants to harmonize the regulatory framework for lending AIFs within the EU. The proposal aims to enable AIFs to grant loans in all Member States, to create a level playing field between the different Member States and to reduce compliance costs. In addition, the aim is to improve risk management, monitor and prevent risks to financial stability, and protect investors.
Proposal from the EU Commission
In order to recognize lending as a legitimate activity of AIFMs and to enable AIFs to lend anywhere in the EU, including across borders, the proposal adds âoriginating loansâ to the list of permitted activities for AIFMs. It also adds the servicing of securitization vehicles by AIFMs, recognizing that special purpose vehicles are generally used to structure private debt funds.
The proposal then lists specific organizational requirements for AIFMs managing AIFs with lending: To improve risk management, AIFMs need to implement policies, procedures and processes for lending, assessing credit risk and managing and monitoring their loan portfolio. It is expected that specific stress test requirements will also apply.
The proposal also adds certain requirements at the level of the lending AIF itself:
- In order to limit the risks associated with the interlinking with the financial system as a whole, a loan granted to a borrower who is a financial company or an undertaking for collective investment may not, subject to certain start-up provisions, account for more than 20% of the capital of an AIF;
- In order to avoid certain conflicts of interest, AIFs may not grant their AIFM, an agent of their AIFM or their depositary any loans;
- To avoid moral hazard situations where loans are issued to be sold immediately in the secondary market, AIFs must maintain a 5% exposure to loans that they have made and then sold on the secondary market; and
- To avoid liquidity transformation risks, AIFs that lend more than 60% of their net asset value must be closed.
The proposal also adds new transparency requirements. AIFMs that manage lending funds must regularly disclose certain information to investors about the composition of the loan portfolio issued.
Finally, AIFMD reporting will be expanded to provide regulators with more detailed information on AIFMs’ lending activities.
Certain Level 2 measures are required to complete and implement the new framework.
The legislative process was initiated with today’s publication of the legislative proposal. The EU Commission’s proposal is now being examined by the EU Parliament and the EU Council. The current version of the text states that the Member States must implement the adopted amendments, once they have been adopted by the EU co-legislators, within 24 months of their entry into force.
For more information, please get in touch with your usual contact within the Fund Formation Group.
To access the proposed directive amending the AIFMD and the UCITS Directive with respect to delegation arrangements, liquidity risk management, supervisory reporting, custody and custody services and lending by alternative investment funds, click here_
Click here to access the annexes to the proposed directive amending the AIFMD and the UCITS directive with regard to delegation arrangements, liquidity risk management, supervisory reporting, custody and custody services and lending by alternative investment funds_