AIFMD 2 and its impact on Loan Origination

On 25 November 2021, the European Commission published a legislative package including amendments to the AIFM Directive (revised Directive).

The revised Directive introduces, amongst other provisions, additional rules that would be applicable to loan originating AIFs.

This revised Directive comes in reaction to the fragmented regulation of loan funds regimes in Europe. It follows-up on the ESMA opinion of April 2016 which set the direction of travel with a proposed harmonized European framework for loan origination by funds.

Aside from the welcome clarification that originating loans is a permitted activity by AIFM, there are proposed new risk management provisions.

AIFMs that manage AIFs engaged in lending activities will be subject to the following requirements:

• Implementation of effective policies, procedures, and processes for the granting of loans (like assessing credit risk, administer and monitor credit portfolios). This requirement also applies to AIFs purchasing loans on the secondary market
• To avoid maturity mismatches, structuring as closed-ended AIFs when the notional value of loans originated exceeds 60% of NAV
• Diversification of risks and exposures subject to specific limits for specific cases: Loans made to a single financial institution / collective investment undertaking  are restricted, with any such loan being capped to 20% of the AIF’s capital (with flexibility for fund’s raising or at the end of the AIF’s life).
• Risk retention requirements to avoid situations in which loans are originated with the sole purpose of selling them. These AIFs must retain an economic interest of 5% of the notional value of loans they have granted and sold off to the secondary market.
• Reporting to investors on the composition of the portfolio of originated loans.
• In order to limit conflicts of interest, the AIF cannot lend to its AIFM and related parties (e.g., depositary or delegates).

As noted above, with the origination of loans being considered a permitted activity, AIFMs will clearly be able to conduct such activities on a cross-border basis. The harmonization of rules for AIFMs of loan-originating AIFs – especially those dealing with new risk management provisions – are not too far from the criteria already required by the Luxembourg CSSF (with necessary expertise and appropriate resources). It is encouraging that the new measures don’t require an authorization gateway for loan origination funds maintaining a level of flexibility for Luxembourg funds.

Concerns about redemption pressures are addressed by requiring only funds fully engaged in loan origination to be ‘closed ended’. Those which are partly engaged in such activities (less than 60% of NAV) could remain open ended. The draft Directive requires limited diversification when lending to a single credit institution however it doesn’t require that loan origination funds cannot engage in other activities such as short-selling, securities lending, or use of derivatives.

Overall, these proposed new measures are not the overhaul originally expected by some. They re-emphasize the importance of loan funds as one of the main financing sources in the EU. Their activities should not be hindered too much which is increasingly important in these times of recovery.

Member States are in the process of assessing the revised Directive. It remains to be seen whether certain Member States with restrictive loan origination framework will not try to impose further restrictions.

Implementation date is not expected before 2025.