The adoption by the EU Council of new rules under AIFMD II followed the political compromise with the European Parliament reached on 7 February 2024. The new rules will shortly be published in the EU’s Official Journal and will enter into force 20 days later. AIFMD II will subsequently be subject to implementation into national laws in EU Member States, which is intended to take place within 24 months, in early 2026.
The amendments proposed by AIFMD II will significantly impact all alternative investment funds (AIFs) that are active in any type of loan origination.
New requirements applicable to funds providing loans
The new requirements of AIFMD II relate to "loan origination". "Loan origination" is defined as the granting of a loan, either (i) directly by an AIF as an original lender or (ii) indirectly through an SPV or another third party that originates the loan for or on behalf of the AIF or AIFM, whereby the AIF or AIFM is involved in structuring the loan or defining or pre-agreeing the characteristics of the loan prior to gaining exposure to the loan.
All funds that grant such loans will be affected by the new requirements for loan origination. Additional, far-reaching requirements will apply to a "Loan-Originating AIF", which is defined as (i) an AIF whose investment strategy is mainly to originate loans or (ii) an AIF where the notional value of the AIF's originated loans represents at least 50% of its net asset value.
Rules for all AIFs that carry out loan origination
The following new requirements apply to all AIFs that carry out loan origination as part of their activities:
- Ban on "originate-to-distribute": AIFMs are prohibited from managing AIFs with a strategy of originating loans for the sole purpose of transferring those loans or exposures to third parties.
- Lending concentration restrictions: an AIF may not provide loans to its AIFM, any member of the AIFM's group, its staff or depositary. AIFs also may not lend more than 20% of their capital to any single borrower that is an AIF, a UCITS or a financial undertaking. In addition, EU Member States may opt to restrict lending by AIFs to consumers.
- Risk retention requirement: In order to mitigate the risk of AIFMs originating poor quality loans that are then sold in secondary markets, a risk retention requirement is introduced. In principle, AIFs must retain 5% of each loan that they originate during at least the first eight years.
- Policies and procedures: AIFMs must establish and implement policies, procedures and processes for the origination of loans and the administration and monitoring of the credit portfolio. These policies, procedures and processes must be reviewed at least once a year.
- Article 23 disclosures: In their Article 23 disclosures, AIFs must disclose the costs and expenses linked to the administration of the loans attributed to the AIF.
Additional rules for Loan Originating AIFs
The following additional requirements apply to AIFs whose investment strategy is mainly loan originating (Loan Originating AIFs):
- Closed-end preference: In principle, Loan Originating AIFs must be closed-end. However, an AIFM is allowed to manage an open-end Loan Originating AIF if it can demonstrate to the relevant supervisory authority that the AIF's liquidity risk management system is compatible with its investment strategy and redemption policy. ESMA will draft regulatory technical standards setting out further requirements to be met in this respect. In addition, open-end funds in general are required to select appropriate liquidity management tools from a list annexed to the AIFMD II.
- Limits on leverage: Open-end Loan Originating AIFs are subject to a leverage cap of 175% and closed-end Loan Originating AIFs are subject to a leverage cap of 300%. Leverage is defined as the ratio between the committed exposure of the Loan Originating AIF and its net asset value. Lending that is fully covered by capital commitments from investors is not regarded as such exposure. Exposure arises through borrowing cash or securities, leverage embedded in derivative positions, or other means.
The above is subject to certain carve-outs and exceptions, for example in relation to shareholder loans provided by an AIF that do not exceed 150% of the AIF's capital.
Grandfathering periods
Grandfathering provisions apply to loans that were originated before AIFMD II entering into force. AIFs that exist when AIFMD II comes into force may benefit from grandfathering also in respect of the closed-end preference and leverage caps.
Advantages for AIFMs: EU passporting
Once AIFMD II is implemented, AIFMs that engage in loan origination will be allowed to conduct their loan origination activities in all EU Member States on a cross-border basis.
This is expected to facilitate access to alternative lenders for all EU companies, which have seen their access to traditional bank loans become more limited and more costly. By introducing an EU passport for AIFMs that engage in loan origination, the expectation is that access to alternative forms of funding will become easier.
Conclusion and next steps to consider
In conclusion, AIFMD II introduces new requirements for all investment funds with loan origination activities in the EU, regardless of whether or not these are part of their investment strategy. It also introduces an EU passport for AIFMs active in loan origination, allowing them to conduct their loan originating activities in all EU Member States on a cross border basis.
Investment funds providing loans should consider taking the following steps well ahead of the new rules coming into force:
- review whether AIFs providing debt finance are in scope of the new EU rules for loan origination activities and/or whether they may benefit from grandfathering provisions;
- review loan portfolios for concentration risk, risk retention and loan distribution and syndication; and
- review policies, and disclosure, also (in the case of open-end funds) in relation to liquidity risk and leverage.
For further information on the above or other AIFMD II amendments, please contact our Financial Markets team, through [email protected] and [email protected].