Understanding AIFMD II: Navigating Changes in Loan Origination Regulation

2nd April 2024

On 09 November 2023, the European Council published thefinal compromise text(further referred to as “AIFMD II”), amending Directive 2011/61/EUon Alternative Investment Fund Managers (“AIFMD”) and Directive 2009/65/EC on the coordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities (“UCITS Directive”).  

The final text of AIFMD II was approved by the member states of the European Union (“EU”) in the European Parliament on 07 February 2024 and on 26 February 2024, formally adopted by the EU Council. The entry into force will occur 20 days after the publication in the Official Journal of the European Union. The member states will then have a two-year period to transpose AIFMD II into their national laws, with the exception of the measures implementing reporting requirements, which must be applied three years after the entry into force of AIFMD II.  

In this article, we address the changes specific to loan origination under AIFMD II and focus on its anticipated practical implications. 

New requirements under AIFMD II

AIFMD II introduces an entirely new set of requirements specifically addressing loan origination and Alternative Investment Funds (“AIFs”). These requirements make it clear that AIFs are permitted to grant loans, providing the industry with increased legal certainty. Additionally, AIFMD II provides us with updated definitions, affording further clarity and making the requirements easier to understand. 

It is important to note that AIFMD II does not introduce a new fund type e.g. ‘loan funds’, but rather, provides strict requirements for the Alternative Investment Fund Manager (the “AIFM”) when the AIF it manages is granting a loan. Loan origination, from a regulatory perspective, is considered a separate task that an AIFM can additionally perform within the framework of collective asset management (see new systematics in Annex I of the AIFMD). 

Loan Origination

A significant update arising from AIFMD II is the refined definition of ‘loan origination’. Loan origination occurs either directly, with the AIF acting as the lender, or indirectly, when the AIFM is actively involved in structuring the loan or defining the loan agreement. 

Loan-Originating AIFs

Furthermore, AIFMD II introduces the term ‘Loan-originating AIF’, referring to an AIF whose primary strategy involves originating loans or where the notional value of the AIF’s originated loans represents more than 50% of its Net Asset Value (“NAV”). These AIFs can be either closed-ended or open-ended, with the latter requiring the maintenance of appropriate liquidity management systems. 

Risk Management

AIFMD II foresees various measures to ensure proper risk management for Loan-originating AIFs, such as: 

  • AIFMs managing Loan-originating AIFs are required to establish proportionate policies, procedures, and processes. Such policies cover the granting of loans, credit risk assessment, risk diversification, exposure management, and portfolio management. 
  •  Investment restrictions for single borrowers i.e. the nominal value of loans granted by an AIF is limited to 20% of the AIF’s capital if (i) the borrower is a financial institution as defined by Solvency II Directive or (ii) an AIF or a UCITS. 
  •  The leverage of a lending AIF must not exceed 175% for open-ended AIFs and 300% for closed-ended AIFs. 
  •  To maintain integrity within the system, AIFMs and their staff are prohibited from receiving loans from AIFs they manage.  

Risk Retention Requirements

Importantly, to mitigate risk, AIFMD II outlines risk retention requirements for certain Loan-originating AIFs. An AIFM must ensure that an AIF retains 5% of the nominal value of each loan it has granted and subsequently transferred to third parties. The 5% will be retained until maturity for loans whose maturity is up to eight years, or for loans granted to consumers regardless of their maturity. For other loans, the 5% will be retained for a period of at least eight years. AIFMD II foresees exemptions to this requirement, e.g. if the AIFM begins selling assets of the AIF in order to redeem shares or units as part of the AIF’s liquidation. 

Liquidity Management

In principle, loan-originating funds are closed-ended. Open-ended AIFs, susceptible to higher redemptions, face additional scrutiny with imposed leverage limits. An AIFM must be able to demonstrate to its home state regulator that the AIF’s liquidity risk management system is compatible with its investment strategy and redemption policy. Member states have the discretion to further enhance these restrictions, reflecting a cautious approach toward funds with higher redemption risk. 

ESMA’s Role and Transitional Period

The European Securities and Markets Authority (“ESMA”) has been tasked with developing draft regulatory criteria regarding open-ended Loan-originating AIFs. These criteria will guide member states in determining whether a Loan-originating AIF can operate as an open-ended fund. The focus will be on liquidity management, redemption policies, and the characteristics of listed liquidity management tools. 

AIFMD II grants a five-year grace period for AIFMs managing AIFs that grant loans and were launched before the entry into force of the AIFMD review. 

Conclusion

As the financial landscape continues to evolve, adapting to these regulatory changes is essential for all industry participants. The updated requirements for Loan-originating AIFs under AIFDM II aim to enhance transparency, risk management, and overall stability within the sector. 

The above is a high-level outline of some of the important changes under AIFMD II, please get in touch with the Zeidler team should you have any questions on the topic. Staying abreast of such changes will be crucial for financial professionals navigating the intricate world of AIFs. 

How can Zeidler help?  

As your trusted partner, the Zeidler legal team stands ready to assist and provide support. Our global team of professionals is well-versed in the latest legal, regulatory, and compliance developments impacting the asset management industry. We have closely monitored the developments of AIFMD II since the Original Draft. If you require additional information or assistance in understanding AIFMD II and its implications for your business, please get in touch with us.

 

Author

Brigid Dolan