3. Loan origination
AIFMD II - European Parliament Final Report - Loan origination
The EU Parliament final report adds the following three definitions, as in the Council position:
‘loan-originating AIF’ means an AIF whose principal activity is to originate loans and for which the notional value of its originated loans exceeds 60 % of its net asset value; and
‘capital’ means aggregate capital contributions and uncalled committed capital, calculated on the basis of amounts investible after the deduction of all fees, charges and expenses that are directly or indirectly borne by investors;
‘leveraged AIF’ means an AIF whose exposures are increased by the managing AIFM, whether through the borrowing of cash or securities, or leverage embedded in derivative positions or by any other means.
Regarding the requirements to have, for loan originating activities, effective, up-to-date and annually reviewed policies, procedures and processes for granting credit, assessing the credit risk and administering and monitoring the credit portfolio, the EU Parliament final report excludes the shareholder loans where they do not exceed in aggregate 150 % of the capital of the AIF. The reference to capital is broader than the reference to 150% of the NAV of the AIF as mentioned in the EU Parliament draft report.
The 20% limit of the AIF capital relating to certain types of borrowers is not broadened in the EU Parliament final report, there are no additional references to “commitments or overall subscription”.
The ban on the granting of loans to an entity within the same group as the AIFM does not apply where that entity is a financial undertaking that exclusively finances borrowers that are neither AIFM and its staff, depositary and its delegates nor an entity to which the AIFM has delegated functions pursuant to Article 20 of the AIFMD.
The following new obligation is added in the EU Parliament final report: the proceeds of the loan, minus the fees for the administration of the loan, shall be attributed to the fund in full. All costs and expenses linked to the administration of the loan shall be clearly disclosed to investors according to the disclosure to investors obligation in the AIFMD.
The EU Parliament final report does not remove the retention obligation of 5% of the notional value of loans originated by the AIF applicable on an ongoing basis, and this obligation is extended until the maturity of the loans.
The 5% retention obligation does not apply to the loans that the AIF has purchased on the secondary market or where one of the following applies: a) the sale of the loan is necessary for the AIF not to be in breach of its mandate or of one of its investment or diversification rules and such potential breach is unintentional on the part of the manager, for instance as a result of the exercise of subscription or redemption rights; b) the disposal is necessary as a result of the Union sanctions; c) the AIF needs to dispose of the loans in order to redeem investors' units or shares as part of the wind-down of the AIF.
The EU Parliament final report only requires the loan-originating AIF to be closed-ended when the AIFM cannot demonstrate that the AIF has a sound liquidity risk management system that ensures the compatibility of its liquidity management system with its redemption policy. The EU Parliament draft report requires all AIF that cannot demonstrate its liquidity robustness to be closed ended. The EU Parliament final report is more precise in this regard and only applies to loan-originating AIFs. ESMA shall develop RTS relating to the assessment by competent authorities whether a loan-originating AIF has a sound liquidity management system and may maintain an open-ended structure, having regard to the underlying loan exposure, average repayment time of the loans and overall granularity and composition of AIF portfolios.
The following transition period is added in the EU Parliament final report: AIFMs in so far as they manage AIFs that originate loans and that have been constituted before the date of entry into force of AIFMD 2 may continue to manage such AIFs for 5 years following the date of entry into force of AIFMD 2 without having to comply with the obligation for originating AIFs to be closed-ended when the AIFM cannot demonstrate that they have a liquidity management system compatible with the redemption policy. By way of derogation, loan-originating AIFs constituted before the date of entry into force of AIFMD 2 and that do not raise additional capital for 5 years following the date of entry into force of AIFMD 2 shall be deemed to comply with the AIFMD 2.
Access the European Parliament Final Report of 2 February 2023 here.
AIFMD II - The Council position - Loan origination
Loan origination is the most detailed topic in the Council position, in which the amendments and additions to the AIFMD are somewhat different from those in the Commission proposal and the European Parliament draft report, although there is convergence on some provisions. The amendments and changes included in the Council position are as follows.
The Council position includes a new definition of capital: capital means aggregate capital contributions and uncalled committed capital, calculated according to amounts investable after the deduction of all fees, charges and expenses that are directly or indirectly borne by investors.
Other definitions include:
Loan origination means granting of loans by an AIF as the original lender.
A shareholder loan means an advance on the current account granted by an AIFs to an entity 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 entity.
A leveraged AIF means an AIF whose exposures are increased by the managing AIFM, through the borrowing of cash or securities, leverage embedded in derivative positions, or by any other means.
Regarding the implementation of effective policies, procedures and processes, AIFMs that perform loan origination or purchase loans from third parties shall also implement effective policies, procedures and processes for assessing credit risk and administering and monitoring their credit portfolio, keep those policies, procedures and processes up to date and effective, and review them regularly, at least once a year. The Council position refers to loan origination, as does the European Parliament draft report, but the Commission proposal does not. The Council position is the only one referring to the purchase of loans in this provision. Member states may determine that this requirement should not apply to the origination of shareholder loans, as in the European Parliament draft report but with different thresholds, provided that these shareholder loans:
- Do not exceed in aggregate 100% of the AIF’s capital, or
- Are granted to portfolio entities that acquire and manage real estate or participations in real estate companies, and in which the AIF directly or indirectly holds 100% of the capital or voting rights. This requirement should apply on a look-through basis to underlying assets controlled directly or indirectly by the AIF or the AIFM acting on the AIF’s behalf.
An AIFM shall ensure that loans (the singular is used in both the Commission proposal and European Parliament draft report) granted to any single borrower by an AIF it manages do not exceed 20% of the AIF’s capital where the borrower is one of the three types of entity mentioned in the Commission proposal and European Parliament draft report.
To determine compliance with this restriction, the AIFM should combine loans originated by the AIF it manages and the AIF’s loan exposures obtained through an SPV that originates loans for or on behalf of the AIF or AIFM in respect of the AIF. Neither the Commission proposal nor the European Parliament draft report refers to SPVs.
An AIFM shall ensure that the leverage of a loan originating AIF it manages represents no more than 150% of the AIF’s NAV. The leverage should be expressed as the ratio between the AIF’s exposure calculated according to the commitment method defined by delegated acts adopted by the European Commission and its NAV. Borrowing arrangements that are temporary in nature and are fully covered by contractual capital commitments from investors in the AIF should not be considered as constituting leverage for the purposes of this provision. The requirement shall apply to AIFs that gain exposure to a loan through an SPV which originates a loan for or on behalf of the AIF or of the AIFM in respect of the AIF. However, member states may determine that this restriction on leverage should not apply to AIFs whose lending activities consist solely of originating shareholder loans, provided that the loans:
- Do not exceed in aggregate 100% of the AIF’s capital, or
- Are granted to portfolio entities that acquire and manage real estate or participations in real estate companies and in which the AIF directly or indirectly holds 100% of the capital or voting rights. This requirement should apply on a look-through basis to underlying assets controlled directly or indirectly by the AIF or the AIFM acting on the AIF’s behalf. The private equity and real estate fund sector would welcome the adoption of this derogation in national law.
This provision relating to the leverage of loan originating AIFs is also new compared with the Commission proposal and the European Parliament draft report.
The investment limit of 20% should apply by the date specified in the rules or instruments of incorporation or prospectus of the AIF, but it should not exceed 24 months from the date on which the AIF first offers subscription to its shares. Neither the Commission proposal nor the European Parliament draft report mentions a limit for the application date of the investment limit.
The AIFM shall ensure that an AIF does not grant loans to:
- The AIFM or its staff.
- The AIF’s depositary and its delegates.
- An entity to which its AIFM has delegated functions under article 20 and the staff of this entity.
- An entity within the same group, meaning a parent undertaking and all its subsidiary undertakings, unless the entity is a financial undertaking that exclusively finances borrowers excluding those mentioned above. This list of entities is almost identical to that in the European Parliament draft report, but the third exception is exclusive to the Council position.
Member states may prohibit AIFs from granting loans to consumers on their territory, but this shall not affect the marketing of AIFs engaged in consumer lending in the EU. The consumer is defined by reference to article 3(a) of Directive 2008/48/EC (Consumer Credit Directive) as an individual who, in transactions covered by the directive, is acting for purposes outside their trade, business or profession. Neither the Commission proposal nor the European Parliament draft report offers such an option to member states.
An AIFM shall not manage an AIF whose investment strategy, as specified in its rules, instrument of incorporation and prospectus, is to originate loans or gain exposure to loans through an SPV that originates a loan for or on behalf of the AIF or AIFM in respect of the AIF, with the sole purpose of transferring the loans or exposures to third parties (originate-to-distribute). The same provision is included in the European Parliament draft report, except for the reference to originating loan SPVs, but not in the Commission proposal.
An AIFM shall ensure that the AIF it manages retains, for two years from the signature date or until maturity, whichever is shorter, 5% of the notional value of the loans it has originated, or purchased from an SPV that originates loans for or on behalf of the AIF or AIFM in respect of the AIF, and subsequently sold to third parties. This requirement does not apply where:
- The AIF starts selling assets to redeem investors' units or shares as part of the wind-down of the AIF.
- The borrower or any of its shareholders are subject to EU sanctions, or
- The sale of the loan is necessary for the AIF to avoid breaching one of its investment or diversification rules, where this potential breach would exist for reasons beyond the control of the AIF and of the AIFM that manages it, or as a result of the exercise of subscription or redemption rights.
The 5% minimum retention requirement is removed in the European Parliament draft report. The Commission proposal does not include any of the derogations provided above and does not limit such a requirement to two years.
The following transitional period is added: AIFMs, insofar as they manage AIFs that originate loans and that were constituted before the date of adoption of AFIMD II, may continue to manage these AIFs without complying with point (d) of article 15(3), paragraphs 4a to 4f of article 15 and article 16(2a) of the directive until five years after the date of adoption of AIFMD II. These articles relate to new provisions regarding loan originating AIFs. Loan-originating AIFs constituted before the date of adoption of AIFMD II and that do not raise additional capital shall be deemed to comply with these articles.
Access the European Council position of June 2022 here.
AIFMD II - European Parliament draft report - Loan origination
The European Parliament draft report has added two definitions:
Loan origination means the granting of loans by an AIF as the original lender. This definition is relatively narrow and funds acquiring mostly syndicated debt are excluded.
A shareholder loan is a loan granted by an AIF to an entity in which it holds directly or indirectly at least 5% of the capital or voting rights, where the loan cannot be sold to third parties independently of the investment held by the AIF in the same entity.
The European Parliament draft report refers to loan origination rather than loan granting activities. The requirements regarding effective, up-to-date and annually reviewed policies, procedures and processes for granting credit, assessing the credit risk and administering and monitoring their credit portfolio are the same as those included in the Commission proposal. However, the European Parliament draft report includes the exception that such requirements do not apply to shareholder loans that do not exceed in aggregate 150% of the NAV of the AIF.
The 20% limit of the AIF capital relating to certain types of borrowers is retained in the European Parliament draft report with the additions of commitments and overall subscriptions: “An AIFM shall ensure that a loan originated to any single borrower by the AIF it manages does not exceed 20% of the AIF’s capital or commitments or overall subscriptions where the borrower is one of the following: (…)”.
An entity within the same group as an AIFM cannot receive loans from loan originating AIFs managed by the AIFM. The restriction on loan origination to entities that are part of the same group as the AIFM may change the way some private equity-backed deals are structured, since the acquisition entity may be part of the group - in particular in US PE fund structures).
Delegates of a depositary are also prohibited from receiving loans from AIFs which have appointed such depositary. The Commission proposal refers only to the depositary, not its delegates.
The requirement to retain on an ongoing basis 5% of the notional value of loans originated by the AIF is removed in the European Parliament draft report.
AIFs should not follow an originate-to-distribute investment strategy, under which loans are originated with the sole purpose of transferring those loans to third parties. This is a different approach to risk retention than the Commission proposal, a general prohibition rather than a minimum retention requirement of 5% applicable to loans originated by the AIF and sold on the secondary market. This general prohibition does not prevent the trading of some loans on the secondary market, but the extent to which such trading is authorised would depend on the approach adopted by national regulators.
An AIF originating loans should be closed-ended if the AIFM is unable to demonstrate to the regulatory authorities of its home member state that the open-ended AIF has liquidity robustness regarding liquidity mismatches and long-term and illiquid loans – the European Commission will adopt the regulatory technical standards drafted by ESMA regarding demonstration of liquidity robustness for loan origination. This obligation may catch, for instance, AIFs with flexible and opportunistic strategies. The Commission proposal is more precise in requiring that an AIF be closed-ended if the notional value of its originated loans exceeds 60% of its NAV.
Access the draft report of 16 May 2022 from the European Parliament here.
AIFMD II - European Commission proposed directive, November 2021 - Loan origination
Since the growth of loan originating funds in the EU internal market is seen as a positive development, amendments and additions seek to remove unnecessary risk retention requirements and avoid creating product-specific rules. Favouring loan originating funds is also a means to increase financing to SMEs, green projects and other companies. The following changes and amendments to the AIFMD are included in the Commission proposal.
- AIFs have a right to originate loans and trade these loans on the secondary market.
- AIFMs and their staff cannot be granted loans from loan-originating AIFs they manage.
- AIFs’ depositaries are prohibited from receiving loans from AIFs they service.
Entities to which the AIFM has delegated one or more of its AIFM functions cannot receive loans originated by the AIF.
AIFs originating loans shall be closed-ended if the notional value of their originated loans exceeds 60% of its NAV.
For loan granting activities, the AIFM shall implement effective policies, procedures and processes for the granting of credit, assessing credit risk and administering and monitoring their credit portfolio, keep those policies, procedures and processes up to date and effective. and review them regularly, at least once a year.
An AIFM shall ensure that a loan granted to any single borrower by the AIF it manages does not exceed 20% of the AIF’s capital in cases where the borrower is one of the following:
- A financial undertaking within the meaning of article 13(25) of Directive 2009/138/EC (Solvency II).
- An AIF within the meaning of article 4(1), point (a), of the Solvency II directive.
A UCITS within the meaning of article 1(2) of Directive 2009/65/EC (UCITS IV).
This restriction is without prejudice to the thresholds, restrictions and conditions of the EUVECA, ELTIF and EUSEF regulations.
The investment limit of 20%:
- Applies by the date specified in the rules or instruments of incorporation of the AIF.
- Ceases to apply once the AIF starts to sell assets to redeem investors' units or shares after the end of its life.
- May be temporarily suspended for up to 12 months when the AIF raises additional capital or reduces its existing capital.
The application date of the investment limit shall be set in the rules or instruments of incorporation of the AIF, taking into consideration the particular features and characteristics of the assets in which the AIF is to invest. However, the application date of the investment limit, as specified in the rules or instruments of incorporation of the AIF, should not be later than halfway through the life of the AIF indicated in its constitutive documents. In exceptional circumstances, the regulatory authority of the AIFM, upon submission of a duly justified investment plan, may approve an extension of this time limit not exceeding one additional year.
AIFMs shall ensure that AIFs they manage retain, on an ongoing basis, 5% of the notional value of the loans they originate and subsequently sell on the secondary market. This requirement does not apply to loans the AIF has purchased on the secondary market.
You can access a copy of the directive proposed by the European Commission here.
