AIFMD II - the granting of loans by a fund

According to a PwC study published in 2023, debt funds are expanding and are expected to reach a total volume of $2.4 trillion in assets under management in 2027. In Luxembourg, where currently 90% of the top 30 global debt fund managers are managed, assets under investment-strategy management are expected to reach $345 billion by 2025¹.

Private debt remains an attractive investment opportunity. KPMG’s latest 2023 study confirms this by showing that the investor’s appetite for private debt funds continues to grow: assets under management grew by 51%, from June 2022 to June 2023 in Luxembourg.

In this context, AIFMD II provides clarifications expected by Alternative Investment Fund Management (AIFM) managers regarding the AIFM passport regime regulating the issuance of loans across the EU. The new Directive establishes common rules for the granting of loans, covering the management of conflicts of interest, credit risk management and risk diversification according to the type of fund (open or closed). This is an explicit authorization for EU managers to engage in lending. AIFMD 2.0 came into force on 16 April 2024 and is expected to be transposed by 2026.

Let’s look at how AIFMD II applies to AIF²s’ lending.

What is a Loan-Originating Funds (LOF)?

AIFMD II defines ‘loan-originating AIF’ as an AIF whose investment strategy is primarily the initiation of loans.

In order to be classified as an ‘originated loan fund’, AIF loans must represent more than 50% of its net asset value. The AIF must clearly indicate in its prospectus its investment strategy for non-bank loans that it grants and obtain the approval of the competent national authority, the CSSF for Luxembourg or the AMF for France.

Prior to 2024 and the publication of AIFMD II, each EU country had its own rules on financing and granting loans and regulating debt funds, similar to the rules laid down in the instruction ‘DOC-2016-02’ published by the AMF in 2016, or those regulated by the CSSF section 22 of the FAQ of the AIFM Law.

Two main objectives are pursued by the European Commission through AIFMD II:

• Address the imbalances between national jurisdictions that already allowed certain investment funds to lend outside the banking system.

• Financing the real economy by establishing common rules within the EU, which are essential to promote access to finance for small and medium-sized enterprises Finally, an LOF is not allowed to lend to its AIFM, its depositary or its delegates, or the AIFM delegates and its staff, unless it is a financial body that finances borrowers other than related entities.

New provisions on risk management

Credit risk management and risk diversification should be specified according to the open or closed status of the fund.

The general rules to regulate debt limits are as follows:

• The leverage limit of an open LOF cannot exceed 175%, and that of a closed LOF cannot exceed 300%. This ratio shall be calculated on the basis of the exposure of the LOF divided by the NAV according to the methodology of the commitment.

• Exposure and diversification limits at 20% of LOF capital granted to a single borrower where the counterparty is an AIF, a OPCVM³ or a financial institution.

• The ISA must ensure that the LOFs retain 5% of the notional value of the loans issued. All income from loans must go to the LOF. Costs related to the administration of the loan must be disclosed to investors.

• The collective society must formalize policies and procedures to authorize loans. These should be written to properly assess and control credit risk and are subject to periodic review.

• A leveraged LOF is a fund whose exposures are increased by the AIFM through the borrowing of cash or securities, by derivative positions or by any other means.

How can the funds anticipate?

Pending the consultation and subsequent publication of the technical standards (RTS⁴) on the open LOFs, it is necessary for each existing AIF to verify how to align with the new AIFMD II rules.

Luxembourg debt funds must ensure that the granting of loans complies with these rules even if the definition of loan origination is not the same as that of the CSSF, whose scope is slightly broader than that defined at EU level through AIFMD II.

It will be necessary to analyse each case and inform the local regulator of the fund’s domicile throughout the accreditation and supervision process.

For a period of 5 years from the entry into force of AIFMD II (i.e. until 15 April 2029), the leverage limits, concentration limits and the requirement to be a closed-type LOF do not apply to existing AIFs.

AIFs have until 15 April 2024 to apply the leverage and concentration limits and to comply with the requirement to be a closed LOF. However, if these AIFs no longer engage in savings since 15 April 2024, they shall be exempted from those rules.

Jean-Pierre Gomez, Head of Public and Regulatory Affairs, SGSS Luxembourg