Legal Alerts/17 Apr 2024
AIFMD II – A New Chapter of Alternative Investment Fund Regulation in the EU
The Council of the European Union (the “Council”) and the European Parliament (the “Parliament”) reached a provisional agreement regarding amendments to the alternative investment fund managers directive (the “AIFMD”, whilst such amendments are often simply referred to as the “AIFMD II”) already in July 2023. The final legislative text was formally approved by the Parliament and the Council, and the Directive has since been published in the Official Journal of the European Union on 26 March 2024. The amendments entered into force on 15 April 2024, and Member States will have 24 months after this to transpose and enforce these new rules. The majority of the changes will therefore come into effect in April 2026.
AIFMD II includes a new framework for alternative investment funds (AIFs) which originate loans, enhanced rules on delegation by investment managers to third parties, enhancing cross-border depositary services, enhanced data sharing between authorities and the identification and prevention of misleading names and undue costs. We present a brief overview of some of the most important amendments to the AIFMD through the AIFMD II below.
Framework on funds originating loans
The framework on funds originating loans is completely new and applies to funds that provide credit to companies.
Definition of loan origination and loan-originating AIFs
According to the definition in the AIFMD II, loan origination means the granting of a loan directly by an AIF as the original lender or indirectly through a third party or special purpose vehicle, which originates a loan for or on behalf of the AIF, or for or on behalf of an alternative investment fund manager (AIFM) in respect of the AIF, where the AIFM or AIF is involved in structuring the loan, or defining or pre-agreeing its characteristics, prior to gaining exposure to the loan. As a general rule, the loan-originating funds are required to have a closed-ended structure.
Accordingly, loan-originating funds refer to AIFs (i) whose investment strategy is mainly to originate loans or (ii) whose originated loans have a notional value that represents at least 50% of its net asset value. The loan origination provisions apply to all AIFs engaging in loan originating activities, while a few of the provisions specifically pertain to AIFs which originate loans on a significant basis, also referred to as “Loan Originating AIFs”.
Risk retention
The framework includes certain risk retention requirements that are applied when loans are transferred to third parties. The requirements have been introduced to “avert moral hazard and maintain the general credit quality of loans originated by AIFs”. As such, the “originate-to-distribute strategy” is prohibited, excluding certain cases where retention of part of the loan would, for example, not be compatible with the implementation of the fund’s investment strategy or with the regulatory requirements imposed on the fund and its AIFM, such as cases where retaining the loan would lead to a breach of sanctions. An AIF which originates loans must retain 5% of the notional value of each loan it originates and subsequently transfers to third parties.
In light of the above, such percentage of each loan shall be retained:
- until maturity, for loans whose maturity is a period of up to 8 years, or for loans granted to consumers regardless of their maturity; and
- for a period of at least 8 years for other loans.
However, the above retention periods do not apply if e.g. the AIFM commences liquidation of the fund or even in cases where the sale of a loan is needed due to a deterioration in the risk of the loan. Furthermore, they do not apply if the disposal is necessary for the purposes of compliance with restrictive measures or with product requirements.
Loan origination policies
The AIFM must implement policies, procedures, and processes for the granting of loans, including for the assessment of credit risk and for administering and monitoring its credit portfolio, and keep those policies, procedures, and processes up to date and effective, and review them regularly and at least once a year. Shareholder loans are exempt from this requirement, provided that the notional value of such loans does not exceed in aggregate 150% of the fund’s capital. Shareholder loan means a loan that is granted by an AIF to an undertaking 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 same undertaking.
Leverage limits
To further ensure the stability and integrity of the financial system, the framework introduces certain leverage limits to both open-end and closed-end loan-originating funds.
The leverage of a loan-originating AIF is to be expressed as the ratio between the exposure of the AIF, calculated according to the commitment methodology (which e.g. takes into account the leverage created by derivatives) and its net asset value. Generally, the leverage of a loan-originating fund shall be no more than 175% of an open-end fund’s net asset value or 300% of a closed-end fund’s net asset value. Stricter leverage limits can be imposed by national authorities.
Shareholder loans are exempt from the leverage limits, provided that the notional value of such loans does not exceed in aggregate 150% of the fund’s capital.
Reporting obligations and delegation
AIFMs will be required to notify their supervisory authority of a broader range of delegation arrangements. AIFMs must also ensure that their delegates (and subdelegates) comply with the AIFMD II irrespective of the regulatory status or location of any delegate or sub-delegate. AIFMs are required to provide additional information on delegation arrangements to supervisory authorities both during the authorisation application process and in their regulatory reports to authorities.
Delegating AIFMs would be required to provide more specific information on the delegates, including specifying the delegates’ name and domicile or registered office or branch, whether they have any close links with the AIFM, whether they are authorised or regulated entities for the purpose of asset management, their supervisory authority, where relevant, and including the identifiers of the delegates that are necessary to connect the information provided to other supervisory or publicly available data sources.
Further, AIFMs would be required to report i.a. the number of full-time employees tasked with performing the portfolio or risk management. Additionally, if risk management and portfolio management functions have been delegated, the AIFMs would be required to list and describe such delegated activities, including where the portfolio management function is delegated and the amount and percentage of the AIF’s assets that are subject to delegation arrangements concerning the portfolio management function.
The European Securities and Markets Authority (ESMA) will produce regulatory technical standards on the details of the reporting, including reporting frequency and timing by 16 April 2027. Thus, these amendments relating to reporting obligations to competent authorities under Article 24 of AIFMD will be subject to a transposition deadline of 16 April 2027 (and will therefore apply one year later than other requirements).
Other changes
Other confirmed or expected changes include the following:
- Misleading names: It is emphasised in the AIFMD II that the name of an AIF is a distinctive element that influences investors’ choices and gives a first impression of the fund’s investment strategy and objectives. Therefore ESMA is mandated to develop guidelines that specify the circumstances where the name of a fund may be unfair, unclear or misleading to investors by 16 April 2026. However, ESMA confirmed in its public statement that it intends to publish the guidelines “shortly”. This is aimed at, for instance, greenwashing of funds through misleading names.
- Undue costs: ESMA will compile a report to the European Parliament, the Council, and the Commission assessing the costs charged by AIFMs from the retail investors of the AIFs that they manage and explaining the reasons for the level of those costs and for any differences between them, including differences resulting from the nature of the AIFs concerned.
- Appointment of depositaries: The current AIFMD requires for a depositary to be located in the same Member State as the appointing AIF. However, AIFMD II grants the national supervisory authorities of the AIF’s home Member State the authority to permit institutions from another Member State to serve as depositaries after conducting a case-by-case evaluation of the absence of relevant depositary services. This kind of depositary can only be appointed if all conditions are met and prior approval of the competent authority is obtained.
- Remuneration policies: Under the recitals of AIFMD II, it is suggested that ESMA update its guidelines on remuneration policies. This would include aligning incentives with ESG risks in remuneration policies.
- Minimum substance and independence: AIFMs will need to conduct their business with at least two sufficiently experienced natural persons of sufficiently good repute who either are employed full-time by that AIFM or are executive members or members of the governing body of the AIFM committed full-time to conducting the business of that AIFM, and who are domiciled in the Union. Further, it is appropriate to encourage AIFMs managing AIFs marketed to retail investors to appoint at least one independent or non-executive director as a member of their governing body or management body, where possible under national law or under the industry standards of the home Member State of the AIFM, in order to protect the interests of the AIFs and of the investors in the AIFs that the AIFM manages.
- Liquidity management tools: Both EU and non-EU AIFMs will need to provide investors with pre-contractual disclosures concerning the AIF’s framework for liquidity risk management.
- Article 23 Investor Disclosure: The pre-investment (and periodic) investor disclosure requirements under Article 23 of the AIFMD are expanded to include the name of the AIF, a list of the fees, charges and expenses covered by the EU AIFM in connection with the operation of the AIF that are directly or indirectly allocated to the AIF, and information on the possibility and conditions for using liquidity management tools (for open-ended funds).
- Reporting: In addition to enhancing data sharing between national competent authorities, AIFMD II also introduces changes to the information that has to be provided to competent national authorities by an AIFM applying for an authorisation.
If you have any questions about this Legal Alert, please feel free to contact the undersigned or your regular Borenius contact.
