The European Commission published its long-awaited proposals for the review of the Alternative Investment Funds Directive (AIFMD). The Commission was satisfied that the Directive has had a mostly positive impact in creating an internal market for AIFs. However, the review highlighted a number of areas where targeted improvements could be made to further enhance the Directive’s effectiveness and address areas of supervisory divergence.

The key changes aim to:

• Introduce harmonised rules for AIFMs managing funds active in the direct lending space (LOFs);
• Clarify further the requirements for fund managers delegating certain functions to third parties;
• Improve the supply of depositary services in smaller markets;
• Improve the level of data gathered through regulatory reporting;
• Harmonise the availability of liquidity management tools (LMTs) across the Union;
• Include central securities depositories (CSDs) in the custody chain to ensure that depositaries can fulfil their duties and safeguard the protection of investors.

During the review process, some industry commentary spoke of a potential threat to the existing delegation regime, but this has not materialised. The Commission recognises that the regime has contributed to the success of AIFMD. While it has highlighted areas for enhancement, these should not have a significant impact on the existing model.

Key Changes

The key changes affecting Loan Origination Funds (“LOF”s), Delegation & Liquidity Management are below.

Loan Origination Funds

The last number of years have seen a significant rise in the number of Loan Origination Funds (LOFs) launched in the EU. The Commission recognises the important role these funds have in lending into the European economy. However, the EU does not currently have a harmonised regime for LOFs and some local regulators have more prescriptive rules than others. Some of the new requirements for LOFs are as follows:

• AIFMs should have effective policies, procedures and processes for the granting of loans, assessing credit risk and administering and monitoring its credit portfolio, which should be reviewed periodically.
• Loans originated to any single borrower should not exceed 20% of the AIF’s capital.
• Risk retention requirements apply and AIFs must retain at least 5% of the notional value of the loans it has originated and subsequently sold on the secondary market.
• AIFs are prohibited from making loans to the AIFM, its staff or the depositary or to certain delegates.
• Where more than 60% of the investments are made in loan origination the AIF must be closed ended.

Delegation

The Commission recognises that delegation has contributed to the success of the AIFMD. However, it notes that differences in implementation of delegation rules can occur at a national level. And different rules can be applied to UCITS compared to AIFs. In order to address these concerns, the Commission is proposing:

• That ESMA be notified of delegation arrangements where more investment or risk management is delegated outside of the EU than retained within it.
• That ESMA engage in supervisory peer reviews of delegation arrangements to ensure that they do not give rise to so-called “letter box” arrangements.
• That all AIFMs must have at least two employees who are committed on a full-time basis and resident in the EU.
• Aligning the UCITS delegation rules with those of AIFMD.

Liquidity Management Tools

The Commission is seeking to ensure that a full range of liquidity management tools are available to AIFs throughout the EU and has included details of the following tools which can be used by open ended funds. These include:

• Suspensions, Notice Periods, Gates, Redemption Fees, Swing Pricing, Anti-Dilution Levies, In Specie Redemptions and Side Pockets.
• The use of such tools should be notified to local competent authorities.

Timeline

The new proposals will now be considered by the European Parliament and the EU Council. Discussions are likely to continue throughout much of 2022. EU Directives are not directly effective and must be implemented into national law within 2 years of entering into force following publication in the EU Journal. Therefore, it is likely to be late 2024 or 2025 before we see these new changes become effective.

To find out more about this change, talk to your Carne Relationship Manager or contact a member of the team below.

Ireland

Patrick O’Brien
Head of Business Development
+353 1 489 2481
patrick.obrien@carnegroup.com

Ireland

Des Fullam
Head of Regulation & Client Solutions
+353 1 489 6805
des.fullam@carnegroup.com

New York

Nicola Cowman
Director
+1 347 410 0927
nicola.cowman@carnegroup.com

United Kingdom

Aymeric Lechartier
Managing Director
+44 203 973 0108
aymeric.lechartier@carnegroup.com

Luxembourg

Richard Marshall
Director
+352 661 885 262
richard.marshall@carnegroup.com