AIFMD II sets rules for loan-originating funds

Following our articles on the directive’s changes to outsourcing and liquidity management, this time we focus on loan-originating funds. Czech practice already knows this area, but AIFMD II sets a more detailed framework for it.

The aim is to strengthen credit risk management, prevent a fund from having an excessively large share of its loans with a single borrower, and curb the model where a fund grants a loan only to immediately transfer it further.

AIFMD II is expected to be reflected in Czech law through an amendment to the Act on Investment Companies and Investment Funds (AICIF). Although it was meant to take effect already in April, the legislative process has been delayed and it is currently awaiting its third reading in the Chamber of Deputies.
 

Who is subject to the new scheme

The AICIF amendment will explicitly include into the management of special funds, qualifying investor funds and comparable foreign funds the activity of acquiring receivables arising from fund loans. A receivable arising from a fund loan shall mean a claim under a loan agreement entered into on behalf of the fund as the lender (creditor). The same shall apply to a receivable assigned to the fund where the fund manager participated in structuring the loan or in the preliminary negotiation of its parameters. It will also be necessary to assess whether the fund or its manager was economically and factually involved in the origination of the credit exposure.
 

New policies, processes and review

The new regulation will have the greatest impact on credit policy and risk management. The fund manager will have to establish, maintain and apply effective policies, procedures and processes for acquiring receivables arising from fund loans. At the same time, they must set rules for assessing credit risk and managing and monitoring the loan portfolio. These rules will have to be reviewed regularly, at least once a year.

In practice, this will mean revisiting the investment strategy, fund statute, internal policies and contractual documentation. The fund should clearly describe what types of borrowers it may finance, how it assesses their creditworthiness, how it works with collateral, how it monitors repayments and how it proceeds in the event of a breach of the loan agreement. Proper record-keeping of decisions and conflicts of interest will also be important.
 

Limits and prohibited models

AIFMD II introduces a concentration limit. A fund will not be permitted to grant loans exceeding 20% of its capital to a single borrower where the borrower is a selected financial entity, another alternative investment fund or a standard fund. The new rules also introduce leverage limits: for an open-end loan-originating fund, leverage must not exceed 175%, and for a closed-end fund, 300%.

The amendment further restricts lending to certain related persons. For example, a fund must not grant a loan to its manager, its employees, the depositary, or certain persons to whom the manager or the depositary has delegated their activities. AIFMD II also restricts the “originate-and-distribute” model: if a fund grants a loan and subsequently transfers it to a third party, it must generally retain at least part of the exposure for a specified period.
 

Consumer loans

The AICIF amendment explicitly provides for a ban on investment funds granting consumer loans.
 

How to proceed in practice

Fund managers should first determine whether their fund falls under the loan-originating fund scheme or whether it only holds credit exposure as an ancillary part of its strategy. It then makes sense to carry out a gap analysis of the credit policy, limits, leverage, liquidity, conflicts of interest and contractual documentation.