December 19, 2024

Loan Fund Structures under AIFMD2: ESMA’s Proposals

Alexandrine Armstrong-Cerfontaine, Glynn Barwick, Sebastian Bruchwitz, Andrew Henderson, Chris Ormond

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In our recent alert Loan Origination Under AIFMD2: A Guide on loan origination under the revised Alternative Investment Fund Managers Directive (AIFMD2), we noted that the European Securities and Markets Authority (ESMA) would consult on further measures required to implement AIFMD2. Following its consultation on liquidity management tools, which we noted in our alert Liquidity Management Under AIFMD2: RTS for Open-Ended Funds, ESMA on 12 December 2024 published its consultation with draft regulatory technical standards (RTS) to determine the requirements with which a ‘loan-originating AIF’ (LOF) must comply in order to maintain an open-ended structure. The basic rule under AIFMD2 is that an LOF can be open-ended only if the AIFM can demonstrate to its home member state national competent authority (NCA) that the AIF’s liquidity risk management system is compatible with its investment strategy and redemption policy.

The consultation sets outs ESMA’s proposals on the parameters and elements that an AIFM has to take into account to provide a common framework for the assessment performed by the NCA when determining if an LOF can operate with an open-ended structure. The RTS do not change or update the existing level 2 liquidity management provisions in the Commission Delegated Regulation (EU) 231/2013.

The consultation is open for feedback until 12 March 2025, and (as is the case for the AIFMD2 level 2 measures on liquidity-management tools) the RTS are due to be finalised by Q3 or Q4 2025 ahead of 16 April 2026, the date by which EU member states are required to implement AIFMD2.

The Requirements in Summary

The regulatory requirements for LOFs include the following:

A sound liquidity-management system
The availability of liquid assets and stress testing
An appropriate redemption policy in regard to the liquidity profile of LOFs,

taking due account of the underlying loan exposures, the average repayment time of the loans, and overall granularity and composition of the LOFs’ portfolios.

Some Points of Interest

Open-ended LOFs will also be subject to the new liquidity-management provisions under AIFMD2 (which, as noted above, ESMA recently consulted on).
These provisions are without prejudice to the thresholds, restrictions, and conditions in EuVECA, EuSEF, and ELTIF regulations. Therefore, for an ELTIF that is an LOF, these provisions will need to be read alongside the ELTIF requirements.
The draft RTS do not include any guidance or clarification on the application of the definition of ‘capital of the AIF’ in AIFMD2 to open-ended AIFs, which is relevant for some of the loan origination concepts.
Although the new rules on LOFs and liquidity-management tools (LMT) in AIFMD2 will not apply directly to firms authorised under the UK AIFM rules, it will still be relevant for UK and other non-UK AIFMs, whether marketing in the EU under Article 42 national private-placement regimes or acting as delegates of EU AIFMs.

Summary of the Proposed Requirements

We have set out below the principal points on how the draft rules apply, along with our comments.

Sound Liquidity Management Feature	Proposed Requirements in the RTS	Comments
Appropriate redemption policy (Article 2)	An AIFM has to define an appropriate redemption policy by considering at least the 15 factors set out in the draft RTS. Along with the frequency of redemptions offered, proportion of liquid assets the LOF will target to comply with redemption requests, targeted credit quality of loans to be granted, and targeted investor base, the AIFM has to consider any minimum holding period, length of notice and settlement period, other redemption conditions, and availability of reliable, sound and up-to-date loans and other asset valuations.	ESMA seeks input on the list of factors, including if there are any others to include.
Availability of liquid assets (Article 3)	An AIFM is to determine an appropriate proportion of liquid assets the LOF will target to comply with redemption requests by considering at least 16 factors set out in the draft RTS. In addition, an AIFM has to determine the type of assets it considers as liquid — and the following can be considered as liquid assets: Expected cash flow generated by the loans granted by the LOF Investments that can be converted into cash to meet redemption requests over the duration of the notice period without significantly decreasing in value	The duration of the notice period is an important element because the longer it is, the more time an AIFM has to meet redemption requests. An AIFM may decide not to consider an asset as part of its ‘liquid assets’ if its value would be subject to a big discount affecting overall liquidity available for meeting redemption requests. ESMA’s questions include how practically AIFMs determine and calibrate the level of liquid assets with respect to loan maturities and portfolio size.
Liquidity stress tests (Article 4)	An AIFM is to conduct liquidity stress tests: At least quarterly, unless a different frequency is justified by the characteristics of the LOF Separately for the LOF assets and liabilities that it then combines to assess the overall effect on liquidity (and hence increase the resilience of the tests) Using conservative scenarios for changes in interest rates, credit spread, and potential loan defaults, as well as in redemption requests considering the investor base, liquidity offered, and its LMTs With scenarios with low probability but high impact on the AIFM’s ability to value the loans	This needs to be tailored to the LOF’s strategy. For instance, a less liquid asset base and/or concentrate investor base, use of leverage, or deteriorating market conditions may increase the frequency. ESMA guidelines on liquidity stress testing will also apply to LOFs.
Ongoing monitoring (Article 5)	To ensure the liquidity management system of the LOF remains compatible with the AIFM’s investment strategy and redemption policy, an AIFM has to monitor specific parameters, such as the level of liquid assets, subscriptions and redemptions, unitholder behaviour, early-warning signs of loan impairment, and leverage levels.	An AIFM will need to be able to demonstrate it has the arrangements in place to assess and monitor the evolution and behaviour of key elements of their funds and loans granted.

In addition to specific questions on the particular features, ESMA is seeking a better understanding of market practices for those currently managing open-ended LOFs, including on proportions (of number of loans granted and total amounts) of ‘shareholder loans’, nonperforming loans, and those whose maturity has been extended; market experiences when selling loans to meet redemption requests; and current valuation and liquidity management practices.

To discuss the contents of this alert, please contact any of the authors or your usual Goodwin contact. You may also be interested in the alerts set out below.

In addition to the alerts mentioned above, you may also be interested in:

End of the Beginning: AIFMD II’s Final Text

ELTIF 2.0 RTS: Second Time Lucky and A Positive Step Forward on Liquidity and Redemptions

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations. Attorney Advertising.