Changes to the EU landscape for private credit funds in the EU

By Marianna Tothova; Philippa List, Dechert

Published: 17 June 2024

In a notable change of policy direction, EU legislators have introduced specific rules to regulate alternative investment funds (AIFs) that originate loans by way of amendments to the alternative investment fund managers directive (the amended directive commonly referred to as AIFMD 2.0). The intention behind the policy move is to protect investors and to ensure financial stability of the EU financial markets.

AIFMD 2.0 entered into force on 15 April 2024 and will come into effect on 16 April 2026. AIFMD 2.0 provides transitional provisions and exemptions from certain rules applicable to funds existing before the 15 April 2024 and/or to the loans in their portfolios.

AIFMD 2.0 contains general rules applicable to EU AIFs that originate loans. The rules prohibit “originate to distribute” strategies, essentially preventing funds from originating loans with the sole purpose of selling them to third parties. The recast directive also introduces a new risk retention requirement, meaning that an AIF must retain at least 5% of the notional value of the loan that it subsequently sells, unless the sale is made in one of certain permitted scenarios (e.g., liquidation of the fund or if the quality of the loan deteriorates). AIFs must retain the 5% amount until the loan matures or, for at least eight years if the maturity of the loan is longer. AIFMD 2.0 also introduces additional reporting, disclosure and diversification requirements and certain conflict-of-interest safeguards for any AIFs that engage in loan origination activities. 

The recitals to AIFMD 2.0 lay down basis for the so called “cross border loan origination passport” for the EU Alternative Investment Fund Managers (AIFMs), which should allow EU AIFs, irrespective of where in the EU the AIFM or the AIF is based, to lend on cross-border basis into any other EU jurisdiction. However, due to a lack of precise operative provisions in the text of AIFMD 2.0 itself, the reality of cross-border lending within the EU will largely depend on the national implementation of AIFMD 2.0 by the EU Member States. 

AIFs that originate loans as their main strategy, or if they invest 50% or more of their NAV into loans that they originate, (so called loan originating funds), will be subject to additional requirements under AIFMD 2.0. 

Firstly, leverage caps – calculated in accordance with the commitment method – are introduced:

  • open-ended loan originating funds may be leveraged up to 175% of the NAV; and 
  • closed-ended loan originating funds may be leveraged up to 300% of the NAV. 

Secondly, loan originating funds must be operated as closed-ended unless the AIFM that manages the loan originating fund is able to demonstrate to the competent authorities of the home Member State of the AIFM that the fund’s liquidity risk management system is compatible with the investment strategy and redemption policy, in which case the fund can remain open-ended. 

AIFMD 2.0 also regulates the open-ended AIFs more generally, whether they originate loans or not, by extending the existing liquidity management provisions in AIFMD to provide new obligations and powers for AIFMs that manage open-ended AIFs. Under AIFMD 2.0, an AIFM that manages an open-ended AIF is to select at least two “appropriate” liquidity management tools (LMTs) from a list of seven LMTs included in a new annex to AIFMD 2.0 (in addition to the suspension of subscriptions and redemptions and the creation of the side pockets which are to only be used in exceptional circumstances and where justified having regard to the interests of the AIF’s investors). The selection of the LMT must be based on an assessment of the suitability of those tools to its investment strategy, the liquidity profile and the redemption policy of the AIF.

The European Securities and Markets Authority (ESMA) is due to issue detailed regulatory technical standards (RTS) on both of these critical topics - placing existing and future open-ended loan originating funds in an uncertain position until the finalised RTS are available. 

AIFMD 2.0 also amends the information that must be disclosed to investors both before investment and periodically thereafter. For AIFs that engage in loan origination, the information to be provided periodically post investment has been amended and now includes details of the composition of the originated loan portfolio (this requirement applies to all AIFs, not only loan originating funds) and, on an annual basis, (i) all fees, charges and expenses that were directly or indirectly borne by investors and (ii) any parent company, subsidiary or special purpose entity utilised in relation to the AIF’s investments by or on behalf of the AIFM.

To conclude, EU Member States’ have until 16 April 2026 to adopt and publish the national laws, regulations and administrative provisions necessary to implement AIFMD 2.0 in their respective jurisdictions. While ‘goldplating’ of the primary rules is not necessarily expected, especially in the areas where detailed RTS will be published by ESMA, some EU Member States may see implementation as an opportunity to regulate other issues related to the topic, such as lending to consumers. The EU direct lending landscape will no doubt change during the course of the next two years and beyond.