On 12 April 2016, the European Securities and Markets Authority (“ESMA”) published its Opinion to the European Commission (and others) on key principles for a European framework on loan origination by funds.
The Opinion comes at an interesting time, as investors continue to allocate significant amounts of capital to direct lending funds. This article sets out some observations arising from the Opinion for both EU and non-EU managers of loan originating funds.
The Opinion was provided in response to the Commission’s Capital Markets Union Action Plan. The Action Plan, released in September 2015, set out how the Commission plans to boost business funding and investment financing, and is supportive of alternative sources of finance and sees venture capital and asset management as integral to the single market for capital in the EU.
The Action Plan noted the current disparity between Member States’ laws on loan origination and the challenges faced by managers of credit funds operating in the EU on a cross-border basis and their need to comply with different local requirements. Against this backdrop, the Commission stated that it would assess the need for a coordinated approach to loan origination and the case for a European framework.
The Opinion suggests that the Commission’s vision may well come to fruition. Whilst it is likely to be several years before any such regime takes effect, the Opinion provides some indication of how it might look.
Refreshingly, there is no reference to shadow banking (which has previously been regarded as a “bad thing” by European regulators) in the Opinion, though some concerns about systemic risk and maturity transformation are touched on.
Observations for EU managers
For EU managers of loan originating funds operating on a cross-border basis, the proposed European framework would be beneficial in that managers would no longer have to navigate national practices (which are helpfully summarized in the Annex to the Opinion). Inevitably, the trade-off may be more compliance obligations.
Many EU managers of loan originating funds will already be authorised as “AIFMs” in accordance with the Alternative Investment Fund Managers Directive (“AIFMD”). However, various Member States allow certain managers to be merely registered (as opposed to being fully authorised), and thereby subject to more light-touch compliance obligations. The Opinion suggests that such registered AIFMs may need to become authorised to the extent that they wish to manage loan originating funds.
As regards the fund vehicle itself, ESMA invites the Commission to consider whether the prior authorisation of a loan originating fund vehicle is necessary (this is currently a requirement in a number of Member States, including Ireland and Spain). For the avoidance of doubt, this is in addition to the authorisation/registration of the manager in accordance with AIFMD. Further, as regards form, ESMA is of the opinion that any loan originating fund vehicle ought to be closed-ended, without regular rights to redemption.
Potential features of any loan origination regime suggested in the Opinion include:
- Possible restrictions on investment strategy, confining a relevant fund from carrying on business other than loan origination
- Prohibition in originating loans to individuals, financial institutions, collective investment schemes and consumers
- Requirement that loan originating funds should not be allowed to have liabilities with a shorter maturity than the loans granted
- Mandatory leverage limit for loan originating funds
- Restrictions on investments in loan originating funds being made available to retail investors
The welcome news for EU managers who have recently or will soon embark on raising a loan originating fund is that ESMA appreciates the need for a transitional/grandfathering regime, though no further detail on what this might look like is provided.
Observations for non-EU managers
The Opinion is silent on how the regime might apply with respect to non-EU managers.
There will be concern in some quarters about ESMA’s statement that an “authorisation gateway” could be desirable for policy reasons, and the fact that it invites the Commission to assess whether loan originating funds ought to be subject to some form of authorisation. It is not clear from the Opinion whether ESMA’s reference is limited to EU loan originating funds and their managers, or whether it is envisaging such a gateway to be equally applicable to non-EU funds, which would effectively lock out non-EU managers or force them to come onshore.
The waiting game
While the Opinion provides some insight as to how a European framework on loan origination by funds might look, it raises more questions than it answers.
In addition to being silent on the application of the proposed regime to non-EU managers, ESMA is careful to limit the scope of its Opinion to loan origination, and carves out the related activities of loan participation and loan restructuring.
While any increased regulation will inevitably cause a degree of concern, managers should remain mindful of the wider picture. The Commission is supportive of alternative financing and sees loan originating funds as a “potentially important future source of non-bank credit”, something that is very positive, given all the concern about “shadow banking” in recent years. As such, a European framework on loan origination by funds should not be interpreted as another regulatory assault on asset managers just as AIFMD beds down. Rather, it is an attempt to facilitate cross-border activity by loan originating funds and to harmonize the currently fragmented European market, the trade-off for which may be additional compliance.
The Opinion states that the Commission intends to consult on the elements of a European framework for loan origination in Q2 2016. The Action Plan stated that the Commission was to develop a “coordinated approach to loan origination by funds and assess the case for a future EU framework” by Q4 2016, although it is not entirely clear what this milestone means. With so many open questions, and various other regulatory reforms in the pipeline, it is likely to be several years before any European framework on loan origination by funds emerges. However, managers should watch this space and look for opportunities to influence any loan origination regime through the consultation process.