From 1 October 2014, the Central Bank is accepting applications for the authorisation of loan origination funds in accordance with its newly finalised requirements.
The Central Bank’s requirements for loan origination funds are reflected in a new chapter of its AIF Rulebook and follow a detailed consultation exercise with interested parties (see Central Bank Launches Consultation on Loan Origination Funds). We believe the Central Bank’s requirements reflect the first dedicated regime in Europe for regulated funds that are established with the primary objective of originating loans. The finalisation of this consultation process will undoubtedly be widely welcomed by managers that were seeking to undertake loan origination from within a regulated, tax-efficient fund structure.
Alternative Source of Funding
Prior to the introduction of these requirements, certain Irish authorised funds have been permitted to acquire or participate in loans in the secondary market (whether or not such loans are securitised or collateralised) but a general prohibition has applied to the origination of loans by Irish funds. Permitting direct lending by Irish funds is particularly timely, not least because many fund promoters point to the evident need to provide for alternative sources of funding to the real economy across Europe. The diversification of such funding sources should also result in a corresponding reduction in the concentration of credit risk within the European banking sector.
Risk Mitigation Measures
While the Central Bank made a number of important clarifications in its finalised requirements, the extent of the various risk mitigation measures that the Central Bank initially proposed in its consultation paper (CP 85) have largely been retained. Certain of these requirements may be viewed as somewhat cautious in nature. However these measures should be understood in the context of the dramatic stresses felt within the European financial system in the recent past and the obvious regulatory objective of the Central Bank to avoid introducing new sources of financial stability risk.
The main conditions that must be met by a loan originating fund include the following:
- The fund must be authorised under the Qualifying Investor Alternative Investment Fund (QIAIF) regime (where investors must certify that they fall within the Qualifying Investor criteria and must make an initial investment or commitment of at least Euro100,000).
- The fund must have an Alternative Investment Fund Manager (AIFM) that is authorised by the competent authorities in an EU Member State in accordance with the EU Alternative Investment Fund Managers Directive (although the QIAIF itself may be authorised by the Central Bank as an internally-managed vehicle under this regime).
- The primary investment policy of the fund must be loan origination (although the fund is permitted to acquire loans on the secondary market and to undertake ancillary activities, including dealing with assets acquired as a result of enforcement of security).
- The fund must comply with a diversification requirement that will limit its exposure to any one issuer or group to 25% of the fund's net assets, subject to both a ramp-up and a ramp-down period during the initial and concluding phases of the life of the fund.
- The fund must be subject to a leverage limit of 100% of its net asset value.
- The Central Bank has prescribed a number of procedures and policies that a loan fund must document and update on a regular basis relating to various aspects of its loan origination activities.
- The fund must comply with certain rules regarding the equal treatment of investors in the context of any due diligence opportunities afforded to investors.
- The fund will be prohibited from originating loans to natural persons, other collective investment schemes or financial institutions, traders in equities or commodities and certain service providers to the fund (including its AIFM and depositary).
- The fund must comply with various requirements when acquiring a loan from a credit institution on a bilateral basis, although these requirements will not be applicable in circumstances where the loan has been offered to multiple parties and is acquired on an arms-length basis.
- A comprehensive stress testing programme must be put in place by the fund to analyse a range of risks.
- The fund must be established for a finite period of time and be closed-ended in nature (although limited distribution and redemption rights may be offered to investors).