Since 2014 the Central Bank of Ireland (the "Central Bank") has permitted regulated direct lending funds to be established as a special category of qualifying investor alternative investment funds ("Loan Origination QIAIFs" or "LQIAIFs").
LQIAIFs operate under the EU Alternative Investment Fund Managers Directive 2011/61/EU ("AIFMD"), meaning alternative investment fund managers ("AIFMs") can avail of EU/EEA cross-border marketing and management passport opportunities.
LQIAIFs are subject to specific requirements set out in a dedicated section of the Central Bank's AIF Rulebook addressing investor protection and regulatory prudential requirements (the "LQIAIF Rules", as discussed further below). The LQIAIF Rules are in addition to the Central Bank's general requirements for QIAIFs.
Maples and Calder advised on the first LQIAIF, authorised on 3 March 2015. However, certain aspects of the LQIAIF Rules presented structuring difficulties for sponsors of direct lending funds, with the result that there was limited uptake of LQIAIFs.
The updated AIF Rulebook extended the scope of activity for LQIAIFs to permit investment in operations "relating" to lending, notably "debt and equity securities of entities or groups to which the LQIAIF lends or which are held for treasury, cash management or hedging purposes."
In its updated AIFMD Q&A (see extract below) the Central Bank further clarified the scope of permitted lending - and related - activity.
"While a loan originating Qualifying Investor AIF can only engage in lending and related activities, not all of its lending has to be structured as bilateral loans. Lending could be structured as an investment in debt securities or as participation in a syndicated lending arrangement. It can also combine lending (whether syndicated or bilateral), debt securities, subordinated debt and equity in a package of related investments." (Our emphasis added.)
The rule changes mean that LQIAIFs can acquire debt and equity securities – but only as part of its lending activity - from entities they have granted loans to, or group companies of those entities. In addition, remit of an LQIAIF's lending activity is effectively widened beyond granting and participating in bilateral loans.
Summary of the LQIAIF Rules
- Focus on lending (as adjusted by the 2017 rule changes): The LQIAIF must limit its operations to the business of direct lending and ancillary/related activities. As an LQIAIF can be a sub-fund of an umbrella, there may be other sub-funds within the umbrella that are not LQIAIFs and therefore are not focussed on lending. As discussed above, lending activity is not restricted to granting and participating in bilateral loans and may cover investment in debt securities, equities or participation in a syndicated lending arrangement.
- Investment diversification: The LQIAIF must adhere to a maximum exposure to any one issuer or group of 25% of net assets.
- Leverage: The LQIAIF may not be leveraged more than one times its assets, that is, a gross assets limit of 200%.
- Closed-ended: The LQIAIF must be structured as a closed ended fund – distribution facilities and limited redemption facilities (at the discretion of the LQIAIF) are permitted.
- Eligible borrowers: There are restrictions on the type of entities that an LQIAIF may lend to. For example, it may not lend to natural persons, certain parties related to the LQIAIF, other investment funds or borrowers intending to trade financial instruments with lending proceeds.
- Acquired loans: certain restrictions and pre-investment due diligence requirements will apply to loans acquired from credit institutions unless such loans are acquired on an arm's length basis following an open offering;
- Credit management and stress testing: The LQIAIF must maintain effective credit management processes and have a comprehensive stress-testing procedure.
- Investor due diligence: If investor access to premises / staff of the lender is facilitated, this must be afforded to all investors.
- Investor disclosure and reporting: The Central Bank prescribes a range of disclosure requirements and conditions that must be addressed in the LQIAIF's prospectus, marketing materials, periodic reports and investor communications.