Following detailed consultation with industry (CP 85), the Central Bank of Ireland (the “Central Bank”), on 18 September 2014, announced the launch of the first regulatory regime in the EU dedicated to the establishment of regulated investment funds which have as a primary objective the origination of loans (“Loan Originating Funds”). Our earlier briefing note in relation to CP 85 is available here.
Scope of Activities
The Central Bank has revised its AIF Rulebook to provide for a new regulatory framework applicable to Loan Originating Funds. The revised AIF Rulebook sets out the regulatory requirements applicable to such funds and clarifies the scope of activities in which a Loan Originating Fund can engage, specifically stating that a Loan Originating Fund’s operations are to be limited to “the business of issuing loans, participating in loans, participations in lending and to operations directly arising therefrom, including handling assets which are realised security, to the exclusion of all other commercial business”.
Furthermore, while Loan Originating Funds are restricted from engaging in non-loan strategies, the Central Bank will permit investment managers to establish Loan Originating Funds either as a stand- alone fund or as part of an umbrella fund structure with multiple sub-funds catering, at sub-fund level, for both loan originating strategies and non-loan strategies.
New Regulatory Requirements
Under the new regulatory framework, a Loan Originating Fund must be authorised as a Qualifying Investor Alternative Investment Fund (“QIAIF”) and must appoint an authorised alternative investment fund manager (“AIFM”) pursuant to the Alternative Investment Fund Managers Directive (“AIFMD”). In addition to the rules applicable to QIAIFs and AIFMs pursuant to AIFMD and the AIF Rulebook, Loan Originating Funds will have to comply with the following new regulatory requirements:
Credit Granting, Monitoring and Management
A Loan Originating Fund is required to implement and maintain appropriate policies and procedures in relation to the assessment, pricing and granting of credit, the management of concentration risk and credit risk and the diversification of credit positions.
Investor Due Diligence
Where an AIFM intends to provide access to its records and staff to potential investors for due diligence purposes (and it is worth noting that an AIFM is not required to do so), the AIFM must ensure that such access has been made available on a non-discriminatory basis to all potential investors and that all information reasonably considered to be ‘material’ is disclosed to such investors.
A Loan Originating Fund is required to disclose, in its prospectus, a risk diversification strategy which would limit exposure to any one issuer or group to 25% of net assets within a specified timeframe. Failure to achieve such a risk diversification strategy will result in unitholder approval being sought in relation to altering, or continuing with, such a risk diversification strategy. Furthermore, if unitholder approval is not forthcoming, the Loan Originating Fund must terminate.
A Loan Originating Fund is prohibited from originating loans to natural persons, other collective investment schemes, certain connected parties, persons intending to invest in equities or other traded investments or commodities and in certain circumstances, to financial institutions.
Interconnectedness with the Banking Sector
In the context of a Loan Originating Fund acquiring a loan from a credit institution, ‘skin in the game’ requirements will not apply if the loan is purchased following an offering to multiple parties and if the loan is acquired on an arm’s length basis.
A Loan Originating Fund must implement a comprehensive stress testing programme and on at least a quarterly basis, report to the AIFM in respect of such stress testing.
Liquidity and Distribution
A Loan Originating Fund must be established for a finite period of time and be closed-ended in nature, however, limited redemption and distribution rights may be offered to unitholders. In the context of redemptions, unless the assets of the Loan Originating Fund are valued by reference to prevailing market prices, any redemption will require unitholder approval.
A Loan Originating Fund must not have gross assets of more than 200% of its net asset value (with a level of discretion afforded to the Central Bank in this regard) and should the Loan Originating Fund exceed this limit, it must secure the approval of the Central Bank within 30 days in respect of a formal plan to re-align its leverage ratio.
All sales and marketing material (including the Loan Originating Fund’s prospectus) must disclose certain prominent risk warnings and information in relation to items such as, its proposed concentrations and its credit assessment and monitoring process.
In addition to the reporting requirements imposed on Loan Originating Funds pursuant to the AIF Rulebook (and on its AIFM pursuant to AIFMD), a Loan Originating Fund is required to issue periodic reports to its investors, with more detailed reports to be provided to the Central Bank. Such reports must include, inter alia, breakdowns of the originating loans, information concerning non-performing exposures, undrawn committed credit lines, exposures subject to forbearance activities and material changes to the Loan Originating Fund’s credit assessment and monitoring procedures.
It is worth noting that an AIFM will be entitled to market its Loan Originating Funds to Professional Investors (as defined under AIFMD) throughout Europe via its AIFMD passport.
The Central Bank’s announcement is yet another positive step forward for the Irish funds industry and indeed for the wider business community as a whole. The new regulatory regime applicable to Loan Originating Funds has the potential to create a much needed alternative source of funding (to that of traditional bank financing) for the corporate sector both domestically and internationally.
While the Central Bank’s revised AIF Rulebook (available here)came into force yesterday (18 September 2014), the Central Bank has indicated that applications for Loan Originating Funds can be made from 1 October 2014.