The “technical trialogue” meetings are scheduled for early September. Therefore, we expect the final legislative text to be published in late September. Finalisation of the process and publication in the EU’s Official Journal is expected in early 2024. Member States will have 24 months to apply the AIFMD II in national rules, meaning that implementation can be expected by early 2026. A grandfathering period is expected for loan origination funds constituted before the legislation enters into force in early 2024 – early drafts set the transitional period at 5 years.

What follows is a summary of the main areas of interest for AIFMs based on intelligence about the political negotiations, including a summary produced by the European Council. However, the details might change once we receive the final text.

Loan origination funds (LOF)

• The creation of a LOF regime is additive to the general AIFMD requirements. The policy aim is to create a harmonised passporting regime for LOFs, while the points of contention focused on addressing possible risks to financial stability.
• The agreed definition of LOFs has two parts: an LOF is a fund which has (1) an investment strategy which is mainly to originate loans; and (2) which has originated loans the notional value of which represents at least 50% of its NAV.
  • The agreed text defines origination as being “involved in structuring the loan, defining or pre-agreeing its characteristics prior to the purchase”.
• Shareholder loans will be exempt from the requirements if the loans notional value do not in aggregate exceed 150% of the AIF’s capital. The derogation will not apply to real estate shareholder loans.
• Member States will have discretion to prohibit LOFs originating consumer loans.
• The final text will clarify that loans originated by third parties and purchased by the AIF, in which the AIFM has no role in the structuring of the loan, are out of scope.
• The risk retention rule requires the fund to retain 5% of the notional value of an originated loan. An originated loan with a term less than 8 years must be held until maturity, and a loan with a term greater than 8 years must be held for at least 8 years.
  • There will be permitted derogations (exemptions) from the risk retention rule. These exemptions largely permit an AIFM to dispose of the loan if retention would be contrary to the effective management of the fund (such as in the best interests of its investors or to implement the investment strategy), to comply with Union sanctions or with “product requirements”. The latter term has not been defined in the draft text. It might be clarified in the legal and technical revisions, or it might be left to ESMA to provide a definition via “Level 3” guidance.
• The agreed leverage limits distinguish between open-ended and closed-ended structures and go beyond the AIFMD’s existing approach for managing leverage. The cap for open-ended was agreed at 175% and for closed-ended at 300%, calculated according to the commitment method and expressed as the difference between the fund’s exposure relative to the fund’s NAV.
  • Subscription lines of credit taken by the fund are excluded from the calculation.
  • Note that the borrowing/gross method for calculating leverage, which was included in the legislation until a late stage, has been removed – leaving only the commitment method permitted under the rules.
  • The text will include provisions to allow AIFs to rectify their positions should the fund unintentionally breach the cap for reasons beyond the AIFM’s control, and on borrowing arrangements that are fully covered by contractual capital commitments (this latter provision is consistent with ESMA’s interpretation of leverage calculations under the current AIFMD Art 6(4)).
• The text refers to LOFs as closed-ended by default but does permit open-ended LOFs if it can be demonstrated to the national competent authority that the AIF has liquidity management tools available that are consistent with its investment strategy and broader liquidity risk management framework. ESMA is expected to provide further details about what “consistency” might entail, but it is not yet clear how prescriptive ESMA might be.

Liquidity risk management

• Both EU and non-EU AIFMs will be required to make pre-contractual disclosures to investors about the AIF’s liquidity risk management framework. ESMA is expected to produce rules on the form of disclosures, and potentially also guidance on the use of liquidity management tools.
• National competent authorities will be empowered under “certain circumstances” to require EU AIFMs and/or non-AIFMs to activate or deactivate a liquidity risk management tool. The circumstances in which this power might be used are not yet clear, but the rationale is to give regulators the ability to act quickly to address possible systemic risks.

Delegation

• EU AIFMs must report their delegation arrangements to national competent authorities on authorisation. The information to be reported will include the total delegated AUM and percentage of the portfolio, the organisational structure of delegation and sub-delegation, and details about the persons and functions involved. ESMA will produce reporting templates during the upcoming “Level 2” rulemaking phase. The delegation requirements apply regardless of where portfolio management is delegated (i.e., not solely to delegation to the UK, but also the US and other jurisdictions).
• ESMA will be empowered to review delegation arrangements as a whole and make reports to the EU institutions. This is a step back from an earlier proposal to give ESMA powers to review individual delegation arrangements.
• While EU institutions could not agree on restrictions to delegation (mainly because the French attempt was opposed by Ireland and Luxembourg), these measures are likely a precursor to future attempts to introduce more restrictions. Note that ESMA has supported delegation restrictions primarily based on concerns about risk oversight; while the French policy rationale is trade-political: to redomicile high-value portfolio management from London to the EU, and within the EU away from the “global hubs” in Luxembourg and Ireland to France and other Member States.

Independent directors

• The recital text, but not the body of the legislation, will include a reference to the desirability of having at least one non-exec on the board of an AIFM.
• This will not be a binding requirement, but the legislation will require the European Commission to undertake a review of the impacts of a mandatory requirement if it were introduced.

Costs and charges

• AIFM will be required to annually report all direct and indirect fees and charges incurred by the AIF. The details of what will need to be reported are not yet clear.
• With reference to ESMA’s recent report on undue costs in AIFs and UCITS, the recitals will recommend that ESMA undertake work to develop a common understanding of “undue costs” (using an existing ESMA power to promote supervisory convergence). We expect this work to take the form of ESMA guidance to be applied by national regulators.

We will keep you updated as the legislation progresses. Let us know if you have any questions at this stage.

This article was written by Michael Sholem, Sam Brooks, Richard Fletcher, Harriet Miller and Gavin Haran.