ESMA Lends Support for a Harmonised European Framework for Loan Origination Funds
The European Securities and Markets Authority (“ESMA”) published its opinion on 11 April 2016 on the necessary elements for a harmonised European framework for loan origination by funds (the “Opinion”). The Opinion is issued to the European Parliament, Council and Commission at the request of the European Commission as part of its Action Plan on Building a Capital Markets Union (the “CMU”), which was published on 30 September 2015. The goals of the CMU include assessing the need for a coordinated approach to loan origination by funds, and consulting on the elements of a European framework on loan origination. The European Commission intends to consult on that framework in the second quarter of 2016 (the “Commission Consultation”) and the Opinion, while having no legal force, is a useful indication of the direction of travel.
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ESMA Lends Support for a Harmonised European
Framework for Loan Origination Funds
April 2016 / Authored by Dechert’s Financial Services Practice
The European Securities and Markets Authority (“ESMA”) published its opinion on 11 April 2016 on the necessary
elements for a harmonised European framework for loan origination by funds (the “Opinion”)1. The Opinion is issued
to the European Parliament, Council and Commission at the request of the European Commission as part of its
Action Plan on Building a Capital Markets Union (the “CMU”), which was published on 30 September 2015. The
goals of the CMU include assessing the need for a coordinated approach to loan origination by funds, and consulting
on the elements of a European framework on loan origination. The European Commission intends to consult on that
framework in the second quarter of 2016 (the “Commission Consultation”) and the Opinion, while having no legal
force, is a useful indication of the direction of travel.
Which funds are in scope?
The Opinion and Commission Consultation are of fundamental importance to EU fund managers of EU (and
potentially also non-EU) funds that conduct loan origination. EU fund managers of other loan strategies, or of funds
that invest through loans (for example, buy out or turnaround funds) and even managers of EuVECA, EuSEF or
ELTIF could find themselves within the scope of the Commission Consultation and resulting framework. Funds
managed by non-EU fund managers that originate loans in the EU could also be affected.
The Opinion focusses on “loan origination” which ESMA defines as providing credit while acting as a sole or a
primary lender. It distinguishes “loan origination” from “loan participation” (defined as typically involving secondary
market participations) and “loan restructuring” (defined as where a fund invests in reaction to the restructuring of
debt). However, managers of loan strategies other than loan origination may not be out of scope of the Commission
Consultation, which ESMA considers should include the harmonisation of loan participation and activities that fall
between loan participation and loan origination. More fundamentally, ESMA’s view is that funds “should provide
credit under a suitable framework such that systemic risk is mitigated … and is no higher than that posed by bank
ESMA considers that the Commission Consultation should review the exemptions relating to loan origination that are
currently in place in Member States and available to private equity funds, venture capital funds and hedge funds, and
threshold levels of loan originating activities. So the results of the Commission Consultation will be of importance to
managers of a wide spectrum of fund strategies.
While the Opinion expressly does not cover the EuVECA, EuSEF and ELTIF regulations, ESMA acknowledges that
loan origination is possible (to some extent) for those types of funds, and raises as an option mandatory authorisation
under the loan origination regime for managers of such funds (views within ESMA diverge on this point).
ESMA could not reach common ground on all issues and so its Opinion includes more and less interventionist
positions on important points. Given the spread of views within ESMA, input from the fund management industry
bodies and participants will be important to the Commission Consultation to ensure that the outcome is an
appropriate level of regulation.
April 2016 Page 3
While a majority of Member States currently permit loan origination by funds, approaches differ. Some Member
States have long permitted loan origination to corporates on an unregulated basis (for example, the UK) while others
permit loan origination only through specific regulated fund regimes (such as Ireland3, Germany4 and Malta). ESMA
considers ”a common approach at the EU level would contribute to a level playing field for stakeholders, as well as
reducing the potential for regulatory arbitrage”. An overview of ESMA’s assessment of Member States’ differing
approaches is annexed to the Opinion.
ESMA’s key issues for loan origination
ESMA considers that an “authorisation gateway” could be desirable for loan origination funds and their managers,
particularly to allow assessment of credit origination operational capability, monitor systemic risk, and protect
borrowers’ and investors’ interests. ESMA’s desired end goal is a framework that provides national competent
authorities with all necessary powers to monitor, supervise and enforce requirements set for both managers and their
funds. However, rather than concluding that the AIFMD5 is sufficient for this purpose, as a number of member states
have already done in practice, ESMA appears to be indicating either a further legislative proposal or an instrument
supplementing the AIFMD
(a) Authorisation of managers
ESMA recommends that the Commission Consultation should explore mandatory authorisation of managers of loan
origination funds. As AIFMD already requires authorisation of managers above de minimis assets under
management thresholds, the point here appears to be whether or not there should be a sub-threshold regime at all for
loan fund managers. However, having re-opened this question, ESMA does not advance any cogent argument for
differentiating loan fund managers from any other AIFM in this respect.
(b) Authorisation of funds
A key tenet of the AIFMD is that authorisation is at the level of the manager and not the fund. However, the Opinion
suggests that the Commission Consultation should consider whether fund authorisation could be necessary, due to
the “risks inherent in loan origination by funds”. Again, this approach is at odds with AIFMD and ESMA does not
explain why loan origination is perceived to be more risky than other AIF strategies beyond high-level assertions of
systemic, liquidity, maturity transformation and imprudent lending risk; which are already addressed by AIFMD and
are not unique to loan origination funds or to credit funds more generally.
Jurisdictions such as Luxembourg and Malta have introduced or are introducing fund structures which are AIFMD
compliant but which are not subject to any regulatory approval (see for example, the Luxembourg RAIF6).
2 For further information on loan origination, please see the Central Bank of Ireland Discussion Paper on Loan Origination by
Investment Funds (July 2013) and, on the US side, an article entitled – “Mutual Funds and Loan Investments”, in The Investment
Lawyer (March 2015) by Stephen H. Bier and Julien Bourgeois of Dechert LLP.
3 For more information on the Irish loan origination fund structure, please see Dechert OnPoint – “A Borrower and a Lender Be: Irish
Central Bank’s Loan Origination Fund Rules” (March 2015)
4 For more information on the German loan origination fund structure, please see Dechert OnPoint – “OGAW-V Umsetzungsgesetz
verkündet: Auswirkungen auf Kreditfonds” (March 2016)
5 Directive 2011/61/EU of the European Parliament and of the Council of 8 June 2011 on Alternative Investment Fund Managers
and amending Directives 2003/41/EC and 2009/65/EC and Regulations (EC) No 1060/2009 and (EU) No 1095/2010.
6 For more information on the Luxembourg RAIF, please refer to Dechert OnPoint “Pending Luxembourg Bill Introduces Widespread
Changes Affecting SIFs, SICARs and Part II UCIs” (February 2016)
April 2016 Page 4
Luxembourg and other Member States also offer fund structures which are both AIFMD compliant and subject to
regulatory approval, such as the Irish QIAIF and Luxembourg SIF. However, not all Member States offer regulated
funds subject to a bespoke loan origination regime. For example, it has long been possible to structure private funds
in the UK which engage in loan origination activity without any special authorisation at the level of the fund.
(ii) Types and scope of loan origination funds
ESMA considers that loan origination funds should be closed-ended with limited redemption facilities at the
manager’s election and provided that investors are repaid on a non-preferred and equal basis at fixed intervals.
ESMA is concerned by maturity transformation and potential short-term liquidity problems, and therefore considers
that loan origination funds should not be permitted to provide loans with a maturity beyond the life of the fund, and
should be required to maintain “a level of liquidity appropriate to their activities”.
(b) Scope of operations
ESMA notes that one Member State (Ireland) does not permit loan origination funds to conduct non-loan related
investment activity (such as equity investment) in addition to originating loans while most other Member States allow
loan origination funds to conduct other types of investment activity. The rationale for the Irish approach (following
consultations with the European Systematic Risk Board) was to ensure that loan origination is seen as a specialist
activity and not an “add-on”. However, this has proven to be a commercially unattractive feature of the regime.
ESMA does not express a view as to whether loan origination funds should be restricted from conducting other
investment activity, but raises this as an issue for the Commission Consultation and notes that if any resulting
restrictions would reduce the types of funds permitted to originate loans, then there would be merit in a
grandfathering or transitional regime.
(iii) Types of investors
Several of the Member States with existing loan origination fund frameworks do not permit investments by retail
investors in loan origination funds, opting instead for the AIFMD professional investor based criteria. However,
ESMA does not close the door to investment in loan origination funds by retail investors, particularly if afforded
protections similar to those in the ELTIF Regulation.
(iv) Organisational requirements for managers
ESMA advocates a detailed operational and conduct framework for loan origination funds to mitigate the systemic,
liquidity, maturity transformation, financial, legal, and “imprudent lending” risks that it identifies (but does not detail).
As a minimum ESMA considers that fund managers of loan origination funds should be required to have policies,
processes and procedures covering:
risk appetite statement;
risk management procedures;
the assessment, pricing and granting of credit;
credit monitoring, renewal and refinancing
collateral management policy;
concentration risk management policy;
April 2016 Page 5
operational risk control appropriate to loan origination;
assessment and scoring of borrowers;
valuation, including collateral valuation and impairment;
management of forbearance;
identification of problem debt management; and
capability and experience of staff.
These overlap substantially with the requirements of the Irish loan origination fund regime, perhaps unsurprisingly as
those requirements resulted from consultations with the European Systemic Risk Board.
(v) General requirements for loan origination funds: leverage, liquidity, stress testing, reporting
Member States’ approach to the amount of leverage permitted for loan origination funds ranges from outright
prohibition (e.g. Spain and Malta) to no stated limitation (e.g. Luxembourg). Although ESMA considers that there
should be a set limit on leverage, it notes that loan origination funds should be permitted to incur some leverage in
order to allow them to lend to small and medium-sized enterprises, a key focus of the CMU. ESMA recommends that
the Commission Consultation assess the permitted amount and types of leverage (whether from credit institutions
only or from other sources as well).
ESMA recommends that loan origination funds should be required to conduct regular stress tests and that the results
of the stress tests should be reported to the board of the fund manager on a quarterly basis (this requirement is
consistent with the stress test requirements of the Irish regime). ESMA also recommends the inclusion of additional
reporting requirements into the AIFMD Level 2 Annex IV reporting regime7 to monitor the activities of loan origination
funds and fund managers, and an assessment of possible mitigants to deal with systemic risk of loan origination by
funds, including providing regulators with additional macro-prudential tools.
(vi) Diversification, eligible investments and eligible debtors
ESMA recommends that the Commission Consultation consider balancing the need for diversity at the investment
level with the potential utility of funds specialised in industrial sectors with limited access to credit institution finance.
It considers that loan origination funds should be prohibited from engaging in short-selling and securities financing
transactions (including securities lending), from using derivatives other than for hedging, and (as is consistent, for
example, with the Irish regime) from lending to individuals, financial institutions, collective investment schemes, its
manager and other related parties (such as depositary, general partner, or delegates).
7 Delegated regulation EU no 231/2013 of 19 December 2012 supplementing Directive 2011/61/EU of the European Parliament and
of the Council with regard to exemptions, general operating conditions, depositaries, leverage, transparency and supervision, OJ L
April 2016 Page 6
Summary comparison of the ESMA Opinion against key jurisdictions’ current regimes
Ireland Luxembourg UK Malta Germany Italy
Leverage limit Open 200% None stated but
None stated but
130% 130% (retail)
Yes Yes Risk
Yes Yes (risk
Yes Yes Yes No consumer
Yes Yes Yes
Yes Yes Risk
Yes Yes Yes
Yes Yes No No Yes Yes Yes
Open No Yes Yes Yes Yes Yes
Open No No Limited No No Yes
Open Yes No No Yes Yes Yes
Please note that this a high-level comparison which does not take account of the nuances and detail of each
jurisdiction’s regulatory regime.
The Opinion suggests that the conduct of loan origination by fund managers in the EU is likely to be subject to some
sort of additional regulatory requirements following the Commission Consultation and resulting legislative measures.
If appropriately implemented, harmonisation of Member States’ loan origination regimes may benefit cross-border
loan origination activity and the free movement of capital within the EU. Unless lessons have been learnt from
AIFMD implementation, that seems a big “if”.
Inappropriate implementation could result in an unnecessary additional layer of regulation, uncertainty and costs on
top of a regime (AIFMD) that many consider to already be fit for purpose. This could constrict an important source of
credit for EU companies (and SMEs in particular), contrary to the intent of the CMU to increase sources of funding for
8 Excluding ELTIF, EuVECA and EUSEF
April 2016 Page 7
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