Enhanced Opportunities for Loan Originating Funds
In October 2014 the Central Bank of Ireland (CBI) introduced the first bespoke regime for loan originating investment funds in the EU. This was widely welcomed as a very significant development, both in terms of fund innovation and in terms of providing increased sources of financing for the Irish economy.
The CBI’s regime allows loan originating qualifying investor alternative investment funds (L-QIAIFs) to engage in direct lending activities, subject to complying with certain conditions. Since its introduction, the CBI has amended the L-QIAIF regime on two occasions, with the most recent amendment taking effect on 7 March 2018. This amendment significantly enhances an L-QIAIF’s ability to invest in a broad range of fixed income and credit securities, and is likely to make Ireland a more attractive jurisdiction for managers seeking to engage in loan origination and broader credit activities.
Developing the L-QIAIF Regime
The Alternative Investment Fund Managers Directive (AIFMD) does not address the issue of loan originating funds, leaving it to the EU Member States to decide whether or not to allow alternative investment funds to engage in direct lending.
The CBI published a discussion paper on Loan Origination by Investment Funds in July 2013, followed by a consultation paper a year later.
Subsequently, the CBI developed a bespoke framework for L-QIAIFs s which is set out in the CBI’s AIF Rulebook. Under this framework, L-QIAIFs are subject to the general rules applicable to all QIAIFs. Among other things, this means that an L-QIAIF must have a minimum initial subscription of €100,000 or greater and that it can only be marketed to “Qualifying Investors” as defined in the Central Bank’s AIF Rulebook. L-QIAIFs are also subject to certain additional requirements, designed to mitigate the risks which are commonly perceived to be associated with them.
Expanding the Limited Purpose Rule
The additional requirements applicable to L-QIAIFs include a so-called “limited purpose” rule, which restricts the type of activities that an L-QIAIF can carry on.
Currently, the limited purpose rule means that L-QIAIFs are only allowed invest in a) loan origination and acquiring participations in loans on the secondary market; b) debt and equity securities of entities or groups to which the L-QIAIF lends; c) instruments which are held for treasury, cash management or hedging purposes.
On 7 February 2018, the CBI published a Notice of Intention to a rule change to the AIF Rulebook, in which it signalled its intention to allow an L-QIAIF invest in any type of debt or credit instrument from 7 March 2018. As a result, since that date an L-QIAIF can invest in a broad range of fixed income and credit securities as part of its overall investment strategies and is no longer restricted to debt/credit instruments of entities or groups to which it has lent money. This is in addition to the L-QIAIF carrying out each of the other types of investments mentioned in the preceding paragraph.
Authorisation and Passporting
We expect that the recent expansion of the limited purpose rule will greatly enhance the attractiveness of Ireland’s L-QIAIF regime.
Those interested in establishing an L-QIAIF will need to apply to the CBI for authorisation and demonstrate compliance with the requirements set out in the AIF Rulebook. L-QIAIFs benefit from the QIAIF fast-track approval process, which means that an L-QIAIF can be authorised by the CBI in 24 hours. Once authorised, it will be possible to market the L-QIAIF throughout the EU, under the AIFMD marketing passport.
The CBI’s recent amendment of the limited purpose rule suggests that it is becoming increasingly comfortable with the benefits associated with L-QIAIFs, and less concerned about the risks associated with permitting L-QIAIFs to pursue an investment strategy that includes a broad range of fixed income and credit securities.
The aim of the EU Capital Markets Union (CMU) is to create deeper and more integrated capital markets across the EU by reducing fragmentation in financial markets, diversifying financing sources, strengthening cross border capital flows and improving access to finance for businesses. A key part of CMU involves the development of an appropriate EU framework for loan origination and addressing barriers to lending for non-bank entities. Loan originating funds therefore have the potential to make a valuable contribution to growing capital markets and providing alternative sources of funding to market participants. Loan origination funds also offer the opportunity to allow investors gain exposure to this increasingly popular asset class in a diversified and cost-effective manner.
Mark White (Partner and Head of Investment Management Group) and Imelda Higgins (Senior Associate, Knowledge Team) - McCann FitzGerald