AIFMD II: Main Amendments - Fund Management/ REITs

The directive amending the Alternative Investment Fund Managers Directive ("AIFMD II") has been adopted and will enter into force on 15 April 2024 with a transposition deadline two years later on 16 April 2026. AIFMD II tightens the regulatory framework governing managers of credit funds (so-called "loan-originating AIFs") and other funds originating loans as well as amends certain other rules applicable to all AIFMs. This article provides an overview of the main amendments introduced by AIFMD II.

Framework for managers of credit funds and other funds originating loans

AIFMD II includes a regulatory framework for managers of "loan-originating AIFs" (i.e. credit funds) and other funds, which are originating loans. The framework contains exposure and leverage limitations, a risk retention requirement (akin to the one applicable in the Securitisation Regulation), enhances disclosure requirements relating to loan-related costs and restrictions on lending to certain borrowers.

AIFMD II distinguishes between "loan-originating AIFs" which have loan originations as their principal activities and other AIFs that originate loans without meeting the definition of "loan-originating AIFs".

AIFMD II defines "loan-originating AIFs" as:

"An AIF: (i) whose investment strategy is mainly to originate loans; or (ii) whose originated loans have a notional value that represents at least 50 % of its net asset value".
In AIFMD II, "loan origination" or "originating a loan" means:
"the granting of a loan: (i) directly by an AIF as the original lender; or (ii) indirectly through a third party or special purpose vehicle which originates a loan for or on behalf of the AIF, or for or on behalf of an AIFM in respect of the AIF, where the AIFM or AIF is involved in structuring the loan, or defining or pre-agreeing its characteristics, prior to gaining exposure to the loan."

Most of the requirements regarding the activities of originating loans apply to both loan-originating AIFs and other AIFs that originate loans. However, additional requirements apply to loan-originating AIFs.

AIFMD II does not include a definition of a "loan", but it will be interesting to follow whether a portfolio company's issuance of bonds or other debt securities to an AIF will qualify as loan origination by the AIF.

A black letter interpretation of the text indicates that an AIFM managing an AIF originating a single or few loans, will be subject to the requirements (e.g. on effective policies and risk retention). This suggests that even AIFs that are primarily pursuing an equity investment strategy but are allowed to grant loans on an opportunistic basis, could be considered an AIF originating loans, which would broaden the practical scope of these new rules to include buy-out funds, infrastructure funds etc. Depending on the circumstances, some AIFMs may be able to rely on exemptions from some of the new requirements imposed on AIFs that originate loans. Private equity managers whose AIFs will only grant loans alongside equity investments in portfolio companies (as opposed to on a stand-alone basis) will be able to rely on the shareholder loan exemption (meaning that the leverage limitation, the procedural requirements (policies & procedures) and credit risk management do not apply), provided that the notional value of the shareholder loans of the AIF does not exceed in aggregate 150% of the capital committed to the AIF.

The main points are listed below:

Main points

Requirements applicable to AIFMs of loan-originating AIFs:

Leverage limitation: An AIFM shall ensure that the leverage of a loan-originating AIF it manages represents no more than (a) 175% of its net asset value, where that AIF is open-ended; and (b) 300% of its net asset value, where that AIF is closed-ended.
Closed-end preference: A loan-originating AIF must, as a general rule, be closed-ended to avoid liquidity mismatches, but open-ended AIFs are permitted if the AIFM that manages it is able to demonstrate that the AIF's liquidity management system is compatible with its investment strategy and redemption policy.

Requirements applicable to all AIFs originating loans:

Exposure limitation: An AIFM shall ensure that, where an AIF it manages originates loans, the notional value of the loans originated to any single borrower by that AIF does not exceed in aggregate 20% of the capital of the AIF where the borrower is a financial undertaking, an AIF or a UCITS.
Related party loans: The AIFM shall ensure that an AIF it manages does not grant loans to the AIFM, any member of the AIFM's group, its staff, the depositary or any delegates or sub-delegates.
Risk retention: An AIFM shall ensure that the AIF it manages retains 5% of the notional value of each loan that the AIF has originated and subsequently transferred to third parties.
Ban on "originate-to-distribute": AIFMs are prohibited from managing AIFs with a strategy of originating loans for the sole purpose of transferring those loans or exposures to third parties.
Possible ban on loans to consumers: A member state may prohibit AIFs that originate loans from granting loans to consumers in its territory.
Policies etc.: AIFMs must for loan-originating activities, implement effective policies, procedures, and processes for the granting of loans, for assessment of credit risk and for administering and monitoring credit portfolios etc.
Attribution of proceeds: Where an AIF originates loans, the proceeds of the loans, minus any allowable fees for their administration, shall be attributed to that AIF in full.
Disclosure: All costs and expenses linked to the administration of the loans shall be disclosed to investors in accordance with Article 23 of AIFMD.

Some of the requirements, inter alia the exposure and leverage limitations and the risk retention requirement, are subject to certain carve-outs and exemptions. By way of example, the leverage limits and the requirements regarding effective policies do not apply in relation to shareholder loans that do not exceed 150% of the AIF's capital commitments.

Key amendments for all AIFMs

Topics	Amendments
Services to third parties	Super ManCos that provide services (e.g., corporate secretarial functions, HR, or IT services relating to portfolio management and risk management) to third parties (i.e., AIFs other than those AIFs they manage themselves) must appropriately manage any conflicts of interest which these services entail. Where an AIFM manages or intends to manage an AIF at the initiative of a third-party, including cases where that AIF uses the name of a third-party initiator or where an AIFM appoints a third-party imitator as a delegate, the AFIM shall submit detailed explanations and evidence of its compliance with the requirements on conflicts of interest.
Ancillary services	Credit servicing activities and administration of benchmarks are added to the list of ancillary activities that AIFMs may perform.
Authorisation and organisation	AIFMs must employ at least two persons who either are employed full-time by the AIFM or are executive members or members of the governing body of the AIFM committed full-time to conducting the business of the AIFM, and who are domiciled in the EU. When applying for authorisation, AIFMs must provide more detailed information about, inter alia, the persons effectively conducting the business of the AIFM and delegation arrangements.
Investor disclosures	AIFMD II broadens the disclosure obligations under Article 23 of AIFMD, e.g. so that the investor disclosure document must now include a list of fees, charges and expenses that are borne by the AIFM in connection with the operation of the AIF and that are to be directly or indirectly allocated to the AIF. The periodic disclosure obligations are also broadened, to include disclosure to investors on an annual basis, of all fees, charges and expenses that were directly or indirectly borne by investors. Depending on the granularity of information potentially detailed to be provided in future guidelines, AIFMs may be required to provide more details on fees, charges, and expenses (and implicitly any discounts offered) than what they have been used to disclose.
Delegation	When an AIFM performs non-core services (e.g., the MiFID services of individual portfolio management, investment advice, or reception and transmission of orders) and delegates those in whole or in part to a third party, they must notify the Danish FSA (or the competent regulatory authority of the AIFM, if not Denmark).
Liquidity management	A new list of nine specific liquidity management tools has been introduced in Schedule V of AIFMD II. AIFMs managing open-ended AIFs (e.g., a hedge fund) must select at least two relevant liquidity management tools from the list of eligible liquidity management tools included in Schedule V, nos. 2-8 of AIFMD II.
Depositary services	AIFMD II introduces an option for EEA Member States to allow depositaries from other EEA Member States to service Danish AIFs.
List of activities	The activities "originating loans on behalf of an AIF" and "servicing securitisation special purpose entities" are added to Annex I, point 2.

It will be interesting to follow whether the obligation to notify the regulator of additional information relating to a third-party AIFM's management of its conflict of interests, will challenge the business model of third-party AIFMs going forward.

The UCITS directive is amended to align certain regulatory requirements across the AIFMD and UCITS regimes regarding delegation, custodians, supervisory reporting requirements and liquidity management tools.

Grandfathering rules for AIFMs managing existing AIFs

The new requirements in AIFMD II will apply as from the implementation date in the member states (including Denmark).

However, AIFMD II includes a rather complex set of grandfathering rules for AIFMs managing existing loan-originating AIFs and other AIFs that are originating loans:

Subject	Grandfathering rule
AIFMs managing AIFs that are not fundraising after 15 April 2024 (Grandfathering rule regarding AIF-level rules)	AIFMs managing AIFs that originate loans which (i) were constituted before 15 April 2024 and (ii) do not raise capital after that date will indefinitely be deemed to comply with the exposure and leverage limitations and the closed-end preference rule in respect of those AIFs. However, if the AIFs originate loans after 15 April 2024, the above loan origination requirements have to be complied with by the AIFMs in respect of the loans originated after 15 April 2024.
AIFMs managing AIFs that are fundraising after 15 April 2024 (Grandfathering rule regarding AIF-level rules)	AIFMs managing AIFs that originate loans which (i) were constituted after 15 April 2024, and (ii) are still raising capital after 15 April 2024 are grandfathered in respect of the exposure and leverage limitations and the closed-end preference rule until 16 April 2029. However, AIFMs may not increase the value of the loans originated by the AIF, if the value of the loans is already exceeding – or as a result of such an increase would exceed – the new exposure and leverage limits set out in AIFMD II. Further, if the AIFs originate loans after 15 April 2024, the loan origination requirements have to be complied with by the AIFMs as from the [implementation date / commencement date] in the member states of the AIFM in respect of the loans originated after 15 April 2024.
Loans originated before 15 April 2024 (Grandfathering rule regarding loan-level rules)	Where AIFs originate loans before 15 April 2024, AIFMs may continue to manage such AIFs without complying with the following requirements regarding the loans originated before 15 April 2024: (i) The requirements regarding effective policies etc., (ii) the ban on related party loans, (iii) the requirements on attribution of proceeds and disclosure of costs and expenses, (iv) the possible ban on originating loans to consumers, (v) the ban on "originate-to-distribute" and (vi) the risk retention rule. As a result, existing AIFs may have portfolios in which certain loans are subject to the above requirements, while other loans are not – depending on the date of origination.

Subject

Grandfathering rule

AIFMs managing AIFs that are not fundraising after 15 April 2024

(Grandfathering rule regarding AIF-level rules)

AIFMs managing AIFs that originate loans which (i) were constituted before 15 April 2024 and (ii) do not raise capital after that date will indefinitely be deemed to comply with the exposure and leverage limitations and the closed-end preference rule in respect of those AIFs.

However, if the AIFs originate loans after 15 April 2024, the above loan origination requirements have to be complied with by the AIFMs in respect of the loans originated after 15 April 2024.

AIFMs managing AIFs that are

fundraising after 15 April 2024

(Grandfathering rule regarding AIF-level rules)

AIFMs managing AIFs that originate loans which (i) were constituted after 15 April 2024, and (ii) are still raising capital after 15 April 2024 are grandfathered in respect of the exposure and leverage limitations and the closed-end preference rule until 16 April 2029.

However, AIFMs may not increase the value of the loans originated by the AIF, if the value of the loans is already exceeding – or as a result of such an increase would exceed – the new exposure and leverage limits set out in AIFMD II.

Further, if the AIFs originate loans after 15 April 2024, the loan origination requirements have to be complied with by the AIFMs as from the [implementation date / commencement date] in the member states of the AIFM in respect of the loans originated after 15 April 2024.

Loans originated before 15 April 2024

(Grandfathering rule regarding loan-level rules)

Where AIFs originate loans before 15 April 2024, AIFMs may continue to manage such AIFs without complying with the following requirements regarding the loans originated before 15 April 2024: (i) The requirements regarding effective policies etc., (ii) the ban on related party loans, (iii) the requirements on attribution of proceeds and disclosure of costs and expenses, (iv) the possible ban on originating loans to consumers, (v) the ban on "originate-to-distribute" and (vi) the risk retention rule.

As a result, existing AIFs may have portfolios in which certain loans are subject to the above requirements, while other loans are not – depending on the date of origination.

Levels 2 and 3

AIFMD II delegates certain areas to ESMA for more detailed regulations under Level 2 (regulatory technical standards) and Level 3 (guidelines). Accordingly, guidance and detailed regulations will be provided in respect of e.g. (i) the requirements with which loan-originating AIFs are to comply in order to maintain an open-ended structure, (ii) the characteristics of the liquidity management tools set out in Annex V, and (iii) the circumstances in which the name of an AIF is unfair, unclear or misleading.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.