Irish Loan Origination Funds
Following a consultation process (CP85) which closed on 25 August 2014, the Central Bank of Ireland (the “Central Bank”) has published its final rules for loan origination funds which will be structured as Qualifying Investor Alternative Investment Funds (the “LO-QIAIF”). The framework for the LO-QIAIF is set out in a new chapter of the Central Bank’s revised AIF Rulebook issued in September 2014 (the “AIF Rulebook”).
This new regime will be the first dedicated regulatory regime in the EU for loan origination funds and will operate under the EU’s Alternative Investment Fund Managers Directive (“AIFMD”). Managers that are authorised alternative investment fund managers (“AIFMs”) and meet the additional conditions relating to LO-QIAIFs in the AIF Rulebook will be able to manage the new LO-QIAIF and market it within the EU using the AIFMD passport.
The operations of the LO-QIAIF are 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. Therefore, under the current rules, while LO-QIAIFs may also invest in loans in the secondary market, they cannot invest in debt securities such as bonds. To acheive such mixed investment strategy an AIFM could establish multiple sub-funds in an unbrella QIAIF, some dedicated to loan origination and some not.
The LO-QIAIF must apply procedures, policies and processes for a variety of credit granting, monitoring and management activities, including policies and procedures on the following:
- risk appetite;
- assessment, pricing and granting of credit;
- credit monitoring, renewal and refinancing;
- collateral management;
- concentration risk management;
- valuation, including collateral valuation and impairment;
- credit monitoring;
- identification of problem debt management; and
Liquidity and Distributions
The LO-QIAIF must be closed-ended. However, the LO-QIAIF may invite, at dates determined at launch or such other dates as may be approved by the board of the LO-QIAIF/AIFM, without commitment and on a non-preferred basis, redemption requests from unitholders.
The LO-QIAIF may only make distributions or redemptions to the extent that there is cash or liquid assets available and do not endanger the regulatory compliance or liquidity-related obligations of the LO-QIAIF. Unless the assets are valued by reference to prevailing market prices, distributions or redemptions require unitholder approval.
The LO-QIAIF must not have gross assets of more than 200% of its net asset value. However, there does appear to be some scope for discussion with the Central Bank on this leverage limit as the AIF Rulebook refers to “such other [leverage] limit as may be set by the Central Bank from time to time for the loan originating AIF or for one or more class [sic] of loan originating AIF.” It is arguable that managers with sufficient expertise and experience (and who, for example, invest in higher quality borrowers) should be able to operate with higher leverage levels.
In the event of a breach of the above limit, the LO-QIAIF must within 30 days or such longer period as the Central Bank may specify secure the approval of the Central Bank for a formal plan to bring the LO-QIAIF back into compliance with its leverage limit.
Diversification / Eligible Borrowers
The LO-QIAIF must achieve a diversification of its exposures to any one issuer or group to 25% of its assets within a timeframe specified in its prospectus. If it does not achieve this within the specified timeframe, the LO-QIAIF must seek unitholder approval to continue to operate at the level of diversification achieved. The diversification limit will not apply to funds that have reached their end of life phase and are closing out positions.
The AIF Rulebook prohibits lending to the following categories of borrowers:
- natural persons;
- the AIFM, management company, general partner or depositary of the LO-QIAIF or to delegates or group companies of these;
- other investment funds;
- financial institutions or related companies, except for bona fide treasury management purpose ancillary to the primary objective of the LO-QIAIF; and
- persons intending to invest in equities or other traded investments or commodities.
Skin in the Game
While there is no requirement for manager “skin in the game”, the LO-QIAIF is not permitted to acquire a loan from a bank under arrangements which involve:
- the retention by the bank or an affiliate of an exposure correlated with the performance of the loan;
- the provision of an administration, credit assessment or credit monitoring service in relation to the loan by the bank or an affiliate;
- unless the seller of the loan, or, where within scope of banking consolidated supervision, an entity within its group, will retain a net economic interest of at least 5% of the nominal value of the loan as measured at origination.
Investor Due Diligence
Where the AIFM intends to provide access to its records / staff to any investor for the purposes of a due diligence process, it must ensure that such access has been made available on a non-discriminatory basis to all “unitholders”. The reference in the AIF Rulebook to “unitholders” is helpful as this refers to only those investors that the LO-QIAIF ultimately accepts subscriptions from and become registered unitholders of the LO-QIAIF. It does not impose an obligation on the AIFM to provide this information to each and every investor that expresses interest in the LO-QIAIF.
The LO-QIAIF is required to maintain a comprehensive stress testing programme to identify possible events or future changes in economic conditions that could have a negative impact on the LO-QIAIF’s credit exposure. The programme must provide for at least monthly exposure stress testing of the principal market risk factors and apply at least quarterly multi-factor stress testing scenarios.
Disclosure to Investors
Certain information must be included in the QIAIF’s prospectus and sales materials, including information on risk and reward profile, levels of concentration, as well as risks arising from the proposed concentration. Details of the credit assessment monitoring process and information on whether, the AIFM will provide investors with access to records and staff for the purpose of a due diligence process must be disclosed.
The periodic reports issued by the LO-QIAIF to unitholders must include certain information, such as a breakdown of the originated loans between senior secured debt, junior debt and mezzanine debt.
In addition, a report must be submitted to the Central Bank on undrawn committed credit lines.
The introduction of the new LO-QIAIF regime is a welcome development and we expect that there will be considerable interest in the product. The Central Bank has recognised this and will accept applications for LO-QIAIFs from 1 October 2014.Download PDF