Consultation on loan originating Qualifying Investor AIF
On 28 July 2014, the Central Bank of Ireland (CBI) issued a consultation paper (CP85) on the proposed “Loan originating Qualifying Investor Alternative Investment Fund” (LOQIAIF).
The LOQIAIF will be introduced via an update to Chapter 2 of the Central Bank’s AIF Rulebook. As a QIAIF, the loan origination fund will be available to professional investors and may be structured as an internally managed vehicle. CP85 allows a wide range of enterprises to avail of the loans, subject to an assessment of suitability by the manager taking into account the due diligence and disclosure rules outlined in CP85. Loan origination to natural persons, the AIFM, the depositary, delegates, other CIS, financial institutions and other investment businesses is prohibited.
The LOQIAIF can only operate as a single strategy fund, ie, the fund can only invest in loan origination, and so cannot be a multi-strategy fund. It remains to be seen whether a single-strategy loan origination sub-fund will be permitted.
Central Bank consulting areas
This will be the first regulatory regime in the EU for loan origination funds, and fund managers will be able to avail of the AIFMD’s pan-European marketing passport for professional investors.
The Central Bank is consulting on ten specific areas:
- Credit assessment granting and monitoring – the fund must have an effective credit assessment and management process with established policies, and must abide by the Central Bank’s Code of Conduct for Business Lending to Small and Medium Enterprises.
- Diversification - exposure is limited to 25% of net assets, to one group or issuer
- Liquidity – the QIAIF must be closed-ended, but may at authorisation specify pre-determined interim redemption dates within the fund’s life-cycle
- Due diligence – in addition AIFMD’s requirement that investors be treated fairly, CP85 proposes that access to information for due diligence is non-discriminatory
- Valuation – CP85 queries whether the AIFMD’s valuation rules are sufficient
- Leverage - this will be restricted to 200% of total assets. The composition and calculation of total assets remains to be determined.
- Investor disclosures – including the fund’s risk/reward profile, anticipated concentration levels, credit monitoring process, and a risk warning that the Central Bank may tighten lending standards and leverage limits. The prospectus must disclose whether the fund will allow investors to access records for due diligence. The AIFM must disclose information that a reasonable investor would consider important when considering investing in the fund. The prospectus must also disclose the implications of a new Code of Conduct which will apply when loans are made to SMEs. Periodic statements must disclose details of the fund’s loan book.
- Interconnectedness with the banking sector – to mitigate risks of arbitrage between bank lending and AIF lending, CP85 proposes a requirement that the fund disclose details of any undrawn committed credit lines in periodic reports: it explains that when aggregated and looked at in conjunction with the data on drawn facilities, it should provide useful information to regulators on the relationships between the banking and non-banking sectors.
- Connection between a credit institution and a fund – if this is ongoing, CP85 proposes that specific rules apply in addition to the requirements in AIFMD regarding securitisation and the AIF Rulebook requirements regarding transactions with connected parties.
- Reporting and stress testing – in addition to the rules in AIFMD regarding concentrations, exposures, borrowings, CP85 proposes periodic stress testing and similar reporting on individual loans as is provided by the banking sector.
The CBI first published a Discussion Paper on loan origination by investment funds in July 2013. Following that paper and the related discussions and responses received, the CBI identified certain significant risks, including:
- Risks of regulatory arbitrage with other segments of the financial sector
- Risk of runs on investment funds – arising from a potential mismatch between the liquidity and maturity of the investment fund’s assets and liabilities.
- Contagion risk with the banking sector through interconnectedness between the loan originating investment fund and a partner bank.
- Risks of excessive credit growth and pro-cyclicality: instruments must be available to authorities to address excessive credit growth and leverage across the entire financial system.
The CBI considers that certain of those risks are already mitigated through the protections inbuilt into the Alternative Investment Fund Managers Directive (AIFMD), but that the Irish regulatory regime requires supplementation to ensure that other risks are addressed.
As these LOQIAIFs would be the first loan originating funds within Europe, it is expected that they will generate significant interest across the funds industry. The Central Bank deadline of the 25 August 2014,for accepting responses on CP85 is now closed.