AIFMD II: What private fund managers need to know

(9 min read)

In this briefing, we take a look at the main changes introduced by AIFMD II from 39,000ft. Member states will likely have until 2026 to implement AIFMD II. The briefing highlights the new regime for loan originating AIFs, the additional reporting and disclosure requirements for AIFMs, the amended delegation and substance requirements, the new rules for the fair treatment of investors and undue costs, and the conflicts of interest provision. Whilst not directly applicable to UK based private fund managers, AIFMD II will have a material indirect impact on those who raise capital in the EU and/or are party to delegation arrangements.

On 10 November 2023, the final text of the Amending Directive to the Alternative Investment Fund Managers Directive (2011/61/EU) (AIFMD II) was published. A copy of the final (albeit unofficial) text is available here. We understand that the European Parliament is currently due to consider the text at its plenary session commencing on 5 February 2024.

Assuming that the text is approved and published in the Official Journal without undue delay, we would expect AIFMD II to likely come into force in 2026 as Member States will have 24 months in which to implement it in their jurisdictions. There will be a grandfathering period in respect of some of the loan origination provisions, which will come into force one year later.

AIFMD II will not of course, be directly applicable to UK AIFMs. Nonetheless, a number of the provisions of AIFMD II will be of relevance to UK based AIFMs whether they are acting as a delegate of an EU AIFM or are marketing cross-border into Member States.

Whilst AIFMD II is not a complete overhaul of the AIFMD, it does, as expected, introduce a number of amendments that will be of interest to private fund managers. We have picked the top five that private fund managers need to know about:

a new regime for alternative investment funds (AIFs) originating loans (including leverage limits and a potential lending passport);
additional reporting requirements to investors under article 23;
amended delegation and substance requirements;
new requirements for the fair treatment of investors and undue costs; and
conflicts of interest.

We examine each of the main changes below.

Loan origination - what does this mean for European fund managers?

AIFMD II establishes a new regime for loan originating AIFs. In respect of a number of provisions, including in relation to leverage limits and loan origination to consumers, AIFMD II makes it clear that Member States are not prevented by AIFMD II from adopting national product frameworks that define certain categories of AIF with more restrictive rules and even prohibiting loan origination by AIFs to consumers in their territory if they deem it to be in the public interest. The high-level summary of the rules below should therefore be seen as a baseline - we fully expect certain Member States to gold plate these and adopt a more restrictive approach:

Loan-originating AIF: This is defined as an AIF "whose investment strategy is mainly to originate loans; or where the notional value of the AIF's originated loans represents at least 50% of its net asset value";
Close ended: AIFMs must ensure that loan-originating AIFs are close ended unless the AIFM can "demonstrate to the [National Competent Authority] of the AIFM's home Member State that the AIF's liquidity risk management system is compatible with its investment strategy and redemption policy";
Originate to distribute: AIFMD II prohibits originate to distribute strategies, i.e., AIFs "whose investment strategy … is to originate loans, with the sole purpose of transferring those loans or exposures to third parties";
Skin in the game: AIFMs must ensure that a loan origination AIF retains 5% of the notional value of each loan that it originates and subsequently transfers to a third party. That percentage needs to be retained until maturity for loans with a maturity of up to eight years or for at least eight years for all other loans. There are four exceptions to the retention requirement: (a) where the AIFM sells assets of the AIF in order to redeem units or shares as part of liquidation of the AIF; (b) where a disposal is necessary to comply with the EU sanctions regime; (c) where necessary for the AIFM to implement the AIF's investment strategy in the best interests of the investors; and (d) the sale is a result of a deterioration in the risk associated with the loan and the purchaser of the loan is informed of that deterioration when buying the loan;
Assessing credit risk: AIFMs must "implement effective policies, procedures and processes for the granting of credit." Similarly, where an AIF gains exposure to loans through third parties, the AIFM needs to have in place effective policies, procedures and processes for assessing the credit risk as well as for administering and monitoring their credit portfolio. Those policies, procedures and processes need to be kept up to date and reviewed at least once a year;
Diversification: An AIFM must 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 institution, another AIF or a UCITS. The 20% diversification rule applies from the date specified in the AIF rules, instruments of incorporation or prospectus, which cannot be later than 24 months from the date of the first subscription for units or shares of the AIF. The rule will also: (i) cease to apply once the AIFM starts to sell assets of the AIF in order to redeem units or shares as part of the liquidation of the AIF; and (ii) be temporarily suspended where the capital of the AIF is increased or reduced; and
Leverage limits: AIFMD II introduces new leverage limits, with AIFMs of loan-originating AIF being obliged to ensure that leverage represents no more than 175%, where the AIF is open-ended and 300% where the AIF is closed-ended. Leverage is calculated as the ratio between the exposure of the AIF and its net asset value. Borrowing arrangements which are fully covered by contractual capital commitments from investors, however, are not considered to constitute exposure for the purposes of calculating that ratio.

Moving forward, we would expect "document hygiene" to be a particular focus for AIFMs managing loan origination funds.

Additional reporting and disclosure requirements

Delegation arrangements - new disclosure and substance requirement

Whilst the delegation regime remains largely intact (for now), there are new disclosure obligations on AIFMs who delegate portfolio or risk management functions and there are now minimum substance requirements for AIFMs. Further, within five years of the entry into force of AIFMD II, ESMA is to produce "a report analysing market practices regarding delegation … [the] report [must] also analyse compliance with the substance requirements" of the AIFMD.

Article 24 will now oblige AIFMs to provide their national competent authority with considerable information on their delegation arrangements. ESMA has been charged with producing regulatory technical standards on the frequency and timing that AIFMs will need to report within 36 months of AIFMD II entering into force - so we are likely to see these in 2027.

Key information that will need to be reported includes:

(a) the delegates’ name and domicile, whether they have any close links with the AIFM, whether they are authorised or regulated entities for the purpose of asset management and where relevant, their supervisory authority;

(b) the number of full-time equivalent human resources employed by the AIFM for performing day-to-day portfolio or risk management tasks within the AIFM;

(c) a list and description of the activities concerning risk management and portfolio management functions which are delegated;

(d) where the portfolio management function is delegated, the amount and percentage of the AIF’s assets which are subject to delegation arrangements concerning the portfolio management function;

(e) the number of full-time equivalent human resources employed by the AIFM to monitor the delegation arrangements;

(f) the number and dates of periodic due diligence reviews carried out by the AIFM to monitor the delegated activity, a list of issues identified and, where relevant, the measures adopted to address those issues and the date by which those measures are to be implemented;

(g) where sub-delegation arrangements are in place, information required in points (a), (c) and (d) in respect of the sub-delegates and the activities related to the portfolio and risk management functions that are sub-delegated;

(h) the commencement and expiry dates of the delegation and sub-delegation arrangements.

Finally, the threshold conditions for national competent authorities to grant an AIFM authorisation under article 8 has been amended. The two natural persons required to be either employed full-time by the AIFM (or be an executive member or members of the governing body of the AIFM committed full-time to conduct the business of that AIFM) must now be domiciled in the EU.

Private fund managers should consider reviewing their arrangements to ensure that they not only meet the substance requirements but also that they have the appropriate systems and controls in place to fulfil their monitoring and reporting obligations.

Conflicts of interest and white labelling

Fair treatment of customers and undue costs

Next steps

Please do get in touch with Richard Small, Jan Grüter, Ben Cocoracchio or your usual Private Funds contact if you would like to discuss the impact of AIFMD II or the steps that we are seeing fund managers take in advance of the new regime coming into force.