New loan origination QIAIF regime - finally a viable option?
By Gayle Bowen & Aongus McCarthy, Pinsent Masons – Under new rules implemented by the Central Bank of Ireland (“Central Bank”) last month, Irish Loan Originating Qualifying Investor AIFS (“L-QIAIFs”) are now permitted to adopt broader credit focussed strategies. Previously L-QIAIFs were prohibited from engaging in any activities other than lending and ancillary related operations. This restriction was generally viewed by industry as the main obstacle to their growth in the Irish market.
These new changes are widely anticipated to create new interest in the L-QIAIF product among asset managers.
What is loan origination?
The funding gap which followed the global financial crisis, highlighted the need to create alternative sources of finance outside of the banking sector. L-QIAIFs can provide borrowers with alternative and viable credit lines, whilst offering an attractive risk versus return profile, when compared against other more traditional asset classes. However, due to the fact that loan origination is treated as ‘shadow banking’ by the Central Bank, L-QIAIF are subject to more onerous requirements when engaging in direct loan originating activities, which we set out in more detail below.
L-QIAIFs are funds that source loan assets for their investment portfolio by directly originating loans, acting as the primary sole or primary lender rather than confining themselves to investing via loan assignments or participations.
The Central Bank has confirmed that funds that acquire credit or debt instruments, without directly originating loans (e.g. through loan participations and loan assignments) are not subject to the L-QIAIF regime.
The background to the L-QIAIF regime in Ireland
In October 2014, Ireland became the first EU Member State to establish a specific domestic regulatory framework for loan originating investment funds. However, the initial regime applied quite stringent rules, in particular, L-QIAIFs were prohibited from engaging in activities other than originating and participating in loans, which was widely regarded as an overly-restrictive approach by the Central Bank.
Further enhancements were introduced in January 2017 to permit L-QIAIFs to also hold investments connected to the loan origination strategy, including investing in debt and equity securities of entities or groups to which the L-QIAIF originated loans, which was helpful but did not address the issue of having a broader multi-credit focus.
As a result of these restrictions, L-QIAIFs that wished to invest in other assets, such as debt or equity securities (other than those of the borrower the L-QIAIF had lent to), typically needed to establish as an umbrella fund and create a separate sub-fund for non-loan strategies. As a consequence, the take up of the L-QIAIFs regime in Ireland to date has been lower than initially anticipated.
Under the new regime, the Central Bank now permits L-QIAIFs, as part of their core investment strategy to hold a broad range of debt or credit instruments and to mix assets within the same fund.
L-QIAIF regime: applicable requirements
In addition to the general rules applicable to QIAIFs and AIFMs pursuant to Alternative Investment Fund Managers Directive (“AIFMD”), Irish law and the Central Bank requirements, L-QIAIFs must also comply with additional Irish requirements.
Under the new rules, L-QIAIFs must limit their operations to the business of:
• issuing loans;
• participating in loans;
• investment in debt/credit instruments;
• participations in lending; and
• to operations relating thereto, including investing in equity securities of entities or groups to which the L-QIAIF lends or instruments which are held for treasury, cash management or hedging purposes.
Benefits of the L-QIAIF regime in Ireland
The following are some of the key benefits of the new L-QIAIF regime in Ireland:
|Fast-track Regulatory Authorisation
||L-QIAIFs can avail of a fast track twenty four (24) hour authorisation process|
|Transparent Regulatory Framework
||L-QIAIFs are fully regulated by the Central Bank in accordance with AIFMD|
|EEA Marketing Passport
||L-QIAIFs can avail of the AIFMD pan-European passport and be sold under a quick notification process across the EEA to professional investors|
|Choice of Multiple Legal Structures
||L-QIAIFs may be established using a variety of legal structures, including an Irish Collective Asset-management Vehicle (ICAV), a public limited company (PLC), a unit trust, a common contractual fund (CCF) or an Irish Limited Partnership (ILP). L-QIAIFs may be established with segregated liability between sub-funds|
Proposed changes to Irish ILP legislation will further enhance the L-QIAIF regime
The Investment Limited Partnership (Amendment) Bill (the “ILP Bill”) proposes to modernise and update the partnership law in Ireland to create a more flexible vehicle that can be used by L-QIAIFs.
The proposed new ILP structure offers many enhanced features over the existing partnership structures, which includes permitting the creation of umbrella partnership structures with segregated liability, which is currently not permitted within Irish partnership structures.
The purpose of the ILP Bill is to ensure that there are viable limited partnership structures in Ireland for asset managers to consider when structuring their fund products; in particular, for L-QIAIFs, private equity and venture capital funds, as well as infrastructure funds. To date, many asset managers have domiciled such products within their fund ranges in other European jurisdictions given the absence of an appropriate Irish structure.
It is envisaged that the proposed changes will become law in Ireland during the course of 2018.
What might the future hold for the L-QIAIF?
Notwithstanding the fact that Ireland was the first European member state to establish a domestic framework for loan originating funds, due to the initially conservative approach adopted by the Central Bank, there has to date been a low uptake in this product in Ireland.
However, the new rules combined with the strong legal and regulatory environment in Ireland, the settled and transparent requirements applicable to L-QIAIFs and the fast track authorisation process have already attracted increasing interest in L-QIAIFs among asset managers. In addition, the availability of the AIFMD marketing passport and proposed changes to the ILP structure further enhances the attractiveness of L-QIAIFs to managers looking to raise capital in Europe, particularly with Brexit on the horizon.
While the recent changes are a welcome development, Pinsent Masons and Irish Funds will continue to engage with the Central Bank to make even more enhancements to the L-QIAIF regime, including more flexible leverage and liquidity provisions, however, the new changes most significantly have removed what was generally viewed as the largest obstacle to the growth of L-QIAIFs in Ireland.
• AIFMD compliant AIFM – L-QIAIFs must designate a fully authorised AIFM, which can be external or the L-QIAIF itself, ie, internally managed (sub-delegation of investment management is permitted).
• Liquidity and Distributions – L-QIAIFs must be closed-ended and established for a finite period, however distributions and redemptions may be permitted in certain circumstances.
• Prohibited Loans – L-QIAIFs may not originate loans to any of the following: (a) natural persons; (b) the AIFM, management company, general partner, depositary, or to delegates or group companies of these; (c) other collective investment undertakings; (d) financial institutions or related companies of these, except in the case where there is a bone fide treasury management purpose which is ancillary to the primary objective of the L-QIAIF; or (e) persons intending to invest in equities or other traded investments or commodities.
• Diversification – L-QIAIFs must apply a risk diversification strategy to achieve a diversified portfolio of loans and limit exposure to any one issuer or group to 25% of net assets within a specified period of time.
• Leverage – L-QIAIFs must not have gross assets of more than 200% of net asset value.
• Stress Testing – L-QIAIFs must have a comprehensive stress testing programme in place, which identifies possible future economic changes that could have an unfavourable effect on the L-QIAIF’s credit exposure and which assesses the ability of the fund to withstand such events.
• Credit Assessment, Granting and Monitoring Processes – L-QIAIFs must establish and implement appropriate, documented and regularly updated procedures, policies and processes in the following key areas: a risk appetite statement; 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; forbearance, delegation of authority; and documentation and security.
• Disclosure Obligations – L-QIAIFs must adhere to additional disclosure obligations in the prospectus, financial statements and /or sales marketing materials, in relation to credit assessment and monitoring processes, supplementary risk warnings and information on the L-QIAIF’s risk and reward profile and anticipated concentration levels.
Gayle Bowen is the head of Pinsent Masons Asset Management and Investment Funds practice in Ireland. Gayle has extensive experience advising asset managers on licensing options, the establishment of Irish regulated UCITS & AIFMD compliant alternative products and in relation to the global distribution and marketing of Irish funds. Gayle also has particular expertise in relation to cross border mergers. Gayle is a member of the Irish Funds Brexit Steering Group and is the outgoing Chair of the Irish Funds Legal & Regulatory Committee, which liaises with the Central Bank, the Irish Government and European bodies to represent the interests of the Irish funds industry. Gayle has received ratings as a leading lawyer from Chambers, Legal 500 and IFLR.
Aongus McCarthy is an associate in Pinsent Masons’ Asset Management and Investment Funds practice in Ireland. Aongus advises primarily in the area of investment funds and has advised on a wide range of legal and regulatory matters. Aongus has particular experience in the structuring, establishment and operation of all types of investment funds including UCITS and alternative investment funds as well as the establishment and operation of UCITS management companies and alternative investment fund managers (AIFM).