ESMA consults on new rules for open-ended loan originating funds

Mark Shaw of Pinsent Masons was commenting after ESMA published a consultation on proposed changes to the regulatory technical standards (RTS) of open-ended loan-originating AIFs under the revised Alternative Investment Fund Managers Directive (AIFMD).

Shaw said the consultation should be seen in the wider context of the credit market.

He said: “Debt offered by non-bank providers continues to supply significant growth and opportunity. According to the Private Debt Survey 2024 conducted by KPMG, private debt in Luxembourg alone has soared to an impressive €510 billion. With the unceasing fundraising in this area, ESMA is now looking to address regulation of a subset of private credit funds – open-ended loan-originating AIFs. The general background of private debt informed the proposed RTS, as ESMA balances financial stability in the post-global financial crisis world on one hand and business access to private credit on the other.”

The current regulatory preference under AIFMD has been for loan-originating AIFs to be closed-ended unless certain additional requirements are met. The proposed RTS lays the foundation for open-ended structures in the loan-origination space, by setting out these additional requirements. 

Shaw said: “Loans generally lend themselves better to closed-ended structures, where the repayments and any associated liquidity issues are not exacerbated by the investors redeeming their investments periodically, due to investors being tied for the duration of the AIF’s term. However, this may limit the asset class for certain investors; opening up the market by allowing open-ended loan originating AIFs should permit a wider pool of investors to benefit from the diversification that the asset class offers, whilst the proposed RTS addresses the additional risks associated with open-ended loan-originating AIFs and focuses on proactive risk management in this space.”

ESMA specifically recognises that loan-originating AIFs should be able to adopt an open-ended structure, provided that AIF managers can demonstrate appropriate liquidity risk management systems compatible with the investment strategy and redemption policies. The proposed RTS will overlay the current AIFMD rules for loan-originating AIFs contained in ESMA’s guidelines on liquidity stress testing in UCITS and AIFs.

AIF managers are required to periodically conduct stress tests under both normal and exceptional liquidity conditions, at least on a quarterly basis, unless a higher frequency is justified. The proposed RTS requires open-ended loan-originating AIFs to consider prescribed elements when making their demonstration to competent authorities, which extend beyond the current scope of liquidity management and stress testing.

Specifically, the assessment of available liquid assets contains credit-specific considerations, including the credit quality of loans granted, estimate default rates or the targeted level of leverage, including leverage arising from hedging strategies, and the related financial obligations. The redemption policy of open-ended loan-originating AIFs must align with their liquidity management strategies. Therefore, the redemption frequency, length of distribution notices, and the amount of liquid assets must be considered collectively to ensure an appropriate management structure, ESMA has said. Shaw said this holistic approach will help in maintaining a balance between investor needs and the AIF's liquidity requirements.

The goal of the proposed RTS is not to create a bespoke regime for open-ended loan-originating AIFs, but rather to impose supplementary procedural checks where additional risks arise in the context of open-ended loan-originating AIFs. ESMA’s consultation closes on 12 March 2025. ESMA intends to finalise the RTS in late 2025.