ESMA Publishes Consultation Paper on Regulatory Technical Standards (RTS) for Open-ended Loan-originating Funds

Background

The directive that makes amendments to the Alternative Investment Fund Managers Directive (AIFMD)¹ (and, to the relevant extent, the UCITS Directive),²  referred to as “AIFMD 2.0”³ entered into force on 15 April 2024. EEA Member States have 24 months to implement the provisions of AIFMD 2.0 into the national law, with the provisions on AIFMD 2.0 going live on 16 April 2026.

Among other changes, AIFMD 2.0 introduces specific requirements for alternative investment funds (AIFs) that originate loans, differentiating between AIFs when originating any loans, with additional requirements that apply to AIFs that originate loans on a significant basis – defined in AIFMD 2.0 as “Loan-Originating AIFs”.

AIFMD 2.0 requires alternative investment fund managers (AIFMs) to ensure that any Loan-Originating AIF they manage is closed-ended, unless, by way of derogation, the AIFM can demonstrate that the AIF’s liquidity risk management system is compatible with its investment strategy and redemption policy.

AIFMD 2.0 mandates ESMA⁴ to develop the RTS to determine the requirements with which Loan-Originating AIFs are to comply in order to be able to maintain an open-ended structure. According to the mandate in AIFMD 2.0, those requirements are to include a sound liquidity management system, the availability of liquid assets and stress testing, as well as an appropriate redemption policy having regard to the liquidity profile of Loan-Originating AIFs. Those requirements shall also take due account of the underlying loan exposures, the average repayment time of the loans and the overall granularity and composition of the portfolios of Loan-Originating AIFs.

ESMA published the draft RTS⁵ on 12 December 2024.

The RTS have been keenly anticipated given current interest in the market in open-ended and evergreen private credit strategies. The issue is particularly relevant to products launched from 15 April 2024 onwards as no transitional provisions apply to such funds (meaning they will need to be able to or have demonstrated the appropriateness of their structure to the AIFM’s home regulator by 16 April 2026). Whilst the RTS lay out more detail on what the regulators will be looking for in respect of open-ended Loan-Originating AIFs, the RTS do not provide further clarity as to what it means to be open-ended, meaning that existing interpretations will need to prevail. This is particularly relevant for evergreen and semi-liquid structures where the assessment can be a grey area.

The RTS

In the consultation paper, ESMA first notes that the Commission Delegated Regulation (EU) No 231/2013 (Level 2 Regulation)⁶ already contains detailed provisions on liquidity management that all open-ended AIFs must comply with and ESMA concludes that its view is that there are no gaps in the Level 2 Regulation requirements on liquidity management.

Instead, ESMA considers that the RTS should provide a harmonised implementing framework tailored to the specificities of the open-ended Loan-Originating AIFs setting out parameters and elements that AIFMs of such AIFs shall take into account when applying the Level 2 Regulation requirements on liquidity management so they can demonstrate to the competent authorities that the Loan-Originating AIF they manage can maintain an open-ended structure.

ESMA further stresses that the derogation from the requirements for Loan Originating AIFs to be closed-ended as introduced by AIFMD 2.0 is not a bespoke regime for open-ended Loan-Originating AIFs but rather a ‘derogation to the general rule’ and that AIFMs shall be able to demonstrate to the competent authorities of their home Member States why the Loan Originating AIFs they intend to manage can be open-ended. To that end, the RTS provide an implementing framework specifying the elements that AIFMs must take into account to make the demonstration to their competent authorities. It is not because AIFMs comply with the RTS that they can automatically set up an open-ended Loan-Originating AIF.

ESMA specifies that AIFMs need to be able to demonstrate that:

• the liquidity management system of the open-ended Loan-Originating AIF is compatible with its investment strategy and its redemption policy; and
• the key elements of the AIF, including its strategy and dealing frequency, enable it to remain sufficiently liquid to be able to meet redemption requests.

The RTS further cover key elements of the sound liquidity management of open-ended Loan-Originating AIFs:

• AIFMs must define an appropriate redemption policy, tailored to the characteristics of each AIF. In order to ensure that the redemption policy of the AIF is appropriate, the RTS set out the following factors that the AIFM shall, at least, consider:
  
  • the frequency of redemptions offered to investors;
  • the proportion of liquid assets;
  • the portfolio diversification and the liquidity profile of the assets to be held;
  • the investment policy and strategy;
  • the targeted credit quality of the loans to be granted;
  • the targeted investor base and the investor concentration;
  • the anticipated level of subscriptions and redemptions of investors;
  • the duration of the minimum required holding period, where applicable;
  • the length of the notice period and of the settlement period, where applicable;
  • other redemption conditions, where applicable;
  • the expected incoming cash flows of the portfolio;
  • the market conditions and material events that may affect the possibility of the AIFM to implement the redemption policy;
  • the available liquidity management tools, their calibration, and the conditions for their activation;
  • the results of the liquidity stress tests; and
  • the availability of a reliable, sound and up-to-date valuation of the loans and other assets in the portfolio, corresponding to their estimated realisable value at the date of redemptions.
• AIFMs must determine an appropriate proportion of liquid assets that the AIF shall target to hold. The RTS list the following factors that AIFMs should, as a minimum, consider when determining the appropriate proportion of liquid assets:
  
  • the redemption policy of the AIF;
  • the assets considered as liquid (including expected cash flow generated by the loans granted by the AIF and other investments of the AIF if they can be converted into cash over the duration of the notice period without significantly decreasing their value);
  • the portfolio diversification and the liquidity profile of the assets to be held;
  • the length of the notice period and of the settlement period, where applicable;
  • the length of the minimum holding period, where applicable;
  • the available liquidity management tools, their calibration, and the conditions for their activation;
  • redemption caps, where applicable;
  • the repayment terms and schedules of the loans to be granted by the AIF;
  • the targeted maturities of the loans to be granted by the AIF, considering their expected amortisation profile;
  • the targeted credit quality of loans to be granted by the AIF;
  • the targeted underlying exposures of the loans to be granted by the AIF;
  • the expected incoming cash flow of the portfolio;
  • the estimated default rates and rescheduling of the loans to be granted by the AIF;
  • the investor base including the investor type, potential investor concentration and their anticipated subscription and redemption behaviours;
  • if any, the targeted level of leverage, including leverage arising from hedging strategies, and the related financial obligations; and
  • any other liabilities.
    
• AIFMs must continuously carry out liquidity stress tests - the RTS detail what ESMA expects in this regard including, amongst other things, that AIFMs are to conduct liquidity stress tests at least on a quarterly basis, unless a higher or lower frequency is justified by the characteristics of the relevant AIF. The stress tests should be undertaken separately on the assets and the liabilities of the AIF and shall combine the results of these stress tests to determine the overall effect on the liquidity of the AIF.
  When conducting the tests they should:
  • apply conservative scenarios in terms of change in interest rates, credit spread and potential defaults in loans granted, as well as in redemptions requests considering the investor base and the liquidity offered and the liquidity management tools put in place in case of redemption pressure from investors; and
  • consider adequately the characteristics of AIFs they manage and the scenarios with low probability but with high impact on the ability of AIFMs to value the loans.
    
• AIFMs must have in place appropriate systems to perform ongoing monitoring. In order to ensure that the liquidity management system of the AIF remains compatible with its investment strategy and redemption policy, the RTS list a number of elements that AIFMs are to monitor on an ongoing basis:
  • the level of liquid assets;
  • the expected cash flows and potential future liabilities;
  • the amount of subscriptions and redemptions;
  • the repayment of the loans pursuant to the schedules agreed;
  • the behaviour of investors;
  • the portfolio composition and concentration;
  • the maturity of the loans;
  • early-warning signals of loans impairment (e.g. payment delays); and
  • the level of leverage, where applicable.
• AIFMs must also select appropriate liquidity management tools per article 16(2)(b) of AIFMD 2.0.
  

Next steps

After outlining the abovementioned rules and including the draft text of the RTS, the consultation paper includes 22 questions that test various approaches taken by ESMA in the RTS. ESMA also seeks to receive information on various open-ended Loan-Originating AIFs already managed by the AIFMs, including the typical size of such funds, strategies, number of loans in the portfolio or redemption frequency. The industry will no doubt consider the consultation with keen interest and provide granular views of the criteria proposed by ESMA.

The consultation on the RTS closes on 12 March 2025, and per AIFMD 2.0, ESMA is to submit the draft RTS to the European Commission by 16 April 2025.