EC proposals for the reform of the AIFMD and the ELTIF regime – how will the changes affect property managers?
Following its review of the scope and operation of the Alternative Investment Fund Managers Directive1 (AIFMD), the European Commission (the EC or the Commission) has concluded that the AIFMD standards aimed at ensuring high levels of investor protection are for the most part effective, but that changes are needed, the scope of which is targeted but which can have far-reaching effects for real estate fund managers.
The European asset management industry has more than tripled since 20082 just like the European real estate asset class.3 Therefore, the macro-prudential supervision of EU investment funds, as well as the wider debate on systemic risk (given the interdependence of investment funds and asset management in the financial sector in broad sense) figure prominently in the AIFMD and ELTIF regimes (the Commission’s proposals), as intended. Liquidity risk management is at the heart of these new reforms.
Under the AIFMD, other important changes relate to delegation (which is expected to be more extensive and therefore more onerous for real estate fund managers), the reporting of data for market surveillance purposes and the regulatory treatment of custodians. These proposals are clear indicators of a move towards alignment of the rules with the UCITS Directive and a single regulation on investment funds to “support fund market integration”. In addition, harmonized requirements at EU level for loan origination funds/direct loans are also introduced in the new directive.
The amended framework of the ELTIF Regulation aims, in turn, to reduce regulatory costs for managers of ELTIFs and to remove barriers to access for retail investors wishing to invest in ELTIFs (while maintaining the protections currently in place). force).
Liquidity risk management
Liquidity risk management is at the center of this review, which was to be expected given past liquidity issues faced by some investment funds (e.g. 2008 financial crisis, real estate funds, COVID-19). In addition to the proposed changes to the rules applicable to loan origination funds (detailed below), rules relating to the availability and use of liquidity management tools (LMTs) by real estate fund managers are to be harmonized to ensure that any response by property fund managers of open AIFs or by EU regulators in situations of market stress can be more effective and ensure fair treatment of investors. Currently, the AIFMD does not provide a harmonized set of LMTs.
A minimum list of MTLs should be developed at EU level. These include suspension of redemptions and subscriptions, gates, notice periods, redemption fees, swing pricing mechanisms, anti-dilution levies, redemption in kind and side pockets. Real estate fund managers would be required to include at least one LMT from the list defined in the fund’s incorporation document. ESMA is responsible for developing draft regulatory technical standards to provide definitions and specify the characteristics of CMLs.
Real estate fund managers of open-ended funds will be able to temporarily suspend the redemption or repurchase of AIF units or shares in the event of market stress and they will have to implement detailed policies and procedures for the activation and the deactivation of any LMTs and the and administrative arrangements for the use of LMTs.
Origin of loans/direct loan funds
The Commission’s proposals introduce harmonized requirements at EU level for Alternative Investment Fund Managers (AIFMs) managing lending AIFs to promote robust processes for lending/ direct lending by AIFs and to strengthen market integration in this segment. This should increase the overall level of non-bank funding available in the EU, with positive effects on competition, while ensuring better overall monitoring of risks to financial stability. The Commission proposals do not include a definition of what constitutes “the granting of a loan”. However, and this is important, a distinction is made between granting loans and buying loans. In addition, it is not envisaged that there will be grandfathering clauses for existing direct lending structures. In practice, direct loan funds can be used to provide credit facilities to real estate funds; however, real estate funds generally take advantage of lending facilities from other traditional bank and non-bank credit providers.
Managers of alternative funds managing AIFs, which grant loans, will be required to implement effective policies, procedures and processes for the granting of loans, including a credit risk assessment, and to administer and monitor their credit portfolios, which should be reviewed annually. This also covers credit buying activity on the secondary market.
When a borrower is a financial institution or an AIF or a UCITS, the managers must respect exposure limits to diversify their risk and must ensure that a loan originated with the same borrower by the AIF that it manages remains less than 20% of the capital of the AIF.
Annex I of the AIFMD will be amended to recognize lending as a legitimate activity of AIF managers (meaning that AIFs will be able to lend anywhere in the EU, including cross-border in EU Member States). EU where this activity is not yet authorised). As loan origination is an activity of the AIF rather than the AIFM, the current proposals could give rise to some ambiguity. Annex I of the AIFMD has also been amended to legitimize the management of special purpose securitization entities (SSPEs) by AIFMs.
To avoid the immediate sale of loans on the secondary market, AIFs will be required to retain an economic interest of 5% of the notional value of the loans they have granted and sold on an ongoing basis. They must also adopt a closed structure where they engage in loan origination to a significant extent (more than 60% of net asset value).
An alternative fund will not be able to lend to its manager or its personnel, its depositary or its delegate and it will be required, within the framework of the rules of publication of article 23, to report to investors on their “portfolios of initiated loans” under the publication rule in Article 23.
The ELTIF regulation
The revision of the ELTIF regulation aims to improve the attractiveness of the ELTIF as a fund structure for long-term investments and as a non-banking source of financing for the real economy. The amended framework aims to reduce regulatory costs for ELTIF managers and remove barriers to entry for retail investors wishing to invest (while maintaining the protection currently in place).
In order to ensure that the investment strategies of ELTIFs can pursue a global investment mandate, the reference to long-term European projects is no longer included, given that the ELTIF framework explicitly allows the localization of eligible assets and investments. in third countries.
The scope of real asset investment strategies that ELTIF managers can pursue has been expanded. It now includes all assets that have intrinsic value due to their substance and properties, and implies that such assets include infrastructure, intellectual property, vessels, equipment, machinery, aircraft or rolling stock, and immovable property, including rights attached to or associated with immovable property. assets, such as water, forest and mining rights. It also includes investments in commercial property, education, consultancy, research, sports or development facilities, or housing, such as retirement homes or social housing.
ELTIFs may invest in real assets provided that the minimum investment value of these assets is at least equal to EUR 1 million and that it is no longer necessary for the real assets to be held directly or through a “holding indirectly via qualifying portfolio undertakings’.
What changes have not been included?
Finally, it is also interesting to note which reforms are not addressed in the Commission’s proposals, in particular the absence of an AIFMD passport for managers of sub-threshold real estate funds and the introduction of a depositary passport (although that there seems to be a movement in this direction in the longer term). Significantly, no changes are proposed to the compensation rules or the leverage calculation methodology requirements. The rules for unlisted companies, although noted as providing no added value in the AIFMD review process by DG FISMA, have not been changed.
Timeline and next steps
EU Member States will have 24 months after the entry into force of the Amending Omnibus Directive, expected in early 2023, to transpose the legislation and new requirements into national law, which means that the legislative changes are expected to come into effect. force at the beginning of 2025.