By Graham Roche, Director, Ireland
The introduction of the Alternative Investment Fund Managers Directive 2 (AIFMD 2) marks a significant shift in the regulatory landscape for private credit funds in Europe. Effective 15 April 2024 (although member states have until 16 April 2026 to transpose into national law), the new framework harmonises loan origination rules across EU member states, impacting all EU domiciled funds engaged in this activity.
The new regulation is most likely to impact Luxembourg and Ireland, as the second and third largest global fund domiciles respectively, and the two main centres for investment funds in Europe. For Luxembourg, which historically has had no specific rules for loan origination funds, AIFMD 2 introduces regulations for the first time, whilst it will result in the relaxation of Ireland’s more conservative loan origination framework – thus creating a level playing field.
With Europe’s direct lending assets expected to double over the next five years according to Preqin forecasts, AIFMD 2 arrives at a pivotal moment. Ireland has become a major hub for private credit, managing or servicing $169 billion in assets. Ireland aims to extend its share of the direct lending market, thus adding significant capacity to support the forecasted growth in the private credit sector.
Why is the EU introducing harmonised rules for loan origination?
The Capital Markets Union (CMU) is the EU’s initiative to create a single market for capital, facilitating investment and savings across all member states for the benefit of citizens, businesses and investors. Europe remains a regulatory patchwork quilt, with different rules for non-bank lenders in individual EU member states. Such barriers hinder the cross-border flow of capital within the EU.
A key goal of the CMU is to build an integrated European capital market with harmonised rules for loan origination, aiming to provide companies with better access to diverse financing options beyond traditional bank lending. This places private credit at the heart of the CMU, with initiatives like ELTIF 2.0 and AIFMD 2’s harmonisation of loan origination rules acting as key enablers for the asset class.
AIFMD 2’s harmonised rules promote greater regulatory consistency across Europe, offering Irish funds and other EU domiciles, such as Luxembourg, a level playing field. The directive brings regulatory clarity by defining “loan origination” and introduces systemic risk management measures such as limits on leverage and concentration limits, as well as risk retention requirements. Furthermore, asset-level reporting (via Annex IV) will likely be required, though the reporting burden will primarily fall on the fund AIFM.
Will AIFMD 2’s loan origination rules be overly burdensome for private credit managers?
AIFMD 2 aims to promote growth in direct lending by European-domiciled investment funds whilst ensuring there are adequate systemic risk measures in place to protect the integrity of the financial system.
In advance of the AIFMD 2 rules being finalised, some private credit managers had concerns on the level of leverage restrictions the new European regulation would introduce, but with a cap of 300% for closed-ended loan origination funds, it is unlikely to affect most private credit managers, as around 90% of European loan origination funds employ leverage of up to 250%. However, the lower 175% leverage limit for open-ended funds may pose a challenge for some private credit managers, although this is not likely to be a large cohort noting that c.84% of private credit funds are closed-ended.
Furthermore, AIFMD 2 provides several carve-outs and exemptions to certain requirements such as risk retention and concentration limits, and it is anticipated that overall AIFMD 2 will have limited impact on most European direct lending funds while simplifying operations for loan origination funds in many EU member states including Ireland.
What are the key benefits of AIFMD 2 for private credit managers?
- Pan-European loan origination passport: AIFMD 2 introduces a pan-European loan origination passport aimed at eliminating cross-border lending barriers. This would allow, for example, an Irish or Luxembourg-domiciled fund to lend to a French corporate, thus avoiding complex workarounds to avoid falling foul of French banking monopoly rules
- Expanded fund domicile options: The harmonised loan origination rules provide private credit managers greater optionality of fund domicile and facilitate the implementation of the same lending strategy from any EU member state. This unlocks capacity across the wider European funds industry, and Ireland in particular, to underpin the predicted growth of European direct lending funds
- Greater liquidity options: Whilst AIFMD 2 makes it clear that closed-ended funds are the most appropriate structure for direct lending strategies, the new regulations will allow direct lending through open-ended funds subject to appropriate liquidity management tools being in place. Currently most EU member states only permit loan origination through closed-ended funds
- Increased competition: Greater fund domicile flexibility fosters increased competition, benefiting asset managers and investors alike
AIFMD 2 is likely to have a significant impact on direct lending in Europe, and it is important that private credit managers understand the new regulatory requirements for loan origination funds.
Whilst EU member states have until 16 April 2026 to transpose AIFMD 2 into national law, managers should be aware that its provisions apply to all loan origination funds established in Europe since 15 April 2024.
AIFMD 2 will provide opportunities and challenges for private credit managers, but in balance, it is expected to be positive for the industry. Since the AIFMD 2 rules were published in early 2024, many private credit managers are turning to Ireland – attracted by the capacity and expertise within its enviable eco-system of fund service providers, and this suggests managers are already starting to realise some of the aforementioned benefits of AIFMD 2.
Talk to IQ-EQ
IQ-EQ provides a host of services for private credit funds, including AIFM, ELTIF, investment management, fund administration, SPV corporate services, loan administration, and ESG consulting/reporting. If you would like to learn more, contact us today.
