On 12 December 2024, ESMA published a consultation paper containing draft regulatory technical standards ("Draft RTS") pursuant to Directive (EU) 2024/927 ("AIFMD II") which outline the requirements with which loan-originating alternative investment funds ("LOAIFs")1 shall be required to comply in order to maintain an open-ended structure.
The Draft RTS aim to provide for a harmonised implementing framework tailored to the specificities of LOAIFs by setting out the elements and parameters that alternative investment fund managers ("AIFMs") managing open-ended LOAIFs will take into account in order to demonstrate the eligibility of the open-ended structure to their home national competent authority ("NCA").
This latest contribution focusing on liquidity management follows ESMA's consultation on proposed RTS on AIFMD II liquidity management tools ("LMTs") as well as its recent response to the European Commission's (the "Commission") consultation on Non-Bank Financial Intermediation. The latter response acknowledged that AIFMD II has made progress on addressing liquidity mismatches in open-ended funds ("OEFs"), while cautioning that there remain buckets of unmitigated liquidity mismatches in OEFs.
LOAIFs as OEF structures
As outlined in Part 1 of our AIFMD II 101 advisory series, AIFMD II introduces harmonised rules on loan-origination activities and provides that LOAIFs shall be closed-ended, unless their AIFM can demonstrate to its NCA that the liquidity risk management system of the LOAIF is compatible with its investment strategy and redemption policy. The key elements of this requirement include:
- a sound liquidity management system,
- the availability of liquid assets and stress testing, and
- an appropriate redemption policy having regard to the liquidity profile of LOAIFs.
These requirements should 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 the LOAIFs.
In the report, ESMA has noted that it undertook an assessment of existing AIFMD Level 22 liquidity provisions and the outcome has confirmed its view that there are no gaps in the current implementing AIFMD Level 2 requirements on liquidity management.
We have set out below a summary of the key features of the Draft RTS which include, (but are not limited to) provisions on the following features:
A. Sound Liquidity Management
AIFMs that intend to manage an open-ended LOAIF shall be able to demonstrate to their home NCA that:
- the key elements of the open-ended LOAIF, including its strategy and dealing frequency, enable it to remain sufficiently liquid to be able to meet redemption requests; and
- they have selected the appropriate AIFMD II LMTs, as described in Part II.
B. Appropriate Redemption Policy
When designing the redemption policy tailored to the characteristics of the particular open-ended LOAIF, AIFMs shall take into account the factors outlined in Article 2 of the Draft RTS. The elements of an appropriate redemption policy include the investor profiles, the credit quality of the loans to be granted, redemption frequencies, sustainability of redemptions and an appropriate proportion of liquid assets that the open-ended LOAIF shall target.
C. Availability of Liquid Assets
ESMA expects that the AIFM will determine an appropriate minimum proportion of liquid assets that the open-ended LOAIFs shall target in order to meet redemption requirements. ESMA is of the view that it is not possible to specify in the Draft RTS all the assets that can be considered ex-ante as liquid.
In reaching a determination the AIFM shall at least, consider the factors set out in Article 3 of the Draft RTS. Therefore, in determining the adequate proportion of liquid assets, AIFMs shall exercise a prudent approach and consider as liquid the expected cash flow generated by the loans granted. The AIFM may also consider investments as liquid investments, in so far as these can be converted into cash over the duration of the notice period without significantly changing their value.
D. Liquidity Stress Tests ("LSTs")
Existing AIFMD Level 2 rules require AIFMs to conduct robust LSTs under both normal and exceptional circumstances. ESMA's guidelines on LSTs in UCITS and AIFs set down minimum LST standards and the guidelines include a section dedicated to the LST of less liquid assets, which is applicable to LOAIFs.
The Draft RTS propose that the LST scenarios should be applied conservatively in terms of change in interest rates, credit spreads and potential defaults in loans granted, as well as in redemption requests considering the investor base and the liquidity offered and the LMTs put in place in case of redemption pressure from investors. The AIFMs shall employ LSTs which consider adequately the characteristics of the open-ended LOAIFs including scenarios with low probability but with high impact on the ability of AIFMs to value the loans.
E. Ongoing Monitoring
In order to ensure that the liquidity management system of the open-ended LOAIF they manage remains compatible with its investment strategy and redemption policy, AIFMs shall, at least, monitor on an ongoing basis a number of specific parameters of the open-ended LOAIFs they manage within Article 5 of the Draft RTS.
Next steps
ESMA will consider the feedback it receives to this consultation by 12 March 2025.
While ESMA's original mandate required it to propose Draft RTS by 16 April 2025, ESMA now expects to publish a final report to the Commission by Q3/Q4 2025, ahead of AIFMD II coming into effect by 16 April 2026.
[1] As described in Part I of our AIFMD II advisory series, such funds are classified as an AIF, whose investment strategy is mainly to originate loans; or where the notional value of the AIF's originated loans represent at least 50% of the NAV.
[2] See Articles 46, 47, 48 and 49 of Commission Delegated Regulation (EU) No 231/2013 ("AIFMD Level 2 ")
