On 12. December 2024, ESMA published its consultation paper on draft regulatory technical standards (the “Draft RTS”) on open-ended loan-originating AIFs under the AIFMD. ^[1] These Draft RTS are aimed at defining for open-ended loan-originating AIFs the requirements in relation to:

• a sound liquidity management system
• the availability of liquid assets
• stress testing scenarios, as well as
• an appropriate redemption policy

The Draft-RTS are based on requirements already defined by the AIFMD Level-II Regulation.^[2] ESMA rightfully points out that Article 46 of the Level-II Regulation states that AIFM shall be able to demonstrate to the competent authorities of their home Member State that an appropriate liquidity management system and effective procedures referred to in Article 16(1) of the AIFMD are in place taking into account:

• the investment strategy
• the liquidity profile and
• the redemption policy of each AIF.

Art 47 of the Level II Regulation further specifies that an AIFM managing open-ended AIF maintains a level of liquidity in the AIF appropriate to its underlying obligations, based on an assessment of the relative liquidity of the AIF’s assets in the market, taking into account the time required for liquidation and the price value at which those assets can be liquidated, and their sensitivity to other market risks or factors. This required level of liquidity is not static.

Article 47 Level II Regulation instead requires the AIFM to monitor the liquidity profile of the AIF’s portfolio of assets on an ongoing basis and to implement and maintain appropriate liquidity measurement arrangements and procedures to assess the quantitative and qualitative risks of positions and of intended investments which have a material impact on the liquidity profile of the portfolio of the AIF.

These requirements have existed since 2013 and ESMA points out that there are no regulatory gaps in the existing requirements imposed by the Level-II Regulation on liquidity management.^[3] Whether there are actual gaps in the current management of open-ended, loan originating AIF is another question. Consequently, ESMA considers that the Draft-RTS serve as a harmonization and clarification mechanism of existing Level-II requirements for open-ended, loan originating AIF.

The second good news is that it concerns only open-ended AIF.

For obvious reasons and as articles 16 (I) AIFMD and article 46 Level-II Regulation already point out, these requirements do not apply to closed-ended AIF. Consequently, the Draft RTS are solely aimed at open-ended, loan originating AIF. ^[4] As most AIF are closed-ended, they will not be impacted by the Draft RTS. Any AIFM only managing closed-ended AIF may stop reading this newsletter here.

Given the current hype around all things “ELTIF” however, the Draft-RTS and the resulting future legislation might become important for a number of AIFM. ^[5] While the ELTIF-Regulation is based on the assumption that ELTIF should be closed-ended, market participants responsible for the marketing and distribution of ELTIF will tell you otherwise. As a result, most ELTIF – at least those open to retail investors – will be open-ended AIF and are subject to the Level-II Regulation and will be subject to the RTS currently under consideration by ESMA.

According to the CSSF, it is primarily the responsibility of UCI managers or AIFM, to establish effective organizational measures to minimize errors or non-compliance within a UCI. Should errors or non-compliance occur despite preventive measures, these managers are obligated to adhere to the guidelines outlined in the Circular for addressing such issues. Additionally, they must ensure that arrangements with service providers involved in UCI operations are adequately structured according to the Circular's guidelines.

Background to the Draft-RTS

ESMA intends to clarify and modify the AIFMD and Level-II Regulation’s requirements for liquidity management in case of open-ended, loan originating AIF. The Draft-RTS are based on the provisions of the AIFMD II^[6] , which inter alia amends the AIFMD in relation to liquidity management. In addition to the four points already mentioned above, namely a sound liquidity management system, the availability of liquid assets, stress testing scenarios, as well as an appropriate redemption policy, in defining their approach, AIFM managing open-ended, loan originating AIF shall also consider:

• the underlying loan exposures,
• the average repayment time of the loans and
• the granularity and composition of the loan-originating AIF’s portfolios.

Sound liquidity management

A sound liquidity management requires^[7] AIFM (in the future) to be able to demonstrate to their home competent authorities that their liquidity risk management system of open-ended loan-originating AIF is compatible with each AIF’s investment strategy and its redemption policy, its strategy and dealing frequency in order to enable the AIF to remain sufficiently liquid to meet redemption requests. To do so, AIFM are expected to establish an appropriate redemption policy tailored to the characteristics of each open-ended loan-originating AIF, based on the assessment of the following factors:

• The frequency of redemptions offered to investors
• the proportion of liquid assets ^[8]
• portfolio diversification and the liquidity profile of the assets to be held
• investment policy and strategy
• targeted credit quality of the loans to be granted
• targeted investor base and the investor concentration
• anticipated level of subscriptions and redemptions of investors
• duration of the minimum required holding period, where applicable
• length of the notice period and of the settlement period, where applicable
• Other redemption conditions, where applicable
• expected incoming cash flows of the portfolio
• market conditions and material events that may affect the possibility of the AIFM to implement the redemption policy
• available liquidity management tools, their calibration, and the conditions for their activation
• results of the liquidity stress tests
• 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 dates of redemptions.

These factors thus need to be assessed and documented by an AIFM for each open-ended loan-originating AIF. In our view, these factors outline how a detailed documentation of an AIFM for the open-ended, loan-originating AIF could look like.

Availability of liquid assets

In order to assess the sufficient availability of liquid assets, AIFM shall take into account the expected cash flows generated by the loans granted taking into account expected defaults and rescheduling of loans. AIFM may consider as liquid assets any investments by an AIFM that can be converted into cash over the duration of the notice period without significantly changing their value. Again, such an assessment will have to be based on a detailed analysis of the AIF’s investment strategy and on assumptions in relation to marketing success, speed of investment, credit quality etc. The AIFM will have to document this assessment including the assumptions backing the assessment.

Liquidity stress testing

Stress testing shall be done at least on a quarterly basis and be specific to the AIF in question. The assets and liability side of the balance sheet of the AIF shall be stressed separately and then combined, in order to increase its resilience.

Ongoing monitoring

AIFMs shall monitor over the time of an AIF the evolution and performance of the loans granted such as the repayment schedules, early signals of possible defaults, the level of liquid assets and the behavior of investors.

No bad news this time?

Given that according to ESMA there are no gaps between the Level-II Regulation and the Draft RTS one could assume that these provisions will not result in any relevant changes to the current market practice. However, there are a few issues that we would like to pinpoint as “bad news”:

• ESMA makes it clear that these Draft RTS shall be applied to each open-ended, loan originating AIF. The document speaks about how AIFM shall be able to demonstrate compliance with these obligations to their home NCA for each open-ended, loan-originating AIF they manage. In our opinion, such a demonstration means nothing else than documentation requirements for AIFM including the factors mentioned in section 2 above. Even if all the procedures for managing open-ended, loan-originating AIF in line with the Draft RTS are already in place, now they need to be documented as well to be able to present them to the NCA upon request. Some aspects will already be asked for by the CSSF during the authorization process in case of ELTIF.
• Some aspects of the Draft RTS might also pose material challenges to AIFM, e.g. the required assumptions regarding: actual redemption frequencies, expected cash flows generated by the loans, defaults and rescheduling of payment schedules or the “anticipated behavior of investors”.

Summary

These are still draft RTS and therefore not in force yet. However - and as stated above - , ESMA considers these Draft RTS as clarifications and harmonizations of already applicable regulatory requirements. We therefore recommend to AIFM who may have gaps in their documentation to address any such gaps without waiting for the Draft RTS to become legally binding.

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[1] www.esma.europa.eu/sites/default/files/2024-12/ESMA34-1985693317-1085_CP_RTS_on_open-ended_loan-originating_AIFs_under_the_AIFMD.pdf

[2] Commission Delegated Regulation (EU) No 231/2013 of 19 December 2012 supplementing Directive 2011/61/EU of the European Parliament and of the Council with regards to exemptions, general operating conditions, depositaries, leverage, transparency and supervision Text with EEA relevance, https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX%3A02013R0231-20240212

[3] ESMA, reference 11.

[4] We point out that the articles of the AIFMD and the Level-II-Regulation (continue to) apply to all other open-ended AIF.

[5]Please refer to our recent newsletter concerning ELTIF: https://aiqunited.com/editorial/aiqunited-delegierte-verordnung-der-eu-kommission-zu-eltif/

[6] Directive (EU) 2024/927 of the European Parliament and of the Council of 13 March 2024 amending Directives 2011/61/EU and 2009/65/EC as regards delegation arrangements, liquidity risk management, supervisory reporting, the provision of depositary and custody services and loan origination by alternative investment funds (europa.eu), please refer to our newsletter concerning AIFMD II: https://aiqunited.com/de/editorial/aifmd-ueberblick-und-die-wichtigsten-aenderungen-durch-die-aifmd-ii/

[7] As mentioned above, these are still draft RTS and therefore not in force yet. However, and as also stated above,
ESMA considers these Draft RTS as clarifications and harmonizations of already applicable regulatory
requirements.

[8] See also the next section.

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