Ireland pioneers bespoke debt fund regulation

The Central Bank of Ireland has set out new rules which allow alternative investment funds operating in Ireland to lend. Simultaneously, it has designed one of Europe’s first structured regulatory frameworks for private debt funds.

The ‘Consultation on loan originating Qualifying Investor AIF’ published in late July marks the final step before new rules are introduced at the end of the year, lifting a ban on investment fund lending in Ireland which goes back to the 1990s.

The regulations apply to specialised loan origination funds, Martin Moloney, head of markets policy at the Irish central bank, told Private Debt Investor. “Complex investment strategies combining lending with other investment approaches are not an option for these funds,” he said.

The framework has been created in light of changes to the regulatory environment for banks. It has also been driven by a surge in loan origination by funds in post-crisis Europe, which in some cases have replaced banks in terms of lending to SMEs.

“We felt, in light of developing bank regulation that we could look again at the Irish prohibition on lending by funds and, by adapting recent innovations in bank regulation to funds, develop a regulatory regime which would make lending by funds on a prudent basis practical,” Moloney said.

Current CBI proposals aim to mitigate financial stability risks attached to loan origination by investment funds, one of which is cross-border lending.

The AIFMD (Alternative Investment Fund Managers Directive), which came into effect in July, provides a Europe-wide regulatory framework for funds. However, the CBI will introduce one of the region’s first regulatory frameworks specifically for loan funds. In the US, the Business Development Company (BDC) regulations are similar while the SEC has its own regulatory framework, Moloney explained.

Ireland has been well-placed to design the framework because “we deal with so many,” Moloney said. Of the world’s hedge funds, 40 percent are administered out of Ireland, according to accountancy firm PricewaterhouseCoopers. “We’d be very happy for other countries to look at what we’ve done and see it as a good reference point,” Moloney said.

Declan O’Sullivan, a partner at law firm Dechert, who after gathering views on the new rules, commented in a Dechert OnPoint report in August called Irish Loan Origination Funds Move a Step Closer: “The proposed Central Bank regime would appear to be one of the first that seeks to actively regulate loan origination funds. Malta introduced Investment Services Rules for Loan Funds in April of this year while, in other jurisdictions, there are no overarching rules – merely a lack of a prohibition.”

Under the rules, loan funds which qualify will be closed-ended, will not be able to lend more than a quarter of their assets to one borrower and will have 100 percent leverage limits, whereby liabilities cannot exceed assets. There will also be strict requirements on funds to keep investors and the CBI well informed.

“We will want to receive reports on the details of each loan outstanding, giving us granularity to do the macro-economic analysis to spot where risk profiles are getting high,” Moloney said.

The framework has been designed after consultation with the wider fund investment management community, first launched in July 2013. Research has been carried out in conjunc­tion with the ESRB (European Systemic Risk Board).

The new regulations may encourage fund managers to set up loan funds in Ireland or scare them off. O’Sullivan commented: “It will be interesting to see if other jurisdictions follow suit or seek to arbitrage their less prescriptive regimes, and to see which regimes investors and managers prefer.”

However, he cautioned that there were still issues  “worth addressing as part of the consultation,” which was due to close on 25 August 2014.

Many institutional investors may prefer a greater level of leverage, he said. Also, “clarification will be needed” on asset redemption and valuation requirements. The loan fund “limitation appears to be very prescriptive and further analysis should be carried to ensure that loan origination can be used in conjunction with other debt or credit strategies,” O’Sullivan said.