Are Europe's lawmakers friends or foes?

Amid the vague and fluffy language of boosting jobs, growth and investment across the continent, there is a steely determination in the Capital Markets Union (CMU) action plan to translate the single market concept into a reality. 

At the heart of the initiative launched last autumn by the European Commission is a desire to see more alternative forms of financing available for European businesses, particularly small and medium-sized enterprises (SMEs) and start-ups. A greater diversity in funding sources, the EC says, is essential to financial stability across the region. 

The retreat of traditional banking from providing business funding, brought on by tighter lending laws, has starved companies seeking finance. Private debt funds have jumped on the opportunity.

Jonathan Hill, the commissioner overseeing the CMU, says he wants SMEs to have a “wider range of funding sources”. “I want to knock down barriers to make it easier for capital to flow freely across all 28 member states,” he said at the time of the announcement.

The noises from the EC suggest that it sees any future regulatory framework as a boon not a burden towards the further development of the private debt market. More players entering the space and providing loans for SMEs can provide the competition to stimulate the growth of such businesses. Harmonisation of such laws increases the flexibility of debt fund managers across Europe and the speed of any transactions. It's not difficult to work out that dealing with one set of rules is better than dealing with 28.

So far, a number of countries have introduced legislation, responding to the alternative lending activity in their own domestic markets. According to the European Securities and Markets Authority (ESMA), Spain, the UK, Italy and the Netherlands all have legislation permitting loan origination by alternative investment funds (AIFs), although these come with restrictions. 

The Czech Republic and Slovakia both permit funds to originate loans but not as the main activity of the fund. Belgium, Denmark, Sweden and Finland are among a number of countries that permit AIFs originating loans, but with no specific legal framework for the activity. Other countries do not allow AIFs to originate loans in their jurisdictions.

Keeping up with the quirks of 28 different legal regimes is a tricky task for debt funds and harmonisation seems a natural step. 

Jiri Krol, deputy chief executive at the Alternative Investment Management Association, says “harmonisation done well can be highly beneficial and can help firms benefit from a single market functioning efficiently. The language used in the CMU – that it wants to see a greater diversifying of funding sources, that it is supportive of crowdfunding and loan funds – is positive in the main. The EC is open-minded and the direction of travel is good”.

Monica Gogna, partner at law firm Ropes & Gray, says regulations can have both positive and negative effects on the market.

“The benefit of regulation is that it increases transparency in the system, a factor sure to be welcomed by investors and debt fund managers. There is also more co-ordination of the relevant rules across Europe, which can provide a level of certainty when launching a fund. On the other hand, regulations can make it harder for new entrants into the private debt markets because the costs of operating will increase,” she says.


In April, ESMA published its report into what such a framework should look like, putting forward a number of recommendations that should be included as well noting a number of issues it believes the EC should review.

Key points include:

Loan-originating AIFs should be set up as closed-ended vehicles without the right to redemption of units on a regular basis;

Loan-originating AIFs should not be allowed to have liabilities with a shorter maturity than the loans granted by the fund;

There is risk in making loan-originating AIFs available to retail investors on a general basis and ESMA is of the view that the requirements regarding investment should be tailored to the potential type of investor;

ESMA is of the view that funds should provide credit under a suitable framework such that systemic risk is mitigated and, in any case, is no higher than that posed by bank lending.

ESMA also recommends that the EC conducts a review into whether there should be a requirement for a mandatory authorisation of loan-originating funds, arguing that it could allow member states to assess the capability of the debt fund manager and offers protection for both borrowers and investors. 

Authorisation, however, raises the question of what type of restrictions will be placed on AIFs. This is an important consideration because it will go a long way to shaping the types of funds that are marketed to investors across Europe.

Gogna believes fund managers need to closely review the initial proposals set out by ESMA. “The voices of private debt funds need to be heard. The industry needs to engage at an early stage in order to help shape any new proposals governing this area,” she says.

At the lower end of the lending market, the EC recently published its report into crowdfunding and found no immediate need for regulation. On the whole, it was positive about the market which is estimated to have raised around €4.2 billion in capital commitments last year, according to research from UK-based Crowdsurfer Dashboard.

The EC sees crowdfunding as a future source of funding for SMEs that can complement traditional banking. One concern, however, was that there was little cross-border activity. 

As deal sizes in the private debt market increase, it is inevitable that the industry will attract greater interest from EU regulators, says Gogna. Last year, Ares Management solely underwrote a €300 million finance package for French investment firm Eurazeo's acquisition of Irish tax-free shopping and currency conversion company Fintrax. It was an exceptionally large debt deal, but there is a sense that the size of such transactions will increase, with some predicting that a €500 million debt deal is possible this year.

Regulating the still relatively nascent private debt market is a highly complex task. “Over-regulation can defeat the whole point of  opening up the market for alternative lenders to reach SMEs,” says Floris Hovingh, head of alternative lender coverage at Deloitte. “The EC has to be careful not to introduce guidelines that are too punitive for new entrants.”

Hill has until 2019 to turn the CMU idea into a reality, so there is a long period of study and discussion to be had until then. While regulations can be a burden to private debt funds that operated well without any interference, they can also have the positive effect of endorsing the activity by way of creating a framework that ensures the best practices are lawful. 

SMEs which traditionally tap banks for capital may become more open to other viable sources. More will become clear in the fourth quarter of this year when the EC is expected to review the case for a regulatory framework – but it is arguably now that fund managers need to make their voices heard.  


Jonathan Hill is the UK representative on the European Commission. Appointed in 2014 by UK Prime Minister David Cameron, Hill was handed the financial services, financial markets and capital markets union portfolio by EC president Jean-Claude Juncker.  

His key task is ensuring the proper regulation of European financial markets and ensuring that they remain competitive and transparent. He is responsible for establishing the Capital Markets Union by 2019, which aims to change the fragmented nature of the European markets that particularly hurts SMEs. 

Hill was formerly leader of the House of Lords between 2013 and 2014 and under-secretary for state education between 2010 and 2013. His career has been mainly in politics, but he has worked as a consultant for both Quiller and Bell Pottinger.