The European Commission (EC) should focus more of its resources on encouraging the development of a loan origination fund market before trying to introduce rules harmonising the asset class, according to the UK’s Financial Conduct Authority (FCA).
The Alternative Investment Fund Managers Directive (AIFMD) did not fully account for loan origination funds and different EU member states have a multitude of rules governing the asset class. Germany’s BaFIN, for example, recently allowed German funds to issue or restructure loans without needing to obtain a credit license. Ireland has also adopted a liberal stance towards Qualifying Investor Alternative Investment Funds (QIAIFs) engaging in direct loan origination. As such, some policymakers are advocating harmonising the rules, and it is believed the EU is looking to create an alternative credit fund passport.
There are concerns that the EC is jumping the gun by trying to harmonize the rules of a market that is still embryonic. “I am not convinced we need a pan-EU framework for loan origination funds and the case has not been made just yet. In my view, the EU should be concentrating more on what can be done to facilitate the development of the loan origination fund market,” said Kristel Nathanail, asset management and funds policy advisor at the FCA, speaking at the Duff & Phelps annual European Alternative Investments Conference in London.
The drive towards reducing the real economy’s reliance on traditional bank lending is one of the central objectives of the EC’s Capital Markets Union (CMU) project. The CMU seeks to boost non-bank lending by easing rules around issuing securitisations and fostering the development of European Long Term Investment Funds (ELTIFs), a new fund structure governed under the AIFMD that can invest in infrastructure, real-estate and loans, and is marketed to both retail and institutional allocators.
However, non-bank lending, and particularly loan origination funds are still a nascent asset class in the EU and trail far behind their US counterparts. The European Central Bank (ECB) estimates capital markets account for 80% of corporate loans in the US. However, this could well change in the EU. The Alternative Investment Management Association (AIMA), the hedge fund industry group, believes private debt funding for small to medium sized enterprises (SMEs) could grow from six per-cent to around 15% or 20% in five years.
Managers do face challenges when launching loan origination products, a point made by Nathanail. She highlighted the skillsets for loan origination, such as quality credit assessment checking, were different from that of asset management, and a lack of banking expertise could be a problem for those managers. Loan origination products can also be highly complex, and it is essential managers have the relevant skillsets.
There are further concerns about liquidity at loan origination funds, and whether an investor run on these funds could result in a fire-sale of illiquid assets. As such, it is very possible that loan origination funds could find themselves being designated as shadow banks by global regulators.
EC should prioritise loan origination funds development rather than harmonisation of rules
The European Commission should focus more of its resources on encouraging the development of a loan origination fund market before trying to introduce rules harmonising the asset class, according to the UK’s Financial Conduct Authority.