An alternative investment fund (“AIF”) is open-ended if an investor can ask for redemption prior to the AIF’s liquidation or wind up. Open-ended AIFs come with liquidity risks if assets are of an illiquid nature. If an investor requests for redemption, this may prompt a fire sale of assets at an unfavorable price. Increased redemption request, market stress and unfavorable pricing often go hand in hand.
Prospective investors focus on the solidity of a fund’s liquidity management as to avoid that they suffer losses because of fire sales. The AIFMD already provides for a general regulatory protection against liquidity risks. The EU AIFM must secure that the AIF’s redemption obligations are in line with the liquidity profile of its assets.
To ensure compliance with this general principle and to anticipate on market stress - which may boost redemptions beyond normal levels - AIFMD2 requires that EU AIFMs ensure that the open-ended AIFs they manage select at least 2 (from a list of 7) liquidity management tools (“LMT”).
The LMTs achieve that a redemption request can be partially restricted, delayed, met in-kind or made subject to a charge for the redeemed investor. The charge is in fact a compensation for the cost of liquidity assumed by investors that are not redeemed. The EU AIFM can, in exceptional circumstances, and only in the interest of investors, temporarily suspend a redemption request and/or activate side-pockets.
EU AIFMs of open-ended loan origination AIFs must, in addition, show their EU regulator that the AIFs’ liquidity risk management systems are compatible with their investment strategy and redemption policy. An open-ended loan origination AIF has loan origination as primary strategy, or its portfolio consists for 50% at least of the NAV of originated loans.
A 175% leverage cap (leverage/NAV) applies to open-ended loan origination AIF following the commitment approach (e.g., hedges are netted-off). Sublines secured on investor commitments are not considered as leverage.
AIFMD2’s focus on open-ended loan origination AIF is a result of the growth of such funds and thus the liquidity risks that come with them. Investors like these products as they can directly, fully and permanently deployed their capital in the attractive private debt market. With such an offering, credit fund sponsors can tap into pockets of capital they do not have access to with closed-end products.
The European Commission will adopt regulatory standards on the LMTs and the conditions loan origination AIFs should comply with to be open-ended.
Want to know more about this topic? Reach out to one of our colleagues mentioned below.