Spurred by various enquiries on the matter, the MFSA has last week launched the Investment Services Rules for Loan Funds (the “Rules”) which provide for the licensing and regulation of collective investment schemes investing through loans (“Loan Funds”). This paper will analyse the Rules and how these fit into the current Maltese fund legislation.
Eligible Investments to be done “Through Loans”
What distinguish Loan Funds from other funds are their investment objectives and policies. The Rules essentially answer the question many have been asking themselves (and apparently also the MFSA): Can a fund give loans?
Maltese funds structured in terms of the Rules may now answer in the affirmative. In fact these at least 70% of the Loan Fund’s assets are to be invested “through loans”. This understood as constituting:
- the direct origination of loans by the Loan Fund; or
- the acquisition by the Loan Fund of a portfolio of loans or a direct interest in loans which gives rise to a direct legal relationship between the Loan Fund as lender and the borrower.
Here is worth noting that the remaining 30% may be invested in liquid securities. Furthermore, the Rules specifically forbid a Loan Fund or its Manager from using leverage and short selling techniques and from reusing of collateral by the Loan Fund.
There are also certain diversification requirements such not being able to invest more than 10% of the Loan Fund’s capital in a single undertaking and not being able to invest more than 25% of the units or shares of a single loan fund.
We feel that the most far-reaching restriction imposed by the Rules is that which concerns the borrower of the loan which may only be issued to:
- unlisted companies; and
Although not mentioned by the MFSA as one of the reasons for the issuance of the Rules, it is likely that the MFSA was also driven by the EU action plan to improve access to finance for small and medium companies (known as Europe 2020 Strategy) and also by EU Regulations 345/2013 on European venture capital funds which specifically permit the investment in loans given to SMEs.
Loan Fund Structure
Under Maltese law, closed ended funds usually take the form of an investment company with fixed hare capital (INVCO). These are vehicles which are subject to certain restrictions including the requirement to invest mainly in securities.
The Rules state that Loan Funds are to be constituted as closed-ended funds. The term ‘closed-ended fund’ in the Rules understood refers to collective investment schemes:
- Which does not raise capital through the continuous sale of units or shares;
- has a fixed duration;
- the units of the which can only be redeemed at the end of its duration
Whilst the above parameters would not conflict with the provisions of INVCOs in the Companies Act and the INVCO Regulations, the definition above of ‘investment through loans’ would conflict the requirement of INVCOs to invest mainly in securities.
Applicable Licence & Target Investors
Loan Funds are to be made available to:
- professional investors as defined in Section I to Annex II to the Markets in Financial Services Directive (“MiFID”) or,
- to investors who, on request, elect to be treated as professional clients in terms of Section II to Annex II to the MiFID and commit to investing a minimum of EUR 100,000.
Mindful of the risks involved in such investments, it is only natural that the MFSA have made Loan Funds subject to collective investment scheme licences which may target professional investors namely Professional Investor Funds and Alternative Investor Funds. However, in preparing the Rules, the MFSA took the provisions of the AIFMD as transposed into Maltese law in the first half of 2013 as a basis. Therefore, as we will be discussed later on in this article, the Loan Fund licensed as a PIF would be exposed to the additional requirements emanating from the AIFMD and this notwithstanding the Loan Fund is licenced as a PIF and is not managed by an AIFM.
A Loan Fund is required to appoint a fund manager (unless self-managed), a custodian, an auditor, a compliance officer and a money laundering reporting officer.
A Loan Fund may either appoint a third party manager (“Manager”) or be self-managed.
The Manager may be:
- a de minimis fund manager licensed in terms of the Act;
- a fund manager duly authorised in terms of the Alternative Investment Fund Managers Directive (the ‘AIFMD’) and licensed in terms of the Act or, in the event of an AIF, a European AIFM;
- a de minimis fund manager authorised/registered in another Member State;
- a fund manager authorised/licensed in a Recognised Jurisdiction.
Irrespective of whether the Loan Fund is licensed as a PIF or an AIF, the Manager (or in the case of a self-managed Loan Fund, the Loan Fund itself) will be responsible for portfolio management and risk management of the Loan Fund and other permitted services.
Apart from the usual requirements incumbent on third party managers managing Maltese fund, during the application process, the fund manager of a Loan Fund will have to demonstrate to the MFSA that it possesses the required skills and expertise to ensure that any lending decisions are made with due consideration and will also have proven experience in the area of granting of loans including credit assessment, credit provisioning monitoring and control of exposures as outlined in the Rules.
Whilst AIFs are required to have a custodian appointed, certain collective investment schemes licensed as PIFs do not require to appoint a custodian.
By virtue of the Rules, irrespective whether the Loan Fund is licensed as a PIF or an AIF, a custodian is to be appointed for the Loan Fund.
Most Loan Funds would be able to benefit from the depositary lite regime as are inherently collective investment schemes which:
1. have no redemption rights exercisable during the period of 5 years from the date of the initial investments; and
2. in accordance with their core investment policy , generally do not invest in assets that must be held in custody; or
3. generally invest in issuers or non-listed companies in order to potentially acquire control of such companies.
This would enable them to appoint an administrator or manager which is also holds a category 4b licence.
Credit Risk Policy
The Rules require the Manager to establish and implement a credit risk strategy and related policies in proportion with the scope and sophistication of the Loan Fund’s activities. The credit policy will establish the framework for lending and guide the credit granting activities of the Loan Fund.
The Credit Risk Policy of a Loan Fund will include a risk appetite statement and address items such as:
- target markets,
- portfolio mix,
- structuring of credit limits, processing and reporting.
Above and beyond the AIFMD
As stated above, Loan Funds and their Managers are exposed to requirements relating to inter alia valuation, liquidity management disclosure and reporting which are based on the provisions of the AIFMD and this irrespective whether the Loan Fund is licensed as a PIF or an AIF and whether the Manager is a de minimis manager or otherwise.
Liquidity Management Policy
The Manager shall employ an appropriate liquidity management system and adopt procedures which enable the monitoring of liquidity risk of the scheme and ensure that the liquidity profile of the scheme complies with its underlying obligations. Whilst this feature is already provided for in the provisions of the AIFMD, the Rules seek to further build on this requirement using concepts normally applied in the banking sector. Notwithstanding that the Loan Fund shall be structured as a closed-ended scheme, the Manager may on a yearly basis opt to redeem and cancel any shares in accordance with the terms of the offer should the fund have excess liquidity. The Rules also make provision for the application of a variable NAV.
Disclosure, Records and Reporting
The Rules contain detailed disclosure obligations to investors with appropriate Standard Licence Conditions modelled on the disclosure provisions prescribed in the AIFMD. Managers are also required to keep detailed records on the credit risk and liquidity management processes of the fund, and to abide by the appropriate reporting obligations for regulatory purposes.