The European parliament has thrown its weight behind the Luxembourg fund industry’s proposed changes to the Alternative Investment Fund Managers’ Directive in a move that might protect private debt funds from the stricter elements of the new draft law and impact positively on Luxembourg, home to 35% of Europe’s private debt funds.

However, market sources warn that we’re not out of the woods yet.

“The next step is the European council’s response [to the proposed amendments]. Then there needs to be an agreement on the final version of the AIFMD. It could take some time,” said Martin Mager, partner at law firm Linklaters in Luxembourg.

Gautier Despret, head of debt at fund administrator IQEQ, said: “The proposed amendments to the AIFMD are favourable for the private debt market. However, the volume of cash available in this area means that this area will be the focus of regulators for quite some time.”

Private debt funds provide financing for small businesses whose model or growth requirements mean they cannot access a bank loan. The asset class has flourished across Europe since the 2008 financial crisis, swelling 40.6% in Luxembourg in one year to €181.7bn as of June 2021, according to KPMG and the Association of the Luxembourg Fund Industry figures.

However, These concerns now appear to be unfounded.

“[The European parliament] has recommended that the AIFMD’s ‘closed-ended’ rule is replaced with appropriate liquidity measurements,” said Mager. “They have also modified the risk retention requirements.”

This means that private credit funds in Europe with more than 60% originated loans in their portfolio may now be allowed to continue taking appropriate liquidity measurements rather than adopt a closed-ended structure as originally proposed by the commission.

It also means that while private debt funds will be prohibited from originating loans with the sole purpose of selling them, they may not face the AIFMD’s original proposal to hold 5% of the value of any loan that they sell as a risk retention requirement.

Both amendments are welcomed. Open-ended private debt funds, approximately 22% of the private debt market in Luxembourg, according to the ALFI and KPMG study, give fund managers more flexibility to manage asset liability and liquidity, therefore appealing to a broader range of investor requirements. The removal of the 5% stipulation allows fund managers to better perform portfolio allocation and rebalancing in line with their mandate and in order to achieve the desired returns, according to Mager.

“If upheld, the parliament’s amendments will allow for a broader investment strategy,” he said.

Opening to broader range of investors

The European parliament has also set a definition of ‘professional investor’ in its response to the AIFMD to those investing as low as €100,000, opening loan origination funds such as private debt funds up to new investor territories.

“The definition significantly widens the fund managers’ market to family offices and high-net-worth individuals,” said Mager. “This is highly significant.”

The move comes as part of a broader trend in European regulation to improve access of smaller ticket investors into alternative assets, formerly the preserve of big-ticket institutional investors capable of investing tens of millions.

The European Long-Term Investment Fund vehicle, a structure that makes it possible for professional and retail investors in the European Union to invest in illiquid companies and projects formerly available only to institutional investors, is another such initiative.

Feeder funds, which channel HNWI into private equity funds, are the market’s answer to improving access to illiquid alternative assets.

“Private debt also uses feeder funds. It’s an asset class that works well for the greater liquidity requirements of a greater number of investors, because interest payments on the debt make it more cash generative than private equity,” Despret said.

The investment opportunity to alternative funds of smaller tickets investors is huge. According to market development institution Luxembourg for Finance, Luxembourg’s private banking market alone has €466bn in assets under management.

However, Mager points out that the European parliament’s support is only one step in the journey towards a new AIFMD II. The European Council will need to give its view. “It could take some time.”

According to consultancy EY, any legislative amendments of the AIFMD II are expected to occur in 2025.

The AIFMD is designed to protect investors in alternative investment funds by providing a supervisory framework for alternative investment fund managers.