At present, Irish non-UCITS investment funds are prohibited from originating loans, though they may invest in syndicated loans (loan participation). In recent months, the Central Bank has been reviewing the prohibition on loan origination and, as part of its review, has published a discussion paper inviting interested parties to offer their views on whether the prohibition should be relaxed and, if so, what requirements should be imposed by the Central Bank to address the regulatory risks associated with such funds.
The discussion paper describes loan origination investment funds as those which undertake to source loan assets for their investment portfolio by directly originating loans rather than confining themselves to investing via loan assignments or loan participations.
The Central Bank has identified the following risks arising in respect of such funds:
- Concentration Risk
- Illiquidity risk
- Risk of investor runs
- Money Creation
- Dominant lenders
- Misalignment with investor risk appetite or investor capability
The Central Bank has identified the following as possible measures to mitigate these risks:
The Central Bank considers that the best approach to diversification for a loan origination fund may be a maximum percentage of assets exposure to a single borrower, perhaps circa 10 per cent. However, the Central Bank has asked for feedback as to how geographic diversification might be addressed.
Types of loans
The Central Bank has stated that they may limit the types of loans an investment fund can originate to senior secured debt though it has conceded that based on engagement with stake holders there would appear to be some merit and demand for allowing an element of second charge/mezzanine/unsecured lending where the risk mitigants are deemed to be sufficiently robust to support this.
To avoid any maturity / liquidity mismatch, the Central Bank considers that the term of the loan should be no more than the term for which the investment fund is closed. However, it has requested feedback as to whether there is a case to be made for allowing a lending term which extends beyond the term of the fund, albeit with requirements concerning maximum lending terms and disclosure to investors of the potential liquidity / maturity mismatch.
Measures to Address Liquidity and Maturity Mismatches
In order to avoid mismatches between the maturity or liquidity of assets and liabilities, the Central Bank suggests that loan origination is likely to be more appropriate within closed-ended funds. Respondents are asked if they agree.
Constraints on Leverage
The Central Bank favours the imposition of leverage limits but has asked for feedback as to what the appropriate leverage restrictions should be.
Financial Commitment by Investment Manager
The Central Bank suggests that there should be a co-investment requirement on the investment manager so as to ensure appropriate lending and therefore investor protection.
Investment Manager Competence, Remuneration and Expertise
The Central Bank believes it to be of paramount importance that the investment manager can demonstrate that they have undertaken successful lending on an on-going basis over a medium-term time horizon.
Constraints on the Type of Investor
The Central Bank would restrict investment in loan origination funds to investors that would be permitted to invest in a qualifying investor AIF. Respondents are asked if they agree.
Credit Assessment Requirements
The Central Bank would require sound credit assessment and credit monitoring policies. They may also explicitly prohibit lending to certain entities including the following:
- Any connected party of any investment fund, its manager or its service providers under any circumstances
- Other investment funds
- Financial institutions or related entities
The Central Bank has also indicated that some element of post-authorisation supervision of lending practices would be appropriate but the intensity and scale of such supervision needs further consideration.
The Central Bank has invited responses to the discussion paper by 13 September 2013.
Contributed by Niall Crowley