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Private Credit Funds have staked out a central role in the global economy, topping out at $2.1 trillion as of year-end 2024, with three-quarters of the global exposure within the United States.1 Private credit has been gaining market share on syndicated public loans steadily over time. Research for the Federal Reserve suggests that borrowers prefer the flexibility offered by private credit loan structures over syndicated public loans, and that investors prefer the outperformance of private credit loans.2 The International Monetary Fund's (IMF) 2024 Global Stability Report put global regulators on notice that they "should pay close attention to liquidity and conduct risk in private credit funds, especially retail, that may face higher redemption risks."3 In this, the European Union appears to be leading the way. Indeed, the IMF points directly to actions taken by European regulators by amending the Alternative Investment Fund Manager Directive (AIFMD) to address loan origination alternative investment funds by means of "AIFMD II"4 as leading the way in implementing these very policy recommendations.5 It is noteworthy that while in effect from April 15, 2024, AIFMD II's national legislation is due to be implemented before April 16, 2026. That being said, new fund launches are effectively under the AIFMD II rules presently, as a practical matter.
With all of that, US credit fund managers might be inclined to cast a jaundiced eye at signing up for AIFMD's state of the art investor protection and the perception of a concomitant thicket of regulatory burden that comes with it. However, over rating EU regulation could be a mistake and could result in missing a critical opportunity to build a private credit fund that is evergreen open-ended and efficient to market globally. AIFMD II actually deregulates private credit funds, opening a clear pathway to global evergreen private credit funds for institutional investors, coupled with the opportunity for marketing with a European Union passport. Furthermore, the authors would submit that evergreen funds are an important trend in private credit (regardless of the breadth of their target investor audience) and that AIFMD offers a hospitable platform for even this emerging trend in private credit. Further, we contend that the trend in evergreen private credit funds is for open-ended funds that offer periodic redemptions, and that they too are now highly accessible under AIFMD.
This article provides US private credit fund managers with a view on the criteria as to when to say "yes" to European regulation and how the emerging private credit trends of evergreen open-end funds can be accommodated in the context of AIFMD II.
The Trend May Be the Friend of Evergreen Open End Funds — Including in Europe
Traditionally, US private credit funds followed a format similar to US private equity funds. They have been blind-pool, closed-ended funds, issuing limited partnership interests subject to capital commitments, with a defined marketing period, rules for subsequent investors and recycling, an investment period during which the portfolio holdings ramp up, distributions over time, performance compensation through a European distribution waterfall, subject to a hurdle rate and clawback in the event of over distribution, and then a liquidation period. These traditional closed-end private credit funds tended to target 10-year terms, with limited extensions. Investors have no redemption rights, and as such, matching the Fund's liquidity profile with its liquidation date is reasonably manageable as maturity dates and liquidation timing can be matched. This closed-end structure demonstrated resilience during COVID, suggesting that the systemic risk profile of closed-end funds is manageable.6
That being said, a US fund-formation trend is emerging for evergreen private credit funds, and AIFMD II invites their development in Europe. Evergreen funds offer investors the benefit of an
| Private Equity Style Closed-End Fund (Private Credit) | US Style Evergreen Open-End AIF (Private Credit) | AIFMD permits for both types (but has open-end specific requirements) | |
| Blind Pool | Yes, although warehouse transactions typically permitted/disclosed. | Not after initial launch (warehouse transactions typically permitted for launch); holdings transparent to investors once fund portfolio is mature (aids investor due diligence). | Yes |
| Investment | Capital Commitments as a percentage of total commitments. | NAV in (and also, NAV out). | Yes |
| Marketing Period | Commitments accepted until Final Closing Date, can be subject to a hard cap. | Indefinite (continuous). | Yes |
| Investment Period | Fixed term tied to Final Closing Date. | Indefinite and determined by each investor individually. | Yes |
| Reinvestm-ent Rules | During the Investment Period; recycling is typical. | Automatic indefinitely (typically). | Yes |
| Successor Fund | New closed-end fund launch precluded until threshold of assets raised are contributed. | Inapplicable. | Yes |
| Managem-ent Fees | Management Fee based on commitments/ contributions (May include step downs at end of investment period). | Management Fee based on NAV. No Step Down and No Investment Period. | Yes |
| Transaction Fee Offsets | Typical for fees earned from portfolio companies retained by the fund sponsor. | Typical for fees earned from portfolio companies retained by the fund sponsor. | Yes |
| Profits Allocation/ Carry | Typically based on European waterfall distributions, subject to a hurdle rate, with "GP" Catch Up (sometimes less than 100 percent). | Typically structured as a performance fee, rather than as a profit allocation. | Yes |
| Performa-nce Fee | Sometimes a performance fee instead of a profits allocation, and when a fee, often European waterfall (but sometimes annual) subject to hurdle rate and "GP catch up." | Annual performance/ incentive fee (contingent upon profits/surpassing hurdles using NAV). | Yes |
| Equalizat-ion Payment Required of Subsequ-ent Investors | Yes, nearly always, at an interest rate; typically accompanied by a reduced management fee for "early" investors to incentivize first closers who may be concerned of dilution by subsequent investors. | None. | Yes |
| Alternative: Marketing Period Net Income | Allocation of income earned to contributed capital, with no equalization payment. | Since there is no marketing period, net income is allocated based on NAV. | Yes |
| Leverage Limit for Leveraged Funds | Typically, 150 percent of aggregate commitments in practice (due to credit facility collateral constraints) but up to 200 percent in fund documents. | Approximately, 200 percent or more of NAV of the Fund. | Yes — AIFMD introduces distinct leverage limits (see below) |
| Liquidity Managem-ent | Limited means to exit make liquidity management self-executing. |
Liquidity regulated through gates and suspension periods. Gates are objective and clearly defined. Suspension Periods can be subjective and at the discretion of the GP for the liquidity management of the Fund (in good faith). | Yes — AIFMD introduces rules that are aligned with market practice (see below) |
| Valuation | No impact on entry or exit, management fees or performance/ profits sharing. Frequency tends to be linked to investor reporting; independent valuation takes place within the process. | NAV as determined in the GP's discretion within a set of stated valuation rules for different asset classes Independent valuation takes place within the process. | AIFMD Introduces rules that are aligned with market practice (see below) |
| Redempt-ion | None. | Yes: ranged from periodic/quarterly, to annual to rolling 3-year periods. Often subject to policies limiting aggregate redemptions. | AIFMD introduces rules aligned with market practice (see below) |
established portfolio of loans (that is, evergreen funds are not blind pools), the flexibility of matching their investment period to the investor's time horizon, and potentially, staying invested indefinitely, minimizing the burden on institutional investors of repeatedly obtaining trustee approvals. These evergreen funds are almost bound to be open-ended, at least as that term is understood in Europe, since they will afford a mechanism for exit at the investor's initiative.7 As such, a brief comparison of the contrasting features of closed-end and open-end fund market terms is worth making, while applying the test of "can we do that under AIFMD." The following chart provides the key features of open-ended evergreen funds.
The chart indicates that if the pull of access to Europe is compelling, then the overlay of EU regulation would not prove an impediment to launching a global, evergreen, open-end private credit fund, subject to regulation on leverage, liquidity management, valuation and redemption.
| What you Need to Know | Open-End Private Credit/Loan Origination Funds | Closed-End Private Credit Funds |
| Do Loan Originating AIF rules apply? | Yes, whenever the fund's investment strategy is mainly to originate loans or if the fund's originated loans have a notional value that represents at least 50 percent of their NAV. | Same |
| Does AIFMD Have Leverage Rules for Loan Originating AIFs? | Yes. Both open-end and closed-end funds are subject to leverage limits. The European Union perceives heightened risk to financial stability in open-end AIFs and therefore has set lower leverage limits on open-end leveraged AIFs. | Less risk, less regulation, more leverage permitted |
| What is a Leveraged AIF? | An AIF whose exposures are increased by means of borrowing (cash or securities) or embedded in derivatives or in any other means. | Same |
| How is leverage measured? | The leverage of a loan-originating AIF shall be expressed as the ratio between the market exposure of that AIF and its NAV.9 | Same |
| What is the applicable leverage limit? | 175 percent for open-end AIFs (excluding capital call lines). | 300 percent for closed-end AIFs (excluding capital call lines) |
| What are the liquidity management rules for loan origination AIFs? |
Open-ended loan funds must employ an "appropriate liquidity management system" and must adopt "procedures to monitor liquidity risk" and must conduct "stress tests" and open-end funds must be able to demonstrate to their regulator that they have implemented a liquidity risk management system compatible with its investment strategy and redemption policy. | Unlevera-ged closed-ended loan funds are exempted |
| What are the mandatory elements of a liquidity management system? | Open-End funds must implement at least 2 of 9 permitted liquidity management tools (LMTs). | None |
| What are the permitted liquidity management tools? | (i) Suspension of redemption; (ii) redemption gates (that is, a cap on redemptions); (iii) extension of redemption notice periods; (iv) redemption fees; (v) swing pricing (that is, exiting investors pay liquidation costs); (vi) dual pricing for entry/exit; (vii) anti-dilution levy; (viii) redemptions in kind to professional investors; and (ix) side pockets. The LMT of suspension of subscriptions, repurchases and redemptions, or side pockets is to be limited to exceptional cases. | Not applicable |
| Would the US manager need to document and detail our credit process? | Yes. Loan origination funds must document their implemented credit risk policies, procedures and processes and portfolio company monitoring, and must review them regularly and at least once a year. | Same |
| Are there any diversification requirem-ents? | Yes, but only in special cases. Loans to financial undertakings are limited to limited to 20 percent of the AIF's capital. Also, loans to staff of the manager, or to the depositary generally are prohibited conflicts. Making consumer loans may be prohibited by member states (and typically will be). | Same |
| Is the Fund subject to asset retention rules? | Yes, but they are not onerous. A loan origination AIF should retain at least 5 percent of the notional value of each loan it originates Also, having a strategy of originating loans with the sole purpose of selling them is prohibited. | Same |
| Is an Independent Valuation Function Required? | Yes, and for open-end funds valuation must be carried out for each issuance and redemption, and must be performed by a qualified external valuator or by a larger firm (such as a bank/ insurance company acting as the manager) in a way that is functionally independent from portfolio management. | Yes, upon increase or decrease of capital |
| Is a redemption policy required? | Yes. The AIFM that manages an open-ended AIF shall identify, manage, and monitor conflicts of interest arising between investors wishing to redeem their investments and investors wishing to maintain their investments in the AIF, and any conflicts between the AIFM's incentive to invest in illiquid assets and the AIF's redemption. |
AIFMD Impacts on US Style Evergreen Open-End Private Credit Funds
AIFMD introduces rules for loan origination funds that will affect fund design and operations, particularly for open-end private credit funds. While these rules do impose themselves on the market, they are in fact both a harmonization of rules across Europe and a simplification of rules previously in place in certain member-states that now better facilitate launches of loan origination funds.8
The chart below demonstrates that open-end private credit funds are regulated in a thoughtful way in Europe that can readily be aligned with market practice. Further, these regulations are not impeding the launch of evergreen open-end private credit funds in practice, and in fact are an accelerant, particularly in the use of Irish fund structures. Lastly, when the overlay of access to Europe is taken into account, US managers will want to take a hard look at the opportunity afforded by AIFMD II.
What Is Next for Open-End Loan Origination Funds?
The community of EU watchers currently awaits final guidance from the European Securities Markets Authority (ESMA) on draft regulatory technical standards (RTS) with final approval by the European Commission later this year. Much can be gleaned both from the draft RTS and ESMA's preexisting 2020 guidance on stress testing for Undertakings for Collective Investment in Transferable Securities (UCITS) and AIFs. ESMA's broad 2020 RTS outline focuses on sound liquidity management, the avail-ability of liquid assets, stress testing and an appropriate redemption policy in light of the fund's liquidity profile. The current RTS requirement that open-end AIFs have available liquid assets would appear to be the element most likely to affect open-end private credit funds' investment returns and loan making. Fixing an appropriate level of liquid assets in the context of the fund's redemption policies should entail modeling cash flows generated by the loan portfolio, setting conversion privileges, as well as the potential to sell positions without incurring losses.
The 2020 RTS also addresses liquidity stress testing based on conservative scenarios at least quarterly (subject to more frequency when factors, such as a concentrated investor base, present themselves) in light of ESMA's 2020 guidelines on Liquidity Stress Testing (which permit less frequent stress testing when there is less frequent redemptions), as specified in relation to a specific fund's rules.10 These guidelines in turn emphasize that open-end funds' redemption policies and liquidity management tools, such as gates and side pockets, are to be considered in the context of liquidity stress testing. All of which suggests that open-end funds private credit funds will need to consider deploying at least two of the nine approved LMTs during their design phase that will align well with cash flows providing liquidity proportionate to conservative redemption assumptions.
In our view, having mapped out the possibilities in light of the demand for evergreen open-end credit funds, choosing Europe offers US managers an opportunity that should not be overlooked.
Footnotes
1. Fast Growing $2 Trillion Private Credit Market Warrants Closer Watch, IMF Blog, April 8, 2024, by Charles Cohen, Cai Ferreira, Fabio Natalucci and Nobuyasu Sugimoto. See also, Bank Lending to Private Equity and Private Credit Funds: Insights from Regulatory Data, John D Levin and Antoin Mafroy-Camine, Federal Reserve Bank of Boston SRA Notes, February 5, 2025.
2. See, Private Credit Growth and Monetary Policy Transmission, Fed Notes, Ahmet Degerli and Philip Monin, August 2, 2024.
3. The International Monetary Fund, Global Financial Stability Report, Chapter 2 "The Rise and Risks of Private Credit," April 2024 at page 72, citing to AIFMD II.
4. Directive (EU) 2024/927 of the European Parliament and Council of 13 March 2024 amending Directives 2011/61/EU and 2009/65/EC as regards delegation arrangements, liquidity risk management, supervisory reporting, the provision of depositary and custody services and loan origination by alternative investment funds (AIFMD II).
5. The EU published the consolidated text of AIFMD incorporating AIFMD II on March 13, 2024, https://eur-lex.europa.eu/legal-content/EN/TXT/ PDF/?uri=OJ:L_202400927. References used herein are to the consolidated text.
6. See, for example, "Private Credit During the Pandemic and Beyond," Alternative Investment Management Association Limited, September 20, 2021.
7. The term open-ended was defined on December 17, 2013 in Regulated Technical Standards (2013 AIFMD RTS) adopted by the European Union as follows: "The distinguishing factor in determining whether an AIFM is managing AIFs of the open-ended or closed-ended type should be the fact that an open-ended AIF repurchases or redeems its shares or units with its investors, at the request of any of its shareholders or unitholders, prior to the commencement of its liquidation phase or wind-down and does so according to the procedures and frequency set out in its rules or instruments of incorporation, prospectus or offering documents." See, 2013 AIFMD RTS Article 1, Section 2, Closed-End AIFs Are Not Open-End AIFs, 2013 AIFMD RTS Article 1, Section 3.
8. See, for example, Central Bank of Ireland AIF Rulebook, Section 4 regarding Loan originating Qualifying Investor AIF, which presently requires that private credit funds must be closed-ended. Ireland can be expected to align its rules on loan origination AIFs with AIFMD post AIFMD II. This will be a boon to those fund sponsors who look to the ICAV, and its companion Investment Limited Partnership, as a backbone for private credit funds.
9. The "commitment method" is to be used, calculated in accordance with Article 8 of Commission Delegated Regulation (EU) No 231/2013 (the "Commitment Method"). Generally, the Commitment Method is the sum of the absolute values of all positions (converting derivatives to equivalent position in the underlying asset), applying netting arrangements, and, pertinent to private credit fund credit facilities, calculating exposure through the reinvestment of borrowings.
10. Guidelines on liquidity stress testing in UCITS and AIFs, European Securities Markets Authority, July 16, 2020, https://www.esma.europa.eu/sites/default/ files/li bra ry/esma34-39-897_guidelines_on_liquid-ity_stress_testing_in_ucits_and_aifs_en.pdf.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
