The state of alternative lending and pertinent regulation within the European Union is the topic of a new white paper co-authored by Allen & Overy, the multinational law firm, and the Alternative Credit Council (an affiliate of AIMA).
The paper begins with the observation that over the last four years there has been a rapid growth in the volume of non-banking lending in the EU. The debtors in these transactions include small- and medium-sized enterprises, who get more tailored offerings than they would otherwise have gotten from banks.
There are differences in principle between banks and other lenders. Specifically, when banks make loans they put the money of their depositors at risk. When other lenders make loans they put the money of their investors at risk. Governments can be and often are more solicitous of depositors than of sophisticated investors, so bank lending is hedged-in by restraints that are not and should not be applied to other lenders. “Any attempt to superimpose bank-like regulatory approaches on non-bank lenders will erode the uniqueness of the sector and limit the benefits that accrue from a diverse financial system,” the paper says.
Kroll and Williams
The paper is the work of Jiri Kroll, deputy CEO of the ACC, and Nick Williams, a London partner in Allen & Overy. These authors applaud recent efforts of the EC and the EU’s members states to encourage alternative sources of finance, but they point to areas where more such work is necessary, where barriers to the growth of this market exist and can be removed by prudent decisions.
At the continent-wide level, lenders and the funds they manage are treated under the existing system as, respectively, Alternative Investment Fund Managers (AIFMs) and Alternative Investment Funds (AIFs). European directives govern the balance of rights between the investors in and the managers of such funds on the lending side. The task of creating legal protections for the borrower, against for example heavy-handed forfeiture and asset seizure is a matter generally left to the legal systems of the nation states.
The investors in non-bank lenders are for the most part institutional in nature. Indeed, the report suggests that “the openness of these funds to retail investors should be carefully considered,” because it is not suitable for some; for example, it isn’t suitable to investors who do not understand the illiquid nature of the commitment they are making. “Capital allocated to non-bank lenders is typically invested via closed-end fund structures that have a fixed life cycle,” the authors write. “This means that investors are not able to recall this capital and that borrowers benefit from a stable and patient source of finance.”
AIFMD Level 2 Regulation already requires non-bank lenders to exercise due diligence in selecting and monitoring their investments, and requires that this diligence be documented, that is, reflected in written policies and procedures. Kroll and Williams assert their view that “the approach taken by non-bank lenders toward borrower due diligence and identifying credit risk is as, if not more, robust than that taken by traditional lenders.”
The Member Nations
As for the barriers to non-bank lenders that exist country by country, Kroll and Williams particularize these by country, devoting sections to France, Germany, Ireland, Italy, Luxembourg the Netherlands, Spain, Belgium, and the United Kingdom. In France, for example, “loans can only be resold during the life of the fund if the AIFM has a specific operational program approved by the AMF or in specific circumstances.” Italy has a different system, allowing loans to be resold so long as credit maturity does not exceed the fund’s maturity. In Luxembourg, on the third hand, there is no restriction on loan resale.
Perhaps more important as a restraint, there is the issue of domicile and origination. In France, again, loans can only be originated from AIFs which are domiciled in France. A non-France-based AIFM can create a fund domiciled in France for the express purpose of originating such loans, but this is often not economical and “undermines the commercial case for investing in France.” The paper recommends that this requirement be relaxed.
The conclusion of the report is optimistic. Kroll and Williams are “encouraged to see that in a number of jurisdictions, [a] trend toward incremental improvement and reform has taken hold.”