Loan funds are on the rise. According to an analysis by Creditreform Rating, particularly the strong growth of direct lending to companies pushed the European loan fund market above the EUR 100 billion threshold for the first time in 2016. By the end of the first half of 2017, its total volume increased further to EUR 144.4 billion. Indeed, the European loan fund market has been growing even more strongly than its US counterpart since 2013, however the US market is still significantly larger with the direct lending segment alone accounting for a cumulative EUR 105.2 billion in 2016 and real estate loan funds totalling EUR 227.2 billion. Infrastructure funds form the smallest segment of the loan fund market, both in Europe and the US.
Loan funds offer institutional investors the opportunity to invest directly in a loan portfolio and benefit from relatively fast implementation and a broad asset range. The funds either participate in or originate loans. In practice, the question of how loans are originated depends on the requirements of the specific loans and the asset manager’s market strategy.
Loan funds present investors with favourable risk return characteristics, frequently low correlations with other asset classes and good duration play opportunities. In today’s low interest rate environment, they are particularly attractive for investors seeking to match their long-term liabilities.
Although loan funds are a relatively recent type of financing, they are increasingly seen as an alternative to traditional financing channels, not least since stricter regulation has led many banks to shrink their financing activities and also resort to loan funds for origination purposes in a bid to improve their balance sheets.
Loans are an alternative to traditional financing channels.Dr. Sofia Harrschar
After all, refinancing risk from direct loan origination must be priced differently than loan funds that do not have any refinancing risk as long as investors pay in the committed capital.
There is an argument that origination by loan funds is less tightly regulated than that of banks. This is a misconception, however, because the structures required for loan origination are similar for both loan funds and banks. In Germany, these rules are set forth in the circulars on the minimum requirements for the risk management of capital management companies (KA-MaRisk) issued by the German regulator (Bundesanstalt für Finanzdienstleistungsaufsicht, BaFin). In Luxembourg, a similar “circulaire” of the Commission de Surveillance du Secteur Financier (CSSF) applies.
The launch of loan funds is subject to increasingly uniform regulation across the euro area. A banking licence is not required in either Luxembourg nor, more recently, in Germany so that managers of alternative investment funds are free to originate loans from closed-ended funds if they can demonstrate to their regulator that they meet the regulatory requirements for this business in their capacity as AIFM (alternative investment fund manager).
Even though the investment law framework is in place, however, the majority of funds marketed in Germany have been launched abroad. The German loan fund sector is still in its infancy, lagging behind other countries for instance in the Anglo-American region or also Luxembourg where lending via loan fund vehicles has been permitted for quite some time already and the corresponding vehicles are much more numerous. German institutional investors currently look mostly to Luxembourg for their loan investments.
Specialised investment funds (SIF) or reserved alternative investment funds (RAIF) under Luxembourg law are the vehicles of choice. They are fairly similar in terms of their loan origination abilities, with the RAIF requiring no CSSF approval. Since the legal structure is subject to the investor’s tax and regulatory situation, a loan fund can be structured as a limited liability company (SA) or a limited partnership (SCS) under Luxembourg law depending on whether investors are tax-exempt, want to make use of double taxation agreements or are subject to income generation issues.
Loans are complex investments.Dr. Sofia Harrschar
Loans are complex investments. Investors should therefore partner with a KVG that will assist in the structural and operating implementation and work closely with the investor’s legal and tax advisors. Universal-Investment is a pioneer in the launch of special solutions for loan investments of German institutional investors. As a large platform provider, our firm has extensive expertise across all key areas including risk and portfolio management or administration, with the first loan fund launches dating as far back as 2013. Universal-Investment can draw on its expertise in and experience with all aspects of this varied asset class, from ship loans to corporate and public sector or infrastructure loans. This enables us to develop solutions that meet the requirements of investors.
Interest in investment solutions via alternative vehicles is undiminished: at Universal-Investment, the invested volume in debt structures, which also include loan investments, reached slightly in excess of EUR 6 billion at the end of December 2017. Since the end of 2014, the volume has grown sixfold. The invested capital across all alternative structures offered by Universal-Investment (debt and equity structures, hedge funds, securitisations) has almost tripled since the end of December 2014, growing from about EUR 8 billion to EUR 28.3 billion at the end of 2017.
Author: Dr. Sofia Harrschar
Date of issue: 7/19/2018
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