By Dr Charles Cassar, Malta – The Malta Financial Services Authority (MFSA) has recently clarified its position with respect to the licensing and regulation of loan funds in Malta. In this regard the MFSA issued supplementary standard licence conditions (SLCs) which apply to prospective Malta loan funds in addition to the applicable Investment Services Rules for Alternative Investment Funds/ Investment Services Rules for Professional Investor Funds, depending on whether the loan fund falls within the de minimis thresholds or fully AIFMD complaint regime.
For the purposes of this article, a loan fund is deemed to be a fund that is able to invest through loans solely and exclusively to unlisted companies and SMEs.
The term ‘investing through loans’ is understood to mean:
- the direct origination of loans by the fund; or
- the acquisition by the fund of a portfolio of loans or a direct interest in loans which gives rise to a direct legal relationship between the fund as lender and the borrower.
The main regulatory requirements which need to be taken into consideration for licensing and compliance purposes mainly relate to the following areas which are dealt with into further details below:
- Structuring of the Fund
- Eligible Investors and Minimum Entry Levels
- Service providers
- Investment Restrictions
- Credit Risk
- Liquidity Management
- Reporting Requirements
1. Structuring of the Fund
The fund is required to be structured as an unleveraged closed-ended fund. The term ‘closed-ended’ is defined as referring to a collective investment scheme which:
- does not raise capital through the continuous sale of units or shares;
- has a fixed duration;
- the units of which can only be redeemed at the end of the duration of the scheme.
Hence no specific legal structure is imposed. Having said that, the structure under Maltese law which closely fulfils these requirements, is that of the INVCO.
2. Eligible Investors and Minimum Entry Levels
Malta Loan Funds can only be sold to professional investors. Professional investors are interpreted as either:
- falling within the definition under Section I to Annex II of the Markets in Financial Services Directive “MiFID”); OR
- electing to be treated as professional clients on request in terms of Section II to Annex II to MiFID AND commit to investing a minimum of EUR 100,000.
3. Service Providers
A Malta Loan Fund is required to appoint the following service providers:
- Compliance Officer
- Money Laundering Reporting Officer
- Fund manager (unless the fund is self-managed)
The management function is required to have sufficient financial resources and liquidity, experience and expertise in the area of granting of loans including credit assessment, credit provisioning monitoring and control of exposures as deemed necessary by the MFSA.
Where the fund is self-managed, the initial share capital is required to be of at least EUR300,000 and the NAV of the fund is expected to exceed this amount on an on-going basis. This is higher than the capital resources requirement for an external fund manager and a traditional self-managed Professional Investor Fund/Alternative Investor Fund which currently stands at EUR125,000.
The requirement of appointing a custodian is mandatory for a Malta loan fund. This presents an additional requirement for Malta loan funds structured as Professional Investor Funds sold to Qualifying or Extraordinary investors which are not typically required to appoint a Custodian. However Malta loan funds will be able to benefit from the depositary lite regime in certain circumstances, and therefore be able to appoint a category 4b license holder as custodian, which advantageously widens the choice of service provider in this context.
3.2. External Valuer (where applicable)
The valuation function is to be performed by an external valuer which is independent from the fund, fund manager and from any other persons with close links to the fund or fund manager. Where the valuation is carried out in a manner which is functionally independent from the portfolio management and credit granting function, and provided that measures are in place to manage conflicts of interest and undue influence on employees, the valuation function can be performed by the fund manager.
4. Investment Restrictions
Malta Loan Funds are required to abide by a number of investment restrictions, which include inter alia:
- Prohibition of the short-selling any securities
- The fund may invest up to 30% of its assets in liquid securities
- The fund is required to invest not more than 10% of its assets in a single undertaking (the same rule applies to loan portfolios)
- The fund is to invest not more than 10% of its capital in units or shares of one or several other loan funds provided that these funds operate within the same investment restrictions applicable under the rules (with a maximum exposure of 20% to such funds)
- The fund may acquire not more than 25% of the units or shares of a single loan fund.
- Restrictions on borrowing
- Prohibition from the use leverage or the reuse of collateral
5. Risk Management
The risk management function is to be functionally and hierarchically separate from the function of portfolio management in accordance with the principle of proportionality as reviewed by the MFSA. Adequate risk management systems are to be implemented in order to identify, measure, manage and monitor appropriately all risks relevant to the fund’s investment strategy and to which the fund is or may be exposed. This includes the establishment, implementation and maintenance of an adequate and documented risk management policy which identifies all the relevant risks to which the scheme may be exposed.
6. Credit Risk Management
A credit risk strategy and related policies in proportion with the scope and sophistication of the fund’s activities is to be established and implemented. A credit policy must establish the framework for lending and guide the credit granting activities of the Malta loan fund, also including: (i) a risk appetite statement, (ii) target markets, (iii) portfolio mix, (iv) structuring of credit limits, (v) processing and (vi) reporting. Other obligations include; establishing credit limits and approving new credits, establishing credit limits and approving new credits, establishing a credit administration function and implementing a credit provisioning policy.
7. Liquidity Management
An appropriate liquidity management system is to be employed and procedures adopted in order to enable the monitoring of liquidity risk of the fund and ensure that the liquidity profile complies with its underlying obligations. The SLCs sought to build on an already existent AIFMD requirement using concepts normally applied in the banking sector.
The SLCs also provide the option to redeem and cancel any shares in accordance with the terms of the offer, on a yearly basis opt should the fund have excess liquidity even though the fund is to be structured as a closed-ended scheme. The SLCs also make provision for the application of a variable NAV.
8. Disclosures and Reporting requirements
Detailed disclosure obligations modelled on the disclosure provisions outlined in the AIFMD are now applicable.
The Maltese fund industry welcomes the new ad hoc standard licence conditions laying the specific regulatory requirements for loan funds and thereby clarifying a previously moot area in fund regulation, and opening up new fund strategy options for prospective fund setups in Malta.
Dr Maria Chetcuti Cauchi is Regulated Business Partner at Chetcuti Cauchi Advocates in Malta and heads the firm’s Financial Services and the Gaming ,IP & ICT practices. Dr Charles Cassar is the manager in charge of financial services and also manages the firm’s London office. www.ccmalta.com; [email protected]