Impact investors rally against ‘small but potentially fatal’ part of proposed EU legislation

The EU has put forward legislation that, if adopted without amendment, could mean the end for some impact investment funds. Impact investors are calling on EU legislators to correct a fatal flaw in the proposal

Resistance against a relatively small part of the Alternative Investment Fund Managers Directive (AIFMD) review proposal by the European Commission has grown rapidly in recent weeks.

“If this legislation is passed unchanged”, says Hadewych Kuiper, managing director of Triodos Investment Management, “the impact investing sector will no longer be able to offer private debt impact funds to private investors for investing in energy transition projects, micro-finance or small businesses in developing countries, with very negative consequences for the investees, who badly need these resources. That can’t have been the intention of Brussels.” 

Earlier this year, several leading impact investing firms published a position paper setting up their common view on the regulatory proposal.

The signatories – BlueOrchard, Developing World Markets, Finance in Motion, Incofin Investment Management, MicroVest, responsAbility Investments, Symbiotics, Triodos Investment Management and Triple Jump – represent a significant part of the asset management sector that is directly affected by the EU’s proposed regulatory framework.

The position paper was followed by an online petition with a plea as well as a proposed amendment to the legislation.

The petition was widely endorsed and will later this month be handed over to the members of the European Parliament, which will discuss amendments to the proposal after the summer. 

Shadow banking 

So, what’s it all about? One of the goals of the new AIFMD proposal is to regulate the so‐called ‘loan‐originating’ alternative investment funds. A phenomenon also known as ‘shadow banking’.

Member states, like central bank researchers, have been concerned about unfair competition with the banks. Also, loans granted without a banking license threaten financial stability. 

There is little debate about the need for financial stability measures in this context. However, the criticism focuses on a specific element of the approach proposed by the Commission. 

Article 16(2a) of the proposal requires a closed‐end structure if the notional value of the AIF’s originated loans exceeds 60% of its net asset value. “That’s where the pain is”, says Kuiper. “A closed-end structure would imply no liquidity for investors until the ‘end’ of the fund. While existing funds have shown adequate liquidity for over 20 years, also during shocks.” 

Because of the lack of liquidity, critics fear, banks will choose to no longer distribute these funds to investors that count on continuous liquidity. Which would mean that the recent successful growth in banks offering impact funds as part of their private banking menu will be cancelled out. 

Not a complicated solution 

“We really do understand the concerns about shadow banking”, says Kuiper. “Our impact funds however provide loans to investees who do not have access to bank loans. Loans that remain in the fund from the start to the end. And yes, they are open-ended, because we want them to be accessible to private investors.” 

Impact investors without access to open-end AIFs will only have more risky alternatives to choose from, critics say. They can invest in volatile listed securities, in closed-end AIFs and let go of any liquidity needs for a few years, or engage in high risk crowdfunding.  

A solution to the problems does not have to be very complicated, Kuiper and her peers argue. 

“We propose that the EU Council and the European Parliament limit the scope of application of the proposed closed-end requirement to the AIFs that originate loans with the sole purpose of selling them immediately on the secondary market.”  

Alternatively, the European co-legislators could decide to apply an exception for financial products of the said open-ended impact funds, and impose soundness requirements onto these funds, regarding leverage, liquidity and risk retention.  

Call for action 

Without these adjustments, the AIFMD-proposal will have a destructive effect on the valuable impact realised for private business in developing countries, the critical impact investing firms write in their position paper.  

“This will also limit the possibilities for investors to put their private capital at work towards realising genuine positive social or environmental impact. Additionally, it would mean a major setback in realising the EC’s Action Plan on Sustainable Finance and the SDGs,” the paper said.

“We are convinced that the harmful effects of the AIFMD proposal to impact funds, their investors and investees, are not intended that way”, Kuiper adds. “But it is only a small sentence in a very extensive legislation proposal. So our fear is that it will get too little attention, and will not be amended. Hence our urgent call for action.”