Amendment to the ZISIF and AIFMD II

A New Era of Regulation Is Here: What Do the ZISIF Amendment and AIFMD II Bring?

These changes are not random. They are a response to the dynamic growth of the alternative investment market and an effort by regulators to prevent risks that have emerged during past market crises. For Czech fund managers and investment companies, this means a need to adapt to new standards in key areas: loan origination, liquidity management, delegation of activities, and the use of depositary services.

The new legislation represents a shift in the very philosophy of supervising alternative investments. It recognises that this sector is no longer a marginal affair but a key part of the financial ecosystem, providing significant capital for the real economy. With this recognition comes a higher degree of responsibility and stricter requirements for governance, transparency, and resilience.

For Czech managers, this means they find themselves on a single European playing field where the same rules and expectations apply. This brings challenges in the form of needing to implement new processes, but it also opens doors to new opportunities for those who can adapt quickly and effectively. At ARROWS, we see this change as an opportunity and are ready to help you not only meet the new obligations but also use them to strengthen your competitiveness. For an immediate solution to your situation, write to us at consultation@arws.cz.

A Revolution for Loan Funds: New Rules for Loan-Originating Funds

One of the most affected areas is loan origination. The ZISIF amendment introduces a completely new, comprehensive regulatory framework for funds that focus on originating loans, so-called loan-originating funds (LOFs). The aim is to unify the previously fragmented practice and set clear boundaries for this rapidly growing market segment.

What is a "Loan-Originating AIF"?

The new rules apply to any alternative investment fund (AIF) that is in any way involved in loan origination. Particularly strict requirements then apply to a "loan-originating AIF". This is considered to be a fund whose main investment strategy is originating loans, or for which the nominal value of the loans it has originated represents at least 50% of its net asset value (NAV).

The definition is intentionally broad and includes not only direct loan origination but also indirect forms, for example, through a third party or a special purpose vehicle (SPV), if the fund or its manager was involved in structuring the loan. If your funds finance other entities in any way, it is essential to conduct an analysis to determine whether you fall under the new, stricter regime. The lawyers at ARROWS will help you with this analysis. Contact us at consultation@arws.cz.

Key Obligations and Limits for Loan Funds

The amendment introduces several fundamental restrictions that will dramatically affect the business models of many funds:

• Leverage Limits: A hard cap on the use of leverage is being introduced. For open-ended funds, leverage may not exceed 175% of NAV, while for closed-ended funds, the limit is set at 300% of NAV.

• Diversification and Risk Concentration: A new rule states that a loan granted to a single borrower may not exceed 20% of the fund's capital if the borrower is a financial institution, another AIF, or a UCITS fund.

• Prohibition of "Originate-to-Distribute" Strategy: It is expressly forbidden to originate loans with the sole purpose of subsequently selling them to third parties. Funds must now retain an economic interest of 5% of the nominal value of each originated loan that they subsequently sell.

• Operational Requirements: Managers must establish and maintain effective internal policies and processes for assessing credit risk, valuation, and monitoring the entire loan portfolio. Furthermore, there is a strict prohibition on providing loans to related parties, such as the fund manager itself, its employees, or its depositary.

While these new rules may seem restrictive, their main purpose is to create a unified and transparent market for private lending in the EU. The harmonisation of rules opens the door for a "loan passport," which will allow Czech funds to more easily provide loans across member states.

To successfully seize this opportunity, it is crucial to have a partner who understands not only Czech but also European legislation. Thanks to our ARROWS International network, we handle cases with an international element daily and are ready to support your expansion.

Are You Prepared for a Crisis? Mandatory Liquidity Management Tools (LMTs)

Another fundamental change introduced by AIFMD II is the mandatory implementation of Liquidity Management Tools (LMTs) for all open-ended alternative investment funds. The goal is to ensure that funds can withstand extraordinary market situations, such as mass redemption requests, without having to forcibly sell off their assets at a discount.

Managers of open-ended funds will now be required to select at least two tools from a list of nine harmonised instruments that best suit their fund's investment strategy, liquidity profile, and redemption policy. These tools must then be described in detail in the fund's statute or other constitutional documents. This is not an option, but an obligation to be prepared.

The List of 9 Liquidity Management Tools

The legislation defines the following tools from which managers must choose:

1. Suspension of subscriptions and redemptions: Temporary and complete halt of all transactions. This is an extreme tool for exceptional situations.

2. Redemption gates: Setting a maximum percentage of a fund's assets that can be redeemed in a given period. Requests exceeding this limit are carried over to the next period.

3. Notice periods: An investor must announce their intention to redeem units further in advance, giving the manager time to secure liquidity.

4. Redemption fee: A fee paid by the departing investor into the fund's assets, thereby compensating the remaining investors for the costs associated with selling assets.

5. Swing pricing: A mechanism that adjusts the fund's net asset value (NAV) up or down depending on whether subscriptions or redemptions prevail, so that transaction costs are borne by the investors causing them.

6. Dual pricing: The fund sets two prices – a higher one for subscriptions and a lower one for redemptions. The difference covers transaction costs.

7. Anti-dilution levy: A fee paid into the fund upon subscription or redemption that compensates for the impact of large transactions on the asset value for other investors.

8. Redemption in kind: Instead of cash, the investor receives a proportional share of the fund's portfolio assets upon redemption. This tool can generally only be used with professional investors.

9. Side pockets: Illiquid or problematic assets are segregated into a separate part of the fund, while the rest of the portfolio continues to operate normally.

The selection and implementation of LMTs is not a mere formality. It is a crucial strategic decision that will affect the fund's resilience and investor confidence. Properly configured tools protect the value of assets for all investors and show that the fund manager is thinking ahead.

At ARROWS, we will help you analyse your strategy and select a combination of LMTs that not only complies with the letter of the law but also becomes your competitive advantage.

Other Key Changes You Need to Know

The ZISIF amendment and AIFMD II also introduce a number of other significant changes that will affect the day-to-day operations of investment companies and funds. Here is an overview of the most important ones.

Outsourcing Under Scrutiny

The rules for delegating (outsourcing) key activities, such as portfolio management or risk management, are being significantly tightened. The aim is to prevent the creation of "letter-box entities," i.e., management companies that delegate all substantial activities to other entities, retaining only minimal functions and responsibilities themselves.

Managers will now have to report all delegated activities to the regulator in more detail and demonstrate that they retain sufficient professional and technical capacity for effective supervision and control over the delegate. It is high time to review your existing outsourcing agreements. At ARROWS, we will ensure they are reviewed and amended to fully comply with the new requirements. Contact us at consultation@arws.cz.

European Passport for Depositaries

One of the positive changes is the introduction of a European passport for depositaries. It will now be possible for a foreign bank from another EU member state to act as the depositary for a Czech fund, even without a branch in the Czech Republic, provided it obtains consent from the CNB. This change could significantly increase competition in the Czech market, where the number of depositaries is limited, and potentially lead to lower costs and improved services.

However, this flexibility also brings higher demands for due diligence when selecting a foreign partner. The combination of stricter delegation rules and the opening of the depositary market requires a sophisticated, pan-European approach to selecting key suppliers. ARROWS can offer you a unique cross-border legal due diligence service for potential depositaries and delegates, thanks to our international network, ARROWS International.

Broadening Horizons and Simplifying Administration

The amendment also brings some simplifications and new business opportunities. Investment companies will now be able to perform additional activities, such as managing non-performing loans, administering benchmarks, or managing special purpose vehicles in securitisation. At the same time, some redundant administrative obligations are being abolished, such as the minimum capital requirement for investment funds or the obligation to establish a committee of experts for real estate valuation.

International Reach? With ARROWS International, You're Covered

The implementation of AIFMD II definitively confirms that the investment fund market is pan-European. The new rules create a level playing field, which is a huge opportunity for Czech funds looking to attract foreign investors, provide loans abroad, or use the services of top European partners.

In such an environment, it is no longer enough to have a legal advisor who is only familiar with Czech law. You need a partner who navigates the international context with confidence. The ARROWS law firm has a ten-year-old network, ARROWS International, through which we handle legal issues with an international element on a daily basis.

Whether it's structuring a fund for cross-border distribution, negotiating contracts with a foreign depositary, or ensuring compliance with local regulations in other EU countries, we are ready to support you.

How Can ARROWS Help You with a Smooth Transition to the New Legislation?

The new regulation is complex, and its implementation will require careful preparation. At ARROWS, we have many years of experience with investment funds and financial regulation. Our portfolio includes more than 150 joint-stock companies and 250 limited liability companies for which we provide comprehensive legal services. We pride ourselves on speed, high quality, and a deep understanding of our clients' business.

Our team of experts is ready to provide you with comprehensive support, which includes:

• A legal analysis of the impacts of the ZISIF amendment and AIFMD II on your specific business model.

• Drafting and reviewing internal policies (for credit risk management, LMTs, outsourcing, AML).

• Preparing and amending fund statutes and other key documentation to protect you from sanctions.

• Representation in licensing procedures and in all communications with the Czech National Bank.

• Expert training for your management and employees with a certificate of completion.

• Legal advice for expansion into foreign markets thanks to the ARROWS International network.

Don't leave preparation until the last minute. The risks are too high and the opportunities too valuable. We are also happy to listen to your business ideas and, if there is interest, connect our clients if we see interesting business synergies. Contact our team of experts at consultation@arws.cz and ensure a smooth transition to the new regulation.