Private debt continues to expand in Luxembourg, but regulators, fund managers and legal experts warn that the market is becoming harder to navigate. Complex fund structures, rising leverage and divergent investor expectations are challenging efforts to maintain transparency, regulatory alignment and credit discipline.
“The challenge right now is the lack of visibility,” said Douglas Welch, managing director at Pemberton Capital Management. “My primary fiduciary duty is to protect my investors’ capital—but when tariffs are up, down, and we don’t have clarity, it becomes much harder for a lender to make a sound credit assessment.”
That tension between growth and uncertainty was central to a recent panel discussion in Luxembourg, where representatives from the CSSF, law firm Paul Hastings LLP and Pemberton assessed the current state of private debt and the implications of AIFMD II.
Loan origination funds
Jean-François Carpantier, head of the macro risk division at the CSSF, reported that loan origination funds now manage 283 billion euro in net assets, with growth of 25 percent in 2022, 20 percent in 2023 and 13 percent in 2024. Using broader definitions, the figure could reach 423 billion euro. “Private debt does not exist as its own category. It is defined as loan origination in the new version of the AIFMD,” Carpantier explained.
Liquidity and valuation risks remain top of mind for the regulator. “Loan origination funds have no leverage limits,” he said, noting that other funds are capped at 175 percent for open-ended and 300 percent for closed-ended strategies. “On average, loan funds have commitment levels below 116 percent. That is a moderate level.”
Welch said Pemberton’s focus remains unchanged: “Our primary objectives are one: to get the capital back and have the loans serviced.” The firm uses a vintage fund model that self-liquidates. “We either go into liquidation, extend the fund, or sell assets into a new vehicle. That adds legal cost, which impacts LPs.”
Despite macro uncertainty, Welch sees strengths in the European framework. “The regulatory environment in Europe is solid and sound. Regulation, if anything, is a competitive advantage.”
Structural complexity, however, is rising. Diala Minott, partner at Paul Hastings LLP, warned about hidden exposures in layered fund structures. “You might find a leveraged fund has exposure to an unleveraged loan that your fund should not have exposure to,” she said. “What you are not disclosing at the top level can become a problem. Managers do not really release everything operationally.”
US investors want leverage, Germans don’t
Investor preferences vary widely. “German insurers are very sensitive to leverage, but US investors like it,” Minott noted. This divergence has prompted a wave of structural experimentation, including umbrella structures, evergreen formats and run-off classes. Redemption terms now range from two-year notice periods to five-year lock-ups.
“The resulting fund landscape is highly complex,” said Minott. “It’ll be interesting to see what structures emerge over the next 18 months and how they comply with the additional rules.”
Fund classification remains a grey area. “We don’t actually have two categories like open-ended and closed-ended,” she said. “We have about 50 shades of open-ended funds.”
According to the CSSF, 75 percent of loan funds are closed-ended. “For the 25 percent that are open, we expect redemption policies to align with the investment strategy and portfolio liquidity,” Carpantier said. He cited the ECB’s May 2024 Financial Stability Review, which warned of potential cliff-edge losses in loan funds. “That remains a priority.”
At the global level, IOSCO is preparing a consultation for late 2025 to strengthen valuation practices in private markets.
Covenant-heavy
Welch said Pemberton maintains a strict credit discipline, built on detailed agreements entered between lenders and borrowers known as covenants.
“We don’t do covenant-light lending. We are covenant-heavy,” Welch said. “We are very particular about credit quality. The hardest part is understanding how the company performs over a seven-year lifespan. That process is not necessarily something you can put in a box and deliver to the CSSF or SEC.”
Despite the uncertainty, both Welch and Minott see opportunity. “We’re playing a very beneficial role—providing capital to European corporates, which desperately need it,” said Welch, noting that post-crisis rules have restricted bank lending. “Somebody has to.”
Minott added: “In difficult times, people innovate. I’m quite excited to see where we end up.”
Carpantier closed with a forward-looking note: “There will be a recession, sooner or later. Our mandate is financial stability and investor protection. We must ensure these loan funds are resilient and sound when that happens.”
The panel discussion took place on Tuesday 25 March at the Global Asset Management conference hosted by the Association of the Luxembourg Fund Industry, Alfi.
Further reading on Investment Officer Luxembourg:
- Raif growth continues, but signs of caution emerge
- El-Erian: ‘Yields won’t drop further without a recession’
- Private debt funds top €500 bln amid concerns over ESG caution