Risk and regulatory scrutiny for private credit funds: what institutional investors need to know
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Private credit funds have rapidly evolved from a niche strategy into a core allocation for many institutional investors. But as private credit scales, so does scrutiny. This article explores emerging key risks in private credit funds, the response in European Union (EU) and UK regulation, and the implications of this for institutional investors allocating to private credit funds.
Key risk trends
Credit risk management and underwriting standards is an area of focus. Several well publicised cases of private credit providers facing significant losses (such as the bankruptcy of First Brands) have drawn increased focus to the topic. Many have pointed the finger at poor underwriting standards. The question therefore arises, are these examples “one-off”, or do they point to a more systemic issue?
The use of open-ended (evergreen) and semi-liquid private credit funds is another area drawing increased scrutiny. Investor demand, structural flexibility, and managerial advantages have caused increasing numbers of sponsors to launch such funds. These vehicles can offer clear benefits for institutional investors due to their greater liquidity, yet they bring distinctive risk management challenges that do not exist in closed-ended structures:
- Redemption liquidity: even with liquidity management tools, the mismatch between investors’ redemption rights and the underlying illiquidity of private credit assets has the potential to trigger forced sales at depressed prices or force the use of drastic liquidity management measures like suspensions of redemptions.
- Valuation governance: unlike closed-ended funds, these vehicles require frequent valuations that drive subscription and redemption prices. Where private credit positions are thinly traded, the governance around value marks becomes critical.
Regulatory responses
Key questions that arise for institutional investors investing in private credit funds in the UK and EU are:
- How is the UK and EU regulation of private credit managers responding to these trends?
- How might this impact investments by institutional investors in private credit funds?
A potentially surprising fact is that the UK and EU are moving in opposite directions on this topic. Hence, institutional investors will face quite different considerations when assessing private credit funds regulated in each jurisdiction.
Until recently, both regimes, derived from the Alternative Investment Fund Managers Directive (AIFMD) remained virtually the same. But the EU is currently implementing “AIFMD II” changes which significantly increase the level of prescription in the rules for private credit fund managers. Meanwhile, the UK is exploring loosening the regulatory obligations for smaller or medium sized fund managers.
EU AIFMD II: Prescriptive rules for private credit funds and open-ended structures
EU AIFMD II is currently in the process of being implemented by EU member states, with most obligations starting to apply from 16 April 2026. It introduces new, prescriptive rules, addressing the risk trends around underwriting standards, and the use of open-ended structures discussed previously.
Central to the changes is a new specific regime for private credit funds. A new category of “loan-originating AIFs” has been introduced, covering funds which mainly originate loans and hence encompassing most private credit funds. These alternative investment funds (AIFs) are subject to new requirements, such as specified leverage limits, and are generally required to be closed-ended unless they can demonstrate to their home state regulators that their liquidity risk management aligns with their investment strategy and redemption policy. In addition, any AIF that originates loans, regardless of whether it is classified as a “loan-originating AIF,” must meet new requirements. These include diversification rules limiting the amount that may be lent to certain entity types, a 5% risk retention requirement for originated loans sold to third parties, and obligations to establish risk management policies and procedures related to lending. “Originate-to-distribute” strategies are also prohibited.
AIFMD II also sets new, detailed rules for liquidity management. Open-ended funds must choose at least two liquidity tools from an approved EU list and notify regulators when activating or deactivating them (unless routine). Regulators can also require changes to these tools if there are investor protection or financial stability risks.
Many of the amendments focus on credit risk management and underwriting standards. The updated requirements for internal policies and diversification are designed to establish more consistent practices in private credit funds. Additionally, risk retention requirements and the restriction of “originate-to-distribute” strategies are based on concerns that such strategies may reduce rigorous underwriting by not requiring private credit funds to retain a portion of the risk.
It is also clear that EU regulators are focused on the liquidity risk management of open-ended structures – in particular introducing a new regulatory hurdle for private credit funds seeking to adopt the structure. It remains to be seen whether this will reverse or temper the trend towards increased use of these structures. However, the AIFMD II reforms largely do not address the issue of valuation governance in such structures.
UK regulatory reform: a test of more proportionate regulation
The current financial services policy mood in the United Kingdom emphasises a “pro-growth” agenda. Part of this trend is a move away from some of the more prescriptive frameworks inherited from the EU.
For private credit managers, the key proposed reform is the revision of the UK’s AIFMD-derived regime. The latest Financial Conduct Authority (FCA) consultation suggests the following:
| Fund under management (NAV) | Proposed regime |
|---|---|
| > £5bn | Regime similar to the existing framework |
| £100m and £5bn | Principles-based approach with fewer detailed rules |
| < £100m | Limited set of baseline standards |
Whilst further details on the rules are expected in 2026, it is clear that the overall direction of travel is towards removing many of the prescriptive obligations, particularly for smaller fund managers. This would be equally applicable to private credit funds as to other types of funds.
… in contrast to the EU, the UK approach is actually towards less prescription on the issues of credit risk management, liquidity risk management and valuation governance.
It is, however, notable that UK regulators have addressed some of these topics through various other approaches. For instance, the FCA conducted a multi-firm review of private market valuation practices, with findings released in March 2025; the FCA outlined examples of “good practices” and specified its expectations for firms. Likewise, while primarily focused on retail-facing funds, the FCA has in recent years evaluated liquidity management within the sector and articulated enhanced standards in this area. Ultimately, however, these initiatives do not constitute a targeted revision of regulations governing private credit funds.
Conclusion
Although concerns about particular aspects of risk management are increasing, regulatory strategies differ between the EU and UK, resulting in varied implications for institutional investors in UK and EU private credit funds.
For funds under the EU regime, institutional investors may observe positive changes as fund managers are subject to stricter rules regarding liquidity risk management and lending processes. At the same time, AIFMD II may restrict certain strategies within Europe, such as moderating the shift toward open-ended private credit structures and limiting secondary loan stake sales. Hence, the impact on institutional investors will be mixed.
In the UK, institutional investors could encounter more variation among fund managers in the management of these risks due to a generally less prescriptive regulatory approach. As a result, due diligence by investors will become increasingly significant to establish their understanding and acceptance of the risk management and governance practices, particularly for smaller private credit fund managers.
