Now permissible: Loan origination and restructuring by funds
In Germany the origination of loans was only permissible with a respective banking license under the German Banking Act (Kreditwesengesetz, "KWG"). With respect to proposed legislatory changes to the German Capital Investment Act (Kapitalanlagege-setzbuch, “KAGB”), the German Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht, “BaFin”) announced changes to its current administrative practice with regard to loan origination by investment funds (Reference number WA 41-Wp 2100 – 2015/0001). BaFin now understands loan origination as well as loan restructuring being part of the collective asset management and therefore as a permissible investment activity for Alternative Investment Funds ("AIF"). The KAGB in this respect supersedes the KWG requirements.
How does the new practice impact foreign funds?
- Loans as new asset class for funds?
a) Origination of loans
Without a license under the KWG or a EU-passported Banking license loans can be originated by a fund. However, loans may not be granted to consumers and long term debt financing should not be supported by short term borrowings. In general, with respect to the Capital Requirements Regulation (EU) Nr. 575/2013 (CRR) and the transformation of timing differences the use of leverage is considered critical by BaFin so that no simultaneous borrowing from the general public and granting of loans by the fund should be permissible.
b) Restructuring of loans
Restructuring of loans, i.e. changes to the conditions incl. the extension of a loan after its acquisition, will not be seen as part of the origination or granting of a (new) loan. Funds which bought loans in the past are not anymore required to on-sell the loan to a bank in case of restructuring. Consequently, funds may invest in distressed loans.
c) Shareholder loans
The former requirement of shareholder loans being subject to a qualified subordination should not apply anymore.
- Limitation to specific fund types?
The BaFin announcement addresses German fund schemes in form of an AIF only; UCITS-type of funds are out of scope pursuant to their product limitations under the UCITS-Directive. However, in proposing the new administrative practice the BaFin argues in making reference to the new regulatory environment within the EU under the AIFM-Directive and the fact that in some European Countries loan origination is not or only limited subject to supervisory regulation. On that basis loan origination in the German market by European funds should not be subject to a license under the German Banking Act if and when the fund is subject to AIFMD regulation which is similar to the requirements for German Funds. Any other treatment should be a discrimination for which there is no reasonable argument. But, whether this new understanding may also apply to Non-EU Funds is not entirely clear. Taking the background for the new understanding into account, however, one may argue that if the respective fund/undertaking is subject to a similar regulatory supervision as German Funds are such fund/undertaking may originate and restructure loans from borrowers in and with a seat or place of management in Germany.
For German funds/undertakings it is irrelevant whether they are managed by a fully licensed fund manager or by a fund manager registered pursuant to Section 44 KAGB, i.e. the assets under management of the manager are below the thresholds under the AIFM-D. However, the investor basis must be limited to professional or semi-professional investors (Section 1 para. 19 N° 32 and 33 KAGB).
- the fund manager needs an adequate business organization with an appropriate risk management (open-ended funds should invest more than 50 per cent of its NAV into loans);
- the loan origination must be free of conflicts of interest;
- the loan portfolio should be follow a risk diversification approach, i.e. limitation of credit exposure per borrower;
- the fund must maintain a liquidity reserve, although such a requirement makes sense only for open-ended funds which must technically in a position to be able to liaise with the redemption right of the investor.
When defining these requirements in more detail BaFin is making reference to the general "governance"-regulations under the KAGB (Sections 26, 28 and 29 KAGB) and the “Minimum Requirements for Risk Management” (“MaRisk”) although by law both are not applicable to just fund managers registered with BaFin only. BaFin' s understanding, however, is that generally the requirements relating to credit business processes, granting of loans, further processing of loans, monitoring of loan processing, intensive support, management of non-performing loans, risk prevention, procedures for early detection should apply.
It is not yet entirely clear whether beside the regulatory supervision of the manager and/or the fund these further requirements are a condition precedent for an EU and Non-EU fund/undertaking to originate loans in the German market.
- Fund raising in Germany?
When raising capital from investors in Germany under the aspect of investor protection one may argue that the fund must be setup pursuant to the German requirements (see above under 2). But, the sales and marketing requirements under the KAGB do not include for EU or Non-EU AIF which are limited to professional and semi-professional investor any product specifics. Generally, only an AIFM-D-like supervision of the manager and/or the fund by an acceptable competent authorities and protection for money laundry are sufficient so that one may argue that the further limitations may not apply to a foreign loan originating fund when raising capital from German investors. BaFin is arguing in the announcement that the loan origination and restructuring should be limited to those fund types which have no or only limited product specific restrictions so that on this basis the requirements for German funds may not apply to EU and Non-EU funds/undertakings. However, the new administrative practice is an exception to the restrictions under the KWG so that a prudent approach should be that there should be an appropriate and adequate business organisation and riskmanagement.
Any questions? Please contact: Dr. Matthias Geurts
Practice Group: Banking & Finance, Regulatory & Governmental Affairs