Germany: Seminal changes to loan originating funds now in force

Loan origination by investment funds within and into Germany was once only possible to a limited extent. Now, some Alternative Investment Funds (AIFs) are allowed to originate loans within and into Germany, while others at least have more flexibility with regard to the restructuring of loans receivable.

On 12 May 2015, the German Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht, BaFin) announced significant changes to its administrative practice regarding loan origination, as well as restructuring and prolongation of loans by AIFs following the interpretation by ESMA and some other EU member states that loan origination forms part of collective investment management. The German legislator has now followed BaFin’s more flexible view and adopted BaFin’s changes into the German UCITS V Implementation Act. As of 18 March 2016, some AIFs are allowed to originate loans, while others at least have more flexibility with regard to the restructuring of loans receivable, and may grant loans to subsidiaries of the AIF. EU-AIFs can now lend monies into Germany without the use of a fronting bank.

German AIFs

Loan origination

The UCITS V Implementation Act provides for a detailed regulatory regime in the new version of the German Capital Investment Act (Kapitalanlagegesetzbuch, KAGB n.F.), inter alia with regard to loan origination by AIFs. Section 20 para. 9 KAGB n.F. now determines the cases in which AIFs are permitted to originate loans as part of their collective investment management (and thus without a banking licence which will not be granted to German AIFs and their managers (AIFMs)).

What you need to know

• Closed-ended AIFs may now originate loans within and into Germany.
• The detailed risk procedures applicable to German AIF-originated loans are not applicable for foreign AIFs lending monies into Germany.
• AIFs that can acquire loans can now also restructure acquired loans receivable.

Closed-ended special AIFs

The new regime allows (general) closed-ended special AIFs to originate loans subject to the following restrictions:

• Borrowing is limited to 30 per cent of the net capital of an AIF that is available for investments pursuant to section 285 para. 2 No. 1 KAGB n.F. (the Investable Capital). In this context, the Investable Capital consists of the sum of the aggregate contributed capital and the aggregate undrawn committed capital.
• Loans granted to a single borrower shall not exceed 20 per cent of the Investable Capital. This diversification is meant to alleviate the credit risk that comes along with the origination of loans.
• The AIF may not grant loans to consumers.

Special rules apply to loans that are granted to companies of which the closed-ended special AIF is already a shareholder (shareholder loans) according to section 285 para. 3 KAGB n.F. The restrictions mentioned above on loan origination by closed-ended special AIFs are not applicable with regard to such shareholder loans, except where the AIF’s management company decides to apply section 285 para. 2 KAGB n.F. and does not wish to rely on the shareholder loan rules. Shareholder loans are permitted up to an amount of 50 per cent of the Investable Capital where one of the following requirements is fulfilled:

• the borrower is a subsidiary of the closed-ended special AIF pursuant to section 290 of the German Commercial Code (Handelsgesetzbuch); or
• the shareholder loan is a subordinated loan, the principal amount of which shall only be repaid to the extent the borrower has sufficient freely available assets; or
• the shareholder loan amount is below twice the acquisition costs of the equity stake held in the portfolio company by the AIF.

In case the use of leverage by the closed-ended special AIF is below 30 per cent of the Investable Capital, the granting of subordinated shareholder loans are permitted in an amount that exceeds the aforementioned 50 per cent of the Investable Capital.

Open-ended special AIFs

Open-ended special AIFs need to be in a position to liquidate their assets within a short time-frame. Consequently, the new regime does not allow loan origination by open-ended special AIFs (not even short-term loans). However, openended special AIFs may originate shareholder loans under the conditions for shareholder loans set out above in relation to closed-ended special AIFs. In addition, the restructuring of acquired loans receivable (if allowed) will not be considered as origination of a loan (see below).

Closed-ended retail AIFs

The German legislator holds the view that retail investors are hardly in a position to adequately assess the risks connected with loan origination. Therefore, closed-ended retail AIFs may only originate shareholder loans subject to meeting substantial additional requirements. Again, the restructuring of loans receivable will not be considered as origination of a loan (see below).

Open-ended retail AIFs

There will be no changes for open-ended retail AIFs. In particular, the possibility for open-ended retail real estate AIFs to grant shareholder loans to subsidiaries holding real estate assets according to section 240 KAGB remains unaffected. Similar to the above, the restructuring of loans receivable (if the acquisition is allowed) will not be considered as origination of a loan (see below). Loan restructuring

The restructuring and prolongation of loans by some AIFs will no longer be considered as loan origination for banking law purposes, i.e. licence requirements under the German Banking Act, and will consequently be allowed for all AIFs (which can acquire loans subject to existing product rules set out in the KAGB) without a banking licence. According to the wording of the new rules, the thresholds mentioned in relation to the origination of loans by AIFs do not apply to loans acquired (and subsequently restructured as the case may be) by AIFs. We hope that this is not a mistake but rather an intentional decision by the legislator.

Organisational requirements

New obligations for AIFMs managing loan originating funds

All German AIFM managing AIFs that originate and/or acquire loans (including shareholder loans and unsecuritised loans) will become subject to the procedures for large exposure credits (Millionenkreditverfahren) and thus will have to fulfil certain notification requirements.

Fully authorised AIFM

A fully authorised AIFM managing an AIF that originates and/or acquires (and restructures) loans (which are not shareholder loans) has to comply with specific risk management requirements pursuant to section 29 para. 5a KAGB n.F. These requirements will be similar to the internal procedures implemented by banks and are likely to reflect the risk management principles applicable to the credit business of banks as set out in BaFin circular 10/2012 (BA) – Minimum requirements for risk management (MaRisk) – at least for loan originating AIFs. It is expected that BaFin will specify the risk management requirements by issuing a respective guidance note. In practice, this will be challenging for some German AIFMs which cannot, or are not willing to, outsource substantial parts of the loan origination and risk assessments procedures.

Sub-threshold AIFM

Only in the case that a sub-threshold AIFM manages an AIF that originates loans (restructuring and acquisition are excluded), the sub-threshold AIFM becomes subject to certain risk management requirements that are only applicable to fully authorised AIFMs in general (section 2 paragraph 4 and 5 KAGB n.F.).

EU-AIFs/AIFMs

Under the new regime, the German legislator has not provided that EU-AIFs/AIFMs must comply with the same risk and process requirements as German AIFs/AIFMs. For EU-AIFs/AIFMs, the loan origination is deemed to be a part of the collective portfolio management which is now generally excluded from triggering banking licence requirements under the German Banking Act and will consequently be allowed to the extent that it falls within the scope of collective portfolio management under the relevant legislative regime of the home member state of the respective EU-AIF/AIFM.

Third country AIFs/AIFMs

Furthermore, third country AIFs/AIFMs will be allowed to originate loans to German borrowers after passing an AIFdistribution notification granted by BaFin for their managed third country AIFs (Vertriebsanzeigeverfahren). Please note that BaFin will only grant such distribution if the third country AIF/AIFM complies with the minimum requirements of the AIFMD.

_{This article is part of our latest edition of Credit Funds INSIGHT. To download a PDF of the full publication, please click here.}