New legal regime for loan origination and loan restructuring by Alternative Investment Funds in Germany in force

To refresh readers' memories, historically, loan origination by German investment funds was only possible to a limited extent. Solely real estate funds were allowed to grant loans to the fund's real estate vehicles under certain conditions. Some other alternative investment funds (AIFs) were allowed to acquire granted loans/loan receivables but were always restricted when it came to the restructuring or extension of such loans.

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 interpretation by ESMA and some other EU member states, that loan origination forms part of collective investment management; this interpretation was based in particular on the rules applying to EuVECA and ELTIF which are allowed to originate loans. The German legislator followed BaFin's more flexible view and adopted BaFin's changes into the German UCITS V implementation act. We have monitored this development in our Client Briefing of May 2015, in the Q3 2015 Regulatory Radar and the December 2015 issue of Credit Funds Insight magazine.

As of 18 March 2016, some AIFs are allowed to originate loans and others have at least more flexibility with regard to the restructuring of loan receivables and may grant loans to subsidiaries of the AIF.

German AIFs

1. Loan origination

The implementation act for UCITS V 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 paragraph 9 KAGB n.F. determines exhaustively the cases in which AIFs are permitted to originate loans as part of their collective investment management (and thus without a banking licence).

• Closed-ended special AIFs

The new regime allows (general) closed-ended special AIFs to originate loans. The new regime nevertheless imposes the following restrictions on loan origination by such AIFs by virtue of section 285 paragraphs 2 and 3 KAGB n.F.:

• Borrowing by the closed-ended special AIF is limited to 30 per cent of the net capital of the AIF that is available for investments pursuant to section 285 paragraph 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. All direct or indirect fees, costs and expenses which are borne by the investors have to be deducted from this sum. As an effect of this 30 per cent limitation, the aggregate loan amounts that can be granted by a closed-ended special AIF are limited as well. The following example may illustrate this limitation: a closed-ended special AIF has Investable Capital of 1,000. The AIF itself may borrow up to 30 per cent, i.e. 300. Therefore, the closed-ended special AIF can grant a total amount in loans of up to 1,300.
• 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. Applied to the example above, this means that a total of 200 can be granted to every single borrower in the example, i.e. there can be (e.g.) six loans of 200 and one of 100 (amounting to the 1,300 if the full leverage amount is used).
• 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 paragraph 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 paragraph 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 German Commercial Code (Handelsgesetzbuch, HGB); or
• the shareholder loan is a subordinated loan which principal amount 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 even 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. However, open-ended 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 loan receivables will not be considered as origination of a loan, cf. 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 loan receivables will not be considered as origination of a loan, cf. 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 loan receivables (if the acquisition is allowed) will not be considered as origination of a loan, cf. below.

2. Loan restructuring

With effect from 18 March 2016, the restructuring and prolongation of loans by some AIFs will no longer be considered as loan origination for banking law purposes (implementing the BaFin's latest administrative practice into the KAGB), 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 (cf. above) do not apply to loans acquired (and subsequently restructured as the case may be) by AIFs. We hope that this is not only a mistake but rather an intentional decision by the legislator.

GERMAN AIFMs

• 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 (Millionen-kreditverfahren) 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 paragraph 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 requirement 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.

• Sub-threshold AIFM

Only in the case 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 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 under German law, the 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 AIF-distribution 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.

UCITS

For UCITS (undertakings for the collective investment in transferable securities) loan originating and restructuring is not permissible (section 20 paragraph 8 KAGB n.F.). This is in line with directive 2014/91/EU.

Summary

The table below sets out the German types of funds that are permitted to originate loans and/or acquire granted loans as part of their collective investment management (and thus without a banking licence) according to the new German regulatory regime regarding loan funds applicable as of 18 March 2016.