On 12 May, 2015 the German Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht, “BaFin”) announced a milestone change to its established administrative practice in respect of investment funds and lending in Germany (Ref: WA 41-Wp 2100 – 2015/0001). This change is of major importance for German debt funds as well as for EU and third country investment funds seeking to originate, acquire or restructure German loans.
Loan origination transactions carried out by alternative investment funds with institutional investors (“Spezial-AIF”) now qualify as asset management activities that are generally permitted, subject to compliance with the German Capital Investment Act (“KAGB”). The same shall apply to loan restructurings and extensions of maturity (prolongations). Further, in consideration of anticipated restrictive changes to applicable German laws, BaFin issued specific recommendations for AIF managers with respect to their loan origination practices and associated risk management systems which need to be taken into account.
I. Traditional Administrative Practice
With few exceptions, loan origination for the account of investment funds in Germany has traditionally been regarded as inadmissible, largely because of its association with the shadow banking system and for reasons of investor protection. Loan origination activities were viewed in the past as being banking transactions requiring a German banking license under Section 32 para. 1 of the German Banking Act (Kreditwesengesetz, “KWG”).
II. Legal Framework
BaFin’s change of administrative practice is driven by recent statements of the European Securities and Markets Authority (“ESMA”) published in their Report No. 1, 2015 on Trends, Risks and Vulnerabilities in European Union (EU) securities markets, covering market developments from July to December 2014 where ESMA deemed fund investments in loans permissible.
The European AIFM-Directive is silent on loan origination and does not contain any material product rules. Although, it does not provide for an express permission, the AIFM-Directive does not contradict loan origination by AIF.
Other recent European regulations explicitly permit investments in loans granted for the account of certain European AIFs (EuVECA, EuSEF and ELTIF).
While some member states of the European Union already authorized national AIFs acting cross-border to engage in loan origination (in some cases subject to certain requirements to be met), German lending restrictions would impose material competitive disadvantages on German AIFs. Therefore BaFin aims to harmonize the loan originating AIF market and the rules applying thereto.
III. New Administrative Practice
BaFin holds that loan originations (including restructurings and prolongations) for the account of AIFs classify as collective asset management activities (kollektive Vermögensverwaltungstätigkeiten), which are not governed by the KWG according to Sections 2 para. 1 no. 3 (b) and para. 6 no. 5 (a) and therefore not subject to any banking license requirements. Consequently, the key provisions are now laid down in the KAGB which will supersede the KWG provisions previously applicable.
Based on these arguments, BaFin adopts the view that loan originations for the account of AIF, restructurings and prolongations are generally permissible for less restricted AIFs, namely open-ended Spezial-AIFs (Section 282 KAGB), closed-ended Spezial-AIFs (Section 285 KAGB), and investment funds managed by registered sub-threshold managers (Sections 2 para. 4, 4a and 4b KAGB).
IV. Non-German Debt Funds
BaFin remains silent on the applicability of their new practice to non-German AIFs. However, in light of the European ban on discrimination it is expected that foreign AIFs should also be allowed to originate loans to German undertakings provided such AIF are subject to similar supervision (i.e. comparable EU-AIF and third country investment funds subject to similar regulatory requirements).
According to BaFin, the German legislator is currently in the process of preparing a proposal for revised supervisory laws which reflect the new administrative practice with regard to loan originating AIFs. In anticipation of these new laws, BaFin issued certain recommendations and advises the AIF managers to already consider and adhere to them when designing new risk management systems and business models:
- Loans shall only be granted for the account of closed-ended Spezial-AIFs.
- Loans shall not be granted to consumers.
- Loans shall not be originated in a situation where there may be a conflict of interest (e.g. loans to custodians, managers).
- Use of leverage is regarded with a degree of suspicion and shall be very restricted.
- AIF managers shall not grant loans for the account of AIFs and borrow from the public for the account of AIFs simultaneously, as this may entail the qualification of the relevant AIF as taking deposits and entail further licensing requirements.
- AIF-investment management companies shall establish and implement a proper risk management system pursuant to Section 28 KAGB which provides that risks associated with relevant investment strategies can be identified, measured, monitored and controlled in accordance with Section 29 para. 2 KAGB. The “Minimum Requirements for Risk Management” established by BaFin for banks shall be taken into account, to extent these can be made operable.
- There shall be no maturity transformation, i.e. AIFs shall not take up short-term debt in order to finance long term lending.
- AIF-managers shall avoid concentration risks, e.g. by limiting exposures to individual borrowers.
- AIF managers shall ensure that a certain minimum liquidity reserve is maintained in order to be able to discharge due and payable loan obligations owed by the AIF.
The new administrative practice by BaFin is very much welcomed and addresses a need for legal certainty that has been raised by German and non-German debt funds for many years. It would have been even more helpful if BaFin had also explicitly pronounced its views on non-German debt funds, however we believe that BaFin’s statement provides a good basis for the lending activities of non-German debt funds in Germany.