Executive summary Pursuant to recent legislative changes, certain investment funds are now entitled under certain conditions to originate or restructure loans in Germany without the need to obtain a banking licence for lending. Due to the legislative changes, it is now easier to originate or restructure third party loans for certain types of German alternative investment funds (AIFs), and various types of German funds now have broad possibilities to grant shareholder loans or to acquire loans. For EU AIFs, it is now generally easier to originate or restructure loans in Germany. Even foreign (i.e. non-EU) funds may now grant or restructure loans in Germany, but subject to much stricter requirements than those for EU AIFs. This Reed Smith alert sets out an overview of the changes and the updated situation.
Background From a regulatory perspective, the German legal situation and administrative practice regarding the origination of loans, as well as prolongations and restructurings of loans for the account of investment funds, has been subject to various developments and changes during the last twelve months.
In the past, the granting of loans to German borrowers or the restructuring of loans with German borrowers by investment funds (irrespective of whether those were located in Germany or not) generally required a lending licence under the German Banking Act (KWG). There were certain ways used in practice to circumvent this restriction, such as the subscription for bearer bonds (instead of granting a loan), the use of the so-called passive service freedom (passive Dienstleistungsfreiheit) in cross-border cases, or the use of a fronting bank which subsequently sold the loan to the respective investment fund. However, none of those solutions is legally completely safe, thus leaving the risk that the granting of loans qualifies as a prohibited activity by investment funds.
On 12 May 2015, the German Financial Supervisory Authority (BaFin) issued a circular changing its administrative practice (BaFin Circular). Pursuant to the BaFin Circular, certain types of AIFs were permitted to grant, prolong and restructure loans without the need for a German banking licence. Most recently, the German Act on the implementation of the so-called UCITS V Directive (2014/91/EU) (the Act) became effective on 18 March 2016. The Act implements and further sets out the new rules for investment funds for loan originations and prolongations and restructurings of loans, including shareholder loans, in Germany, basically affecting the KWG and the German Capital Investment Code (KAGB).
Although the Act in its name refers to the undertakings for collective investment in transferable securities (UCITS), the actual essence of the Act is to provide for, amend and concretise regulatory provisions for the origination and restructuring of loans by AIFs next to the framework provided for in the directly applicable EU Regulations (as the EuVECA Regulation, the EuSEF Regulation and the ELTIF Regulation). Loan originations or restructurings for the account of UCITS (OGAW) continue to be prohibited.
The Act primarily focuses on the entitlements of German AIFs relating to loan originations and restructurings, but also amends the framework for non-German AIFs, as summarised below.
New framework for German AIFs The following provisions and conditions apply to German (domestic/inländische) AIFs, i.e. AIFs that are subject to German law.
(a) Originations of loans Under the new Act, in principle only German closed-ended special AIFs may originate loans under certain conditions, without the need to obtain a separate banking licence. Other types of German AIFs are generally not allowed to originate loans (save for shareholder loans, see below (c)). In more detail:
German closed-ended special AIFs: The AIF Manager (AIFM) (which in Germany is often separate from the actual fund) may grant loans to German entities and persons for the account of German closed-ended special AIFs without the need to for a German lending licence if all of the following statutory requirements are met:
- The maximum amount for leverage is 30 per cent of the equity available for investments
- No loans are granted to consumers
- One individual borrower may only be granted with a loan of a maximum amount of 20 per cent of the equity available for investments (the purpose of this stipulation is to decrease the credit risk by diversification)
- Certain risk management requirements shall be met by the AIFM (section 29 (5a) KAGB as amended by the Act)
German open-ended special AIFs: Contrary to the BaFin Circular under the Act, German open-ended special AIFs may not grant loans to third party borrowers located in Germany.
German closed-ended public AIFs: Also German closed-ended public AIFs are not permitted to grant or offer loans to third party borrowers.
German open-ended public AIFs: Open-ended German public AIFs are generally not permitted to originate loans. Only in certain very specific cases, loans may be granted to real estate companies for the account of a real estate investment fund (section 240 KAGB). This exemption already applied before the Act became effective and remained unaffected by the Act.
In sum, the setup of German closed-ended special AIFs could be an eligible vehicle to establish a German debt fund that may operate within the above mentioned limits and restrictions.
(b) Acquisition of loans as well the administration/restructuring and prolongation of loans by German AIFs The acquisition of unsecuritised loan receivables was already permissible for certain types of German AIFs before the Act became effective. For example, an open-ended public AIF that is set up in form of an “Other Investment Fund” (Sonstiges Sondervermögen) may invest in unsecuritised loan receivables of up to 30 per cent of the fund’s value. Also, German closed-ended and general open-ended special AIFs are allowed to invest in unsecuritised receivables on the secondary market as long as the loan’s market value can be determined. The same applies to open-ended special AIF with fixed investment rules if the investors provided their consent.
A prior issue was that any restructuring, e.g. prolongation, of such unsecuritised loans was considered to be banking business requiring a German banking licence. The Act now clarifies that an “amendment to the condition of the loan that occurs subsequently to the granting of the loan”, e.g. the administration/restructuring of a loan including the prolongation of a loan, by any German AIF is generally not considered as the granting of a loan. Thus no banking licence under the KWG is required. As a result, German AIFs already owning existing loans are no longer forced to sell a loan to allow for a restructuring, but may restructure such loan themselves to achieve a more favourable result for the investors.
(c) Shareholder loans Finally, the Act provides for further rules on the granting of loans to subsidiaries by German AIFs (shareholder loans). Such shareholder loans are now generally permitted to a broader extent than before, subject to certain conditions for the different types of German AIFs as set out below:
German closed-ended special AIFs: Beyond the above-mentioned requirements, a German closed-ended special AIF may grant loans without a banking licence to companies in which such special AIFs already holds shares (i.e. shareholder loans) in up to 50 per cent of the equity available for investments of the fund and if at least one of the following requirements are met:
- The borrower is a subsidiary of the fund
- The loan is subordinated
- The amount lent to a borrower does not exceed twice the acquisition costs of the borrower’s shareholding
If a maximum leverage of 30 per cent of its equity available for investments is available to the special AIF, the above-mentioned 50 per cent threshold amount for subordinated shareholder loans may also be exceeded. The risk management requirements set out in section 29 (5a) KAGB do not apply for such shareholder loans.
If a loan is granted to a subsidiary, the AIFM shall ensure that such subsidiary itself does only grant loans to entities it holds shares in and one of the requirements above is met by that entity.
German open-ended special AIFs: German open-ended special AIFs are also permitted to grant shareholder loans under the same conditions applicable to German closed-ended special AIFs.
German closed-ended public AIFs: German closed-ended public AIFs may only grant shareholder loans in up to 30 per cent of the equity available for investments of the fund and if at least one of the following requirements is met:
- The borrower is a subsidiary of the fund
- The loan is subordinated
- The amount borrowed does not exceed the acquisition costs of the shareholding
German open-ended public AIFs: No exemptions or special stipulations are set out for shareholder loans by German open-ended public AIFs (except for loans granted to real estate companies for the account of a real estate investment fund pursuant to section 240 KAGB).
In sum, German AIFs are now generally more flexible on granting shareholder loans. The above-mentioned entitlement to restructure such loans, without the need to obtain a banking licence, applies as well in this context.
New framework for non-German AIFs The Act now provides for new exemptions from that rule for non-domestic AIFs, i.e. EU AIFs and so-called foreign (i.e. non-EU and non-EEA) AIFs.
EU AIFs: For EU AIFs, the new legal situation makes it comparatively easy to originate and restructure loans in Germany.
Origination of loans: As a result of the amendments by the Act, the origination of loans by EU management companies without obtaining a lending licence from the BaFin is permitted insofar as they only conduct investment management activities (kollektive Vermögensverwaltung), section 2 (1) no. 3c KWG (as amended by the act); the same applies for EU investment funds, section 2 (1) no. 3d KWG. The restrictions for German AIFs described above do not apply in such cases, i.e. from a German law perspective, foreign investment funds are not subject to the additional requirements set out above and thus are better placed than German AIFs.
German law is still unclear whether a loan must be granted directly. There are good arguments for saying that the exemption also applies if such a fund grants loans not directly but via a subsidiary, at least if the subsidiary is controlled by the fund, the fund itself makes the relevant decision to grant the loan and the subsidiary forms part of the risk management procedures.
Acquisition of unsecuritised loans: The amended statutory provisions do not set out provisions regarding EU AIFs in this regard. Subject to the rules applicable to the fund in its jurisdiction, EU AIFs may therefore acquire unsecuritised loans without being restricted under German law, in particular since the mere acquisition of a loan is not considered to qualify as a granting of loan under German law.
Loan restructuring: The amendments by the Act do not clearly refer to the administration/ restructuring and prolongation of loans by EU AIFs. However, to the extent EU AIFs are permitted to grant loans without a BaFin licence, also the administration/restructuring and prolongation of loans – as comparable minor activity from a regulatory perspective – should be permitted without obtaining a BaFin license.
Shareholder loans: Although the Act is silent on shareholder loans granted by EU AIFs, the granting of shareholder loans should be treated equally to the granting of third party loans.
In sum, a debt fund that qualifies as an EU AIF could be set up to also originate loans in Germany. Depending on the rules in the relevant jurisdiction of the applicable fund, such a setup in a non-German jurisdiction may provide more flexibility than a setup of a debt fund in Germany.
Foreign AIFs (other than EU AIFs): The Act also refers to loan originations by foreign AIFs, but only as set out below:
Origination of loans: Pursuant to the amendments to the KWG provided by the Act, foreign management companies and foreign AIFs (other than EU management companies and AIFs) may also grant loans without a separate BaFin lending licence, but only if they only conduct investment management activities (kollektive Vermögensverwaltung) and if a distribution notification (Vertriebsanzeige) for the fund has been submitted to the BaFin. A distribution notification is required that meets the strict requirements for a distribution of the fund to professional and semiprofessional investors. In practice, it is difficult to meet the requirements for such distribution notification since – in simplified terms – the foreign management company and the management of the AIF must meet the requirements set out by the AIFM Directive (2011/61/EU).
Regarding the granting of shareholder loans, the acquisition of loans and loan restructuring, the same principles as set out above for EU-AIFs should apply.
In sum, a fund that is set up as a foreign (non EU) AIF could theoretically be set up as a debt fund, but in practice it will be difficult to make the required distribution notification to BaFin for the marketing of the fund in Germany.
The Act entered into force on 18 March 2016. Please note that loans granted before 17 March 2016 shall be grandfathered and will therefore not be affected by the amendments to the legal situation set out by the Act.
Client Alert 2016-091