“BaFin changes its administrative practice relating to loan funds
13 May 2015
On 12 May 2015, BaFin declared loan funds to be permissible. Thus, it is now possible to grant loans for the account of Alternative Investment Funds (“AIFs”) for which the German Investment Code (Kapitalanlagegesetzbuch – KAGB) specifies only a few or no product requirements at all.
In view of the European legal situation, as well as in consideration of current discussions at the European Securities and Markets Authority (ESMA), BaFin has changed its administrative practice to the effect that the granting of loans as well as loan restructuring and prolongation by AIFs are to be seen as part of collective investment management and are therefore permissible to the extent that they are consistent with the provisions of the KAGB.
BaFin is recommending that AIF management companies already comply with certain minimum requirements for the granting of loans, the acquisition and restructuring/prolongation of unsecuritised loan receivables, as well as for the granting of shareholder loans for the account of the AIF until the corresponding legal provisions come into effect. BaFin has informed investment industry associations of these recommendations in a letter dated 12 May 2015”
This is an announcement of the German regulator BaFin published on its website. The letter of BaFin dated May 12, 2015 that is referred to therein is only available in German (the “BaFin Letter”).
Does the BaFin Letter mean that funds could now lend directly to German borrowers (“Loan Origination”) and/or restructure or prolong loans held by them (altogether “Lending Activities”) and no longer require a German banking licence for that purpose? – The answer to this question depends on the set-up of the entity that actually conducts the Lending Activity (the “Lender”). Based on the BaFin Letter and except for certain smaller funds structures – the relevant scenarios and the answer to the question can be categorised as follows for Special AIFs:
German Special AIF Set Up: According to the BaFin Letter, in such category, Lending Activities of a Lender do not require a German banking licence. This category is addressed in the BaFin Letter explicitly. To fall into this category, a Lender would need to meet the following requirements:
- the Lender qualifies as a “Special AIF”, i.e. an AIF where Lending Activities are not prohibited from forming part of the collective portfolio management and the investors in which are limited to professional and semi-professional investors; and
- the Lender is domiciled in Germany (“German AIF”), and the Lender is being managed by:
- an internal or external alternative investment fund manager (“AIFM”) that complies with the relevant provisions under the German Investment Code or the European AIFM Directive as implemented in the relevant European Economic Area (“EEA”) member state and that is admitted in Germany (“German AIFM”); or
- an AIFM that is being admitted in an EEA member state, other than Germany (“Non- German–EU-AIFM”); or
- the Lender is domiciled:
- outside Germany within the EEA (such AIF, a “Non- German-EU-AIF”); or
- outside the EEA (“Non-EU AIF”); and the Lender is being managed by a German AIFM.
Non German-EU Special AIF Set-Up: In this category, the Lending Activities of a Lender should not require a German banking licence although this category is not addressed in the BaFin Letter explicitly. However, this category falls into the scope of the European AIFM Directive that BaFin argues to be the basis for the change of its administrative practice and should benefit from a statutory exemption from the banking licence requirement that is based on arguments similar to those used in the BaFin Letter. To fall into this category, a Lender would need to meet the following requirements:
- the Lender qualifies as a Special AIF; and
- the Lender is a Non-German-EU-AIF or a Non-EU AIF; and
- the Lender is being managed by a Non-German-EU-AIFM and that complies with the relevant provisions under the European AIFM Directive as implemented in the relevant EEA member state.
Non-EU Special AIF Set-Up: This category falls outside the immediate relevant scope of the BaFin Letter and the European AIFM Directive. To fall into this category, a Lender would not fall into the categories above, i.e. neither qualify as a German Special AIF Set Up nor as a Non German-EU Special Set Up, which particularly is the case where:
- the Lender qualifies as a Special AIF, and
- the Lender is a Non-EU-AIF, and
- the Lender is being managed by an AIFM that is neither admitted as an AIFM in Germany nor in any other EEA member state (“Non-EU-AIFM”).
A Non-EU Special AIF lending structure should be reviewed in more detail as to whether or not it may benefit from the BaFin Letter. The chances of such a structure benefitting from the BaFin Letter increase with the degree of compliance of the AIFM with the conditions under the European AIFM-Directive for the granting of an AIFM licence.
Qualification as Special AIF is Key: Subject to certain exceptions, Lenders that do not qualify as a Special AIF do not directly benefit from the BaFin Letter. To the extent they are governed by the German Investment Code or fall under the European AIFM Directive, depending on the scope of their authorised activities, they may even be prohibited from conducting Lending Activities. Further, in practice, lending by funds may be made through special purpose vehicles or other affiliates of such funds (LendingCos), rather than by the fund itself. To benefit from the BaFin Letter, such a LendingCo must qualify as a Special AIF, which – in practice – is usually not the case. In such scenarios, the lending structure should be reviewed in more detail and structured so that it may benefit from the BaFin Letter, if it involves an entity other than the actual Lender that qualifies as Special AIF.
Acquisition of Loans (“Loan Trades”): The acquisition of loans did not require a banking licence (even on the basis of the past administrative practice of BaFin) and does not qualify as a Lending Activity as that term is used in this post. However, loan trades by AIFs that are governed by the German Investment Code/European AIFM Directive are subject to regulatory review in terms of whether or not the acquisition of loans is subject to product limitations that apply to the fund. Loan Trades by Special AIFs (and certain other type of funds) are not subject to product limitation. All those AIFs which are not prohibited from acquiring loans (including Special AIFs) are authorised to restructure and prolong such loans held by them and, for the purpose of such activity, do not require a banking licence.
The Key Contents of the BaFin Letter
The bottom line of the BaFin Letter on the change of its administrative practice in respect of Lending Related Business is as follows:
No banking licence requirement for Special AIF: In its administrative practice in respect of Lending Activities and Loan Trades by AIFs, BaFin no longer applies the German Banking Act (and the corresponding BaFin circular on lending business), but, rather, the German Investment Code (Kapitalanlagegesetzbuch KAGB) when reviewing such activities of AIFs. The German Investment Code implements into German law, amongst others, the European AIFM Directive. Under the German Investment Code, Lending Activities (i.e. the granting of loans (Loan Origination) and a restructuring and/or prolongation of loans) and Loan Trades (i.e. the acquisition of loans) is admissible for AIFs that are not prohibited from conducting such activities, i.e. where the German Investment Code does not provide for specific product limitations. Thus, BaFin now takes the view (and changes its administrative practice accordingly) that such admitted AIFs, particularly Special AIFs, may conduct Lending Activities in Germany (without requiring a banking licence according to the German Banking Act) and Loan Trades, because such activities are covered by the authorisation of the AIFM to conduct collective portfolio management.
However, even for Special AIFs, this statement of BaFin is subject to BaFin’s recommendations for limitations on Loan Origination and Loan Trades as described below.
Special AIFs for that purpose are AIFs, where Lending Activities are not prohibited from forming part of the collective portfolio management and the investor base of which is limited to professional and semi-professional investors. Special AIFs include the following fund categories (as such terms are used in the German Investment Code):
- open-ended Special AIFs, including Hedge Funds (i.e. open-end Special AIFs that either use substantial leverage (three times its net asset value) or short sale (Leerverkauf) techniques); an AIF qualifies as “open ended” if its units are, at the request of any of its unitholders, repurchased or redeemed prior to the commencement of its liquidation phase or wind-down, directly or indirectly, out of the assets of the AIF and in accordance with the procedures and frequency set out in its rules or instruments of incorporation, prospectus or offering documents; and
- closed-ended Special AIFs: an AIF qualifies as “closed-ended” if it does NOT qualify as open-ended (see definition above).
Limitations on Loan Origination: Due to pending legislation and regulatory discussions at both European and German level, BaFin recommends that Special AIFs comply with the following limitations when granting a loan (however, for Loan Trades, see below):
- only closed-ended Special AIFs should grant loans (Loan Origination);
- no loans to consumers;
- avoid conflicts of interest;
- limitation of leverage in general (begrenzte Fremdfinanzierung) and no taking of deposits from the public (kein Einlagengeschäft) as otherwise Special AIFs would qualify as a CRR institute under the European Capital Requirements Regulations (CRR) in which case European banking law would apply as well;
- apply adequate risk management system in compliance with the BaFin Circular 10/2012 (BA) – “Minimal Requirement for Risk Management – MaRisk”;
- avoid maturity transformation (Fristentransformation);
- diversify risks, i.e. limit the exposure as per borrower; and
- ensure a minimum of liquid assets.
Limitations on Loan Trades: Further, in respect of acquiring non-securitised (unverbriefte) loan claims, BaFin recommends compliance with the following limitations:
- open-ended Special AIFs:
- for all open-ended Special AIFs: apply a risk and liquidity management that is adequate in comparison to the acquisition of loan activities;
- for open-ended Special AIFs (with firm investment terms), including hedge funds: the acquisition of uncertified loans should not exceed 50% of the overall value of such funds (loan/investment ratio);
- closed-ended Special AIFs: same as in item (i) (a) above (but: no loan/investment ratio).
BaFin Supervision or EU Passport of the Fund Manager: The BaFin Letter explicitly assumes that the Special AIF is set up and is acting in accordance with the German Investment Code (or implicitly that the Special AIF at the least is governed by the European AIFM Directive), and is managed (verwaltet) by an internal or external alternative investment fund manager (the “AIFM”) that is either:
- registered (registriert) with or has been granted a licence (Erlaubnis) by BaFin to manage an AIF; or
- can make use of a Management Passport in Germany.
An entity qualifies as AIFM if it conducts the portfolio management or the risk management for one or more investment funds. The term “portfolio management” includes the right to take final and binding investment decisions. Accordingly, entities that limit their activity to advise investors or funds on specific products and/or recommend the investment in such a product do not qualify as AIFMs for purposes of the BaFin Letter.
No explicit coverage of the Non-EU Category: The BaFin Letter is silent on scenarios where both the AIF and the AIFM are located outside the EEA (i.e. qualify as Non-EU AIFs or Non-EU AIFMs respectively). However, the German Banking Act provides for an explicit exemption from the banking licence requirement for Non-EU AIFMs that comply with the requirements of the European AIFM-Directive for AIFMs. While a number of details are unclear, a relatively robust base for a Non-EU AIFM to benefit from the BaFin Letter should exist where such Non-EU AIFM meets the conditions reflected in the European AIFM Directive that an AIFM needs to fulfill to qualify for a licence.
Such conditions particularly include that an AIFM must:
- be established as a legal person whose regular business is managing one or more AIFs;
- have sufficient initial capital and a certain minimum of own funds;
- have managers of sufficiently good reputation and with sufficient experience also in relation to the investment strategies pursued by the AIF;
- have robust governance on an ongoing basis – this particularly includes adopting independent valuations of AIFs assets, an appropriate management of risks, liquidity, due diligence and conflicts of interest;
- have specific remuneration policies and practices setting limits on pay and bonuses; and
- ensure a functional separation of risk and valuation operations from portfolio management.
Given the above, a Non-EU Special AIF lending structure should be reviewed in more detail as to whether or not it may benefit from the BaFin Letter in light of that background. It is fair to say that the chances of such a structure benefitting from the BaFin Letter increase with the degree of compliance of the AIFM with the conditions under the European AIFM-Directive for the granting of an AIFM licence.
“German Investment Code” means the Capital Investment Code (Kapitalanlagegesetzbuch – KAGB) of 4 July 2013 (published in: Federal Law Gazette 2013 I, p. 1981), as last amended by Article 3 of the Act of 10 December 2014 (published in: German Federal Law Gazette 2014 I, p. 2085)
“European AIFM Directive” means the combination of the Directive 2011/61/EU of the European Parliament and of the Council of 8 June 2011 on Alternative Investment Fund Managers and amending Directives 2003/41/EC and 2009/65/EC and Regulations (EC) No 1060/2009 and (EU) No 1095/2010 (published in: OJ L 174, 1.7.2011, p. 1-73) and the following regulations that were established on that basis: (i) Commission Delegated Regulation (EU) No 694/2014 of 17 December 2013 supplementing Directive 2011/61/EU of the European Parliament and of the Council with regard to regulatory technical standards determining types of alternative investment fund managers (published in: OJ L 183, 24.6.2014, p. 18-20) and (ii) Commission Delegated Regulation (EU) No 231/2013 of 19 December 2012 supplementing Directive 2011/61/EU of the European Parliament and of the Council with regard to exemptions, general operating conditions, depositaries, leverage, transparency and supervision (published in: OJ L 83, 22.3.2013, p. 1-95)