New BaFin Administrative Practice on Debt Funds
Origination and Restructuring of Loans by Investment Funds Allowed
On 12 May 2015 the German Federal Financial Services Supervisory Authority ("BaFin" announced a change in its administrative practice regarding the granting of loans by German investment funds. The new administrative practice significantly increases the business opportunities for debt funds in Germany. While not expressly addressed in the BaFin announcement it should also have implications for nonGerman funds intending to originate loans from borrowers in Germany.
The changes introduced in the BaFin announcement have immediate effect. However, the announcement indicates that further legislative changes will follow.
BaFin’s Administrative Practice on Debt Funds
Under the German Banking Act ("KWG"), the extension of loans is a banking activity which requires a license as credit institution if performed on a commercial basis (gewerbsmäßig) or in a manner which requires a commercial business organization (in kaufmännischer Weise eingerichteter Geschäftsbetrieb). This license requirement also applies to foreign lenders actively targeting the German market by offering loans to potential borrowers domiciled in Germany. Only limited exemptions from the licensing requirement apply for certain market participants (e.g. insurance companies granting loans as part of their business activity). According to BaFin’s previous administrative practice, German investment funds were generally not allowed to grant loans. There were only limited exceptions to this general rule, namely for shareholder loans to real estate companies held by real estate funds.
For some years, certain types of German investment funds have been allowed to acquire loan receivables but not to originate loans themselves. However, under a BaFin circular describing in more detail the scope of the licensing requirement for lending business (“BaFin Lending Circular”), not only the origination of loans but also certain restructuring measures relating to existing loans qualify as banking business (e.g. extension of maturity; adjustment of interest rates). This implies that implementing such restructuring measures can also trigger the licensing requirements.
BaFin’s New Administrative Practice on Debt Funds
BaFin now takes the view that the granting of loans by German alternative investment funds (“AIF”) forms part of the activity of collective portfolio management and is permissible if compatible with investment regulatory product restrictions, i.e. statutory investment restrictions. The investment regulatory provisions on collective portfolio management services are now regarded as overriding the banking regulatory licensing requirement for lending business (lex specialis).
According to BaFin’s new administrative practice, loans may not only be granted but existing loans may in future also be restructured even if the restructuring measures would normally require a banking license.
The new administrative practice only relates to AIF. With respect to UCITS, the general prohibition to grant loans remains unaffected.
It should be noted that the acceptance of repayable monies by a borrower domiciled in Germany may qualify as deposit-taking business by the borrower. This does not apply if such monies are granted by credit institutions and certain institutional investors. Even though not addressed in the BaFin announcement, it appears plausible that to the extent AIF are allowed to grant loans in Germany, the acceptance of such loans by borrowers domiciled in Germany will not qualify as deposit-taking.
Limitations in BaFin’s New Administrative Practice
The BaFin announcement contains various “recommendations” regarding the origination and the acquisition of loans for German AIFs.
While the recommendations are not binding rules, the circular suggests that the recommendations may preempt future legislative amendments so that German asset management companies not observing these rules may find themselves obliged to adjust their business model once relevant amendments to the statutory provisions are implemented. It cannot be excluded that future legislation in this field also includes requirements currently not reflected in the BaFin announcement.
The BaFin circular includes the following recommendations for the origination of loans:
- Only closed-ended debt funds: loans should only be originated by closed-ended funds limited to professional and semi-professional investors.
- Borrower restrictions: loans should not be extended to consumers. Furthermore, lending should be avoided where it creates conflicts of interests (e.g. loans to the depositary or the AIFM)
- Leverage: loan originating funds should not use leverage or should limit leverage to a "very limited level" which is not further specified in the announcement.
- Risk Management: lending procedures should comply with BaFin’s “Minimum Requirements for Risk Management” (“MaRisk”) for credit institutions.
- Avoiding maturity mismatch: long term loans should not be refinanced by short term borrowings (avoidance of maturity transformation).
- Risk diversification: concentration risks should be avoided, e.g. by limiting the exposure per borrower.
- Liquidity: a minimum liquidity should be maintained by investing in liquid assets to ensure that the AIF can meet its lending obligations.
Implications for Foreign Debt Funds
As mentioned above, the general licensing requirement for lending business also applies to foreign lenders actively targeting the German market by offering loans to potential borrowers domiciled in Germany. Therefore, foreign lenders which are not EU/EEA authorized credit institutions passported for lending business into Germany - including debt funds - have so far largely been limited to extending loans to German borrowers on a reverse solicitation basis under the “passive freedom of services” regime.
The recent BaFin announcement focuses on the origination of loans by German AIFs and does not specify the implications for foreign debt funds. Nevertheless, BaFin’s new administrative practice should also have an impact for foreign debt funds. In our view, EU-AIF should be treated equally with German AIFs.
They should consequently be permitted to originate and to restructure loans in Germany without a banking license. It is, however, unclear whether they would have to comply also with the BaFin recommendations as these recommendations are not formulated in any binding way.
With respect to non-EU/EEA AIF, it is less clear whether and to what extent they too can benefit from BaFin’s new administrative practice. The legal rationale supporting the new adminstrative practice is not limited to German or EU AIFs. However, it appears questionable whether BaFin in fact intended to implement such far-reaching changes in its administrative practice. Given that engaging in banking activities without the requisite license constitutes a criminal offense under German law, any new business activities in the light of the BaFin announcement will require careful legal analysis.