With effect of March 18, 2016 the legislator has now implemented into law the new administrative practice of the German Federal Financial Supervisory Authority ("BaFin") pursuant to which originating loans by specific funds is permitted under the German Capital Investment Act ("KAGB") and not subject to license requirements under the German Banking Act ("KWG"). Already in May 2015, BaFin published a new administrative practice and announced corresponding legislative changes (cf. our client information dated May 12, 2015). The legislative changes are implemented by the Implementation Act for UCITS-V (Act Implementing Directive 2014/91/EU of the European Parliament and the Council dated July 23, 2014) (the "UCITS-V-Implementation Act"). The UCITS-V-Implementation Act was adopted on January 28, 2016.
These changes represent an important development in Germany where until May 2015 loan origination was not permitted for German funds and subject to license requirements under the KWG. Therefore, loan originating funds based and / or investing in Germany were faced with substantial legal uncertainty.
While it is generally a positive development that such legal uncertainty around the investment activities of debt funds is finally abolished, the new regime does not come without a price: it will imply additional requirements to be met by authorized but also only registered sub-threshold managers if and to the extent they invest also in debt instruments. Moreover, the new rules will also have an impact on private equity managers / funds many of which grant shareholder loans: even if shareholder loans are generally exempt from most of the requirements to which loan origination is subject, the legislator has introduced some new restrictions and requirements to be met in that regard.
We have summarized hereafter the new regulatory regime regarding debt investments by funds as well as some other (unrelated) interesting amendments to the KAGB which are of relevance in practice.
- The origination of loans by German
closed-ended Special-AIF (funds which are only admissible for
professional and so called semi-professional investors) is
permitted subject to meeting the following requirements:
- The Special-AIF is managed by a German management company ("AIFM") which is either fully authorized or registered as a sub-threshold AIFM.
- The use of leverage by the Special-AIF is only permitted in a moderate amount.
- Loans may not be granted to consumers.
- The AIFM is subject to certain risk management requirements which are similar to the rules applicable to banks.
- Sub-threshold AIFMs which managed funds investing only or also in debt or originating loans (including mezzanine) will be faced with additional requirements to be met. While they have been exempt under the regime so far from most of the requirements under the KAGB, they will now have to comply with risk management, liquidity management and conflicts of interest policies which normally apply only to fully authorized AIFMs (subject to certain exemptions for shareholder loans).
- Shareholder loans may be granted notwithstanding the foregoing requirements, however subject to certain restrictions.
- Restructuring and extension of unsecuritized loans will no longer be considered as loan origination for investment law purposes and hence are now permitted for all AIFs (with respect to retail AIFs subject to the existing product rules of the KAGB).
- Non-German EU AIFs (and their AIFMs) originating loans to borrowers in Germany also benefit from the new rules. Third-country AIFs (and their AIFMs), however, will benefit from the new rules only if they are admitted for marketing to semi-professional investors in Germany. Such marketing approval requires that they agree to comply with all requirements under the AIFM-Directive.
- Besides the above listed amendments for loan originating AIFs the legislator has also implemented some interesting changes including in particular the implementation of transition rules in case of the introduction of a passport for third-country fund managers / AIFs; however, leaving in practice important questions open.
II. THE AMENDMENTS FOR LOAN ORIGINATING FUNDS IN DETAIL
Further to the new administrative practice of BaFin of May 2015 the legislator has now implemented into law that the origination of loans forms part of the collective investment management and hence is governed conclusively in the KAGB (section 20 para. 9 KAGB n.F.). Hence, the question of license requirements under the German Banking Act is no longer relevant to the extent the KAGB prevails. However, not all types of AIFs benefit from such new rules. The following applies in particular:
1. Which AIFs may originate loans?
a) Loan origination by closed-ended Special-AIFs
Closed-ended Special-AIFs may originate loans. "Special-AIFs" are AIFs in which only professional and semi-professional investors can invest and which do not grant any redemption rights prior to the end of their term. "Semi-professional" investors are individual investors which are sophisticated and experienced and invest at least 200,000 € in such AIFs.
The origination of loans by closed-ended Special-AIFs is subject to the following restrictions (section 285 para. 2 KAGB n.F.):
- The AIF may itself only borrow up to an amount of 30% of the "Invested Capital" (as defined hereafter). "Invested Capital" shall be defined as (A) the sum of (i) the aggregate contributed capital and (ii) the aggregate undrawn committed capital minus (B) the sum of all direct or indirect fees, costs and expenses which are born by the investors.
- Consumer credits are excluded.
- Loans granted to any one borrower shall never exceed 20% of the "Invested Capital" (see above).
Under the wording of the law the above thresholds only apply to loans "originated" by the AIF and not to loans acquired (and restructured) by the AIF. It is unclear whether that was indeed the intention of the legislator or an oversight.
Another exception applies to shareholder loans (section 285 para. 3 KAGB n.F.). Notwithstanding the above requirements, they are permitted up to an amount of 50% of the Invested Capital if one of the following conditions is fulfilled:
- the borrower is a subsidiary of the AIF or
- the loan is a sub-ordinated loan and its principal amount shall only be repaid if and to the extent the borrower has sufficient freely available annual surplus and net asset surplus otherwise freely available assets exceeding the liabilities or
- the amount of the loan does not exceed twice the acquisition costs of the equity stake held in the portfolio company by the AIF.
In case a shareholder's sub-ordinated loan is granted and the AIF itself does not borrow in excess of 30% of the Invested Capital the limitation of 50% of the Invested Capital (see above) does not apply (section 285 para. 3 sentence 2 KAGB n.F.).
When originating a loan to subsidiaries (including special purpose vehicles), the AIF must ensure that the subsidiaries, which originate loans themselves, also comply with the above requirements when originating a loan (section 285 para. 3 sentence 3 KAGB n.F.).
These changes relating to shareholder loans may impact on private equity and other fund managers which make generally equity investments but also use shareholder loans. They will be faced with such additional challenges and restrictions by the new regime.
b) Closed-ended Retail-AIFs
Closed-ended retail-AIFs can only originate shareholder loans, and even that only subject to meeting substantial additional requirements.
c) Open-ended AIFs
Open-ended Special-AIFs may only originate shareholder loans under the conditions for shareholder loans set out under a) above (sections 282 para. 2 sentence 3, 284 para. 5 KAGB n.F.). However, they can acquire (and restructure) loans.
Most open-ended Retail-AIFs cannot originate or buy loans under the product rules in the KAGB (including shareholder loans, with the only exception of real estate AIFs which may grant such shareholder loans under certain limited circumstances).
2. Regime applicable to AIFM managing loan originating funds
In addition to the restrictions to be met at the AIF level as set out above, the AIFM managing such AIFs must also meet certain requirements as described hereafter.
a) Requirements applicable to a fully authorized AIFM
In contrast to the rules for AIFs, the legislator has here explicitly stated that such rules apply not only in case the AIFM manages AIFs which originate loans but also to AIFs which acquire (and restructure) loans.
AIFMs which grant loans for the account1 and in the name of their AIFs, or which acquire loans and restructure or extend such loans, must meet certain minimum requirements with respect to risk management (section 29 para. 5a sentence 1 KAGB n.F.). BaFin will issue guidance and more details regarding risk management requirements; they will likely reflect risk management principles applicable to the credit business of banks (BaFin circular 10/2012 (BA) – Minimum requirement for risk management – MaRisk).
AIFMs which only grant shareholder loans or loans which were already permitted under the old rules (EuVECA / EuSEF, UBG, open-ended real estate funds) do not have to comply with the above requirements (section 29 para. 5a sentence 2 KAGB).
In all cases AIFM which originate and acquire loans (including shareholder loans) or acquire unsecuritized loans have to comply with procedure for "large exposure credits" in accordance with section 14 KWG (section 34 para. 6 KAGB n.F.). This means that substantial notification requirements must be complied with upon exceeding certain thresholds. The due date for the first notification is the 21 March 2017 covering the first quarter of 2017.
b) Loan origination by AIF managed by sub-threshold AIFMs
Sub-threshold AIFMs also have to comply with certain rules of conduct, conflicts of interest procedures, risk and liquidity management requirements, which are normally just applicable to fully authorized AIFMs if they originate loans on account of Special-AIFs. This is not the case if the loans are shareholder loans (section 2 para. 4, para. 5 KAGB n.F.). The procedure for "large exposure credits" also applies to these sub-threshold AIFMs.
Other than for fully authorized AIFM, the rules only apply to the origination of loans and not to the acquisition and restructuring of loans.
Registered AIFMs, which in accordance with commercial law are normally not required to prepare annual accounts for closed-ended Special-AIFs managed by them, nevertheless have to produce annual accounts and provide them to their investors in case they grant loans (excluding shareholder loans) (section 285 para. 2 KAGB n.F.). A publication of such reports in the electronic commercial register is not required (section 48a KAGB n.F.).
3. Transition rules / Grandfathering
AIFs / AIFMs which granted shareholder loans prior to March 18, 2016 are grandfathered; such loans are, however, taken into account for purposes of calculating the investment limits which apply as of March 18, 2016 with respect to shareholder loans (section 353b KAGB n.F.).
Closed-ended AIFs (in particular closed-ended retail AIFs), whose subscription period expired prior to July 22, 2013 may still grant shareholder loans after March 18, 2016, notwithstanding the newly introduced requirements, provided that such shareholder loans were already provided for in the partnership agreement or the fund rules of the AIF prior to March 18, 2016 (section 353 para. 4 KAGB n.F.).
4. Impact on non-German AIFs
a) EU-AIFs / AIFM
The investment management by EU AIFM and therefore the loan origination in Germany on account and in the name of EU AIFs is not subject to the banking regulation. The legislator has not provided that EU AIFM must comply with the same requirements comparable to which German AIFM are subject to. There is no limitation to certain categories of AIFs either.
b) Third-country AIFs / AIFM
Third-country AIFM may only rely on the exemption of section 2 para. 1 no. 3c and 3d KWG n.F., as amended. This means that they must be approved for marketing to semi-professional investors in Germany (meaning they fully comply voluntarily with the AIFM-Directive).
III. FURTHER INTERESTING AMENDMENTS TO THE KAGB
Further interesting amendments by the UCITS-V-Implementation Act are summarized as follows:
1. Expansion of the category of the semi-professional Investor
If an interest in a Special-AIF is acquired by act of law (e.g. as inheritance) by a natural person qualifying as retail investor, the AIF does not lose its status as Special-AIF. This retail investor shall be treated as semi-professional investor (section 1 para. 6 no. 2 KAGB n.F.).
Moreover a new category of semi-professional investor is introduced: institutions and foundations under public law as well as entities which have the Federal Republic or a Federal State of Germany as majority shareholder shall also qualify as semi-professional, provided that the Federal Republic or the Federal State invests or is already invested in the relevant Special-AIF when the institution, foundations or entity makes its investment.
2. Change of the reference value of the leverage calculation
Under the new rules of KAGB, the borrowing and exposure for a closed-ended German retail-AIF is limited to 150% of the Invested Capital (as defined above) pursuant to section 263 para. 2 and para. 4 KAGB n.F. Until now the KAGB provided for a limit of 60% of the market value of the closed-ended retail AIF's assets under management.
Below the line no actual quantitative change is introduced. The intention is rather to provide more legal certainty by using another reference value than the volatile market value of the assets under management.
3. Grandfathering for marketing notifications pursuant to sections 329 and 330 KAGB
The KAGB provides that the national private placement regime pursuant section 329 KAGB (marketing of third-country AIFs by EU AIFM) and section 330 KAGB (marketing of third-country AIFs by third-country AIFM) ceases to be in force as soon as the passport for third-country AIFM and third-country AIFs is introduced. Nevertheless, a marketing approval pursuant sections 329 and 330 KAGB remains effective when the AIFM was permitted to market third-country AIFs pursuant sections 329 or 330 KAGB at the moment the third-country passport is introduced (section 295 para. 2 sentence 2 KAGB n.F.).
However, the provisions of sections 329 and 330 KAGB may no longer be relied upon when the AIF is not just marketed in Germany but is also marketing in another EU or EEA member state is "envisaged". In this case the marketing provisions of the third-country passport shall apply (section 295 para. 2 sentence 4 KAGB n.F.). This rules does not seem to be making much sense given that most (if not all) EU Member States will keep the national private placement regimes in place even after the passport is introduced; at least in cases where the third country fund manager intends to market under such private placement regime in other Member States it does not seem required or reasonable to impose the passport regime in Germany simply because such manager intends to market also in other Member States.
It remains unclear how to treat a partial implementation of the third-country passport: the third-country passport is only introduced for some non-EEA states and not others, the question arises whether third-country AIFM for whom no passport regime is available may no longer market in Germany any more at all.
The general organization requirements of the AIFM will be amended by a whistleblower provision (section 28 para. 1 sentence 2 no. 9 KAGB n.F.). An AIFM needs to provide a process which allows employees (under full reserve to the confidentiality of their identity) to report to a suitable unit potential or actual violations of laws as well as criminal offences within the AIFM.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.