German Regulator BaFin Opens the Way for Credit Funds in Germany
By changing its administrative practice, the BaFin allows loan origination and loan restructuring by investment funds in Germany.
On 12 May, the German Federal Financial Supervisory Authority (BaFin) published changes to its administrative practice regarding the assessment of loan origination by investment funds. These changes were triggered by the current regulatory practice of the European Securities and Markets Authority (ESMA) and upcoming legislative changes to the German Capital Investment Act (Kapitalanlagegesetz or KAGB). As a consequence of these changes, the BaFin will now consider loan origination by investment funds permissible.
BaFin’s Previous Administrative Practice
In the past, loans that originated for the account of or by investment funds were not allowed in Germany, and the BaFin required a banking license under the German Banking Act (Kreditwesengesetz or KWG) from all entities that were active in this business. The German legal framework differs from other European countries in this respect because lending is allowed without any restrictions in many European countries so that in such countries so-called credit funds were previously possible.
The New Administrative Practice
Under its new administrative practice, the BaFin considers loan origination and loan restructuring part of collective asset management so that such activities are generally permissible for investment funds under the KAGB. Consequently, the KAGB in this respect supersedes the KWG and provides an exemption from the general KWG license requirement for lending activities.
This new practice will apply to open- and closed-ended special alternative investment funds, to private equity funds with respect to shareholder loans, and to all fund managers that fall under the so-called de minimis exemption under the KAGB (i.e., fund managers with assets of up to EUR500 million under management if no leverage is used, or up to EUR100 million if leverage is used). Funds that are offered publicly and are not restricted to professional and semiprofessional investors will not benefit from this new administrative practice.
The new administrative practice anticipates upcoming legislative changes to the KAGB that will introduce statutory product rules for loan-originating investment funds in the KAGB. Until these rules take effect, the BaFin recommends that fund managers comply, inter alia, with the following rules:
No financing of long-term debt by short-term borrowing
No lending to consumers
No lending to persons if the lending would cause conflicts of interest
Restriction of the use of leverage to limited cases
Observation of certain risk-diversification rules to limit the exposure per borrower
Maintenance of a liquidity reserve for funding obligations of a fund
How to precisely apply these recommendations, in particular whether the BaFin will apply these rules equally to all funds, is currently unclear. For example, it would seem strange if closed-ended funds that have 100% capital commitment from investors for their loans would be required to maintain a liquidity reserve. Also, many of the BaFin recommendations seem inappropriate for private equity funds that only grant shareholder loans.
Consequences for Non-German Funds
The new BaFin practice only concerns German funds. Non-German funds are not subject to the product rules of the KAGB. In the past, non-German funds slated to be active as lenders in Germany were subject to the general rules of the KWG with the consequence that such activities normally required a banking license under the KWG. Whether or not the new BaFin practice will grant other EU funds access to the German market under nondiscrimination aspects remains to be seen.
The marketing of foreign credit funds in Germany should not be affected by the new BaFin practice. Because the marketing rules under the KAGB are separate from the product rules, marketing foreign credit funds on a cross-border basis is subject to the KAGB’s marketing provisions.