Direct Loan Fund in Germany – Proposed Compliance Guidelines | Dechert srl
As summarized in previous Dechert OnPoints1 , Germany introduced a framework for direct lending funds in March 2016 by enacting the UCITS V implementing law (the “Act”).2 The changes implemented by the law also allowed some non-German funds (especially from the EU) to enter the German direct lending market. The revised regulatory framework has generated substantial interest in the debt fund industry, particularly with regard to foreign funds engaging in lending activities with German borrowers. Furthermore, institutional investors continue to show growing interest in this asset class and seem receptive to investing in attractive debt fund strategies.
The imminent changes in banking regulatory rules (including the changes proposed under the new regime known as “Basel IV”3 and advice from the ECB on leveraged loans4) will likely create new opportunities for direct lending funds in Germany and Europe.
In Germany, there are currently two legislative / regulatory projects under consultation that will have an impact on direct lending funds in Germany:
- The “Minimum Risk Management Requirements for Investment Firms” (Mindestanforderungen an das Risikomanagement für Kapitalverwaltungsgesellschaften – „KAMaRisk“)5, which will introduce specific compliance and risk management rules for direct lending funds in Germany.
- The draft complementary act of surveillance (Aufsichtsrechtergänzungsgesetz – FinErgWohn)6, which will introduce potential restrictions for banks, but also funds providing home loans with a view to mitigating the risk of a “credit bubble” in the residential real estate market.
This Dechert OnPoint summarizes the main aspects of these two projects.
Draft risk management guidelines (KAMaRisk) for loan funds by BaFin
On November 8, 2016, the German Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht – BaFin) published a revised version of InvMaRisk, the “Minimum Risk Management Requirements for Investment Firms” (Mindestanforderungen an das Risikomanagement für Kapitalverwaltungsgesellschaften – „KAMaRisk“)7 , for further consultation until November 23, 2016.
Minimum requirements for German AIFMs managing loan funds
As the issuance of loans and the acquisition of non-securitized (secondary) loans involve specific risks, the German Capital Investment Code (Kapitalanlagegesetzbuch “KAGB”) Stipulates additional organizational requirements for managers (AIF-Kapitalverwaltungsgesellschaft – “Bad”) Which grant loans on behalf of AIFs (Direct Lending) or which invest in (secondary) loans. This LAMal must have adequate structures and procedures covering in particular the processing of loans, the management of bad debts and the early detection of risks.
The KAMaRisk provides further guidance on the required processes and will implement minimum risk management requirements for KVGs managing these debt funds, either by originating the loans or by investing in (secondary) loans.
As already indicated by the legislative history of the law and the latest change in BaFin administrative practice regarding debt funds, these requirements are largely based on the regulations for the lending activities of German credit institutions in accordance with BA MaRisk .8
No application to foreign management companies and foreign funds
In accordance with Sec. 2 No. 1 of the KAMaRisk, the German LAMal will be subject to the requirements set out in the KAMaRisk. Foreign AIFMs, foreign AIFs and German branches of EU management companies will generally not be directly subject to the loan origination compliance requirements and minimum risk management requirements set out in the KAMaRisk. . Rather, they will be subject to similar requirements in their respective home jurisdiction.9
There is only one exception to this rule stated in Sec. 2 KAMaRisk No.1: EU AIFMs and EU UCITS management companies managing German funds must comply with KAMaRisk requirements as they relate to risk management requirements related to funds.
Not applicable to shareholder loans
As stated in Sec. 29 par. 5a KAGB in conjunction with Sec. 5 No. 2 of KAMaRisk, the minimum risk management requirements under KAMaRisk will not apply to shareholder loans.ten
Accordingly, shareholder loans (eg to real estate holding companies or other special purpose vehicles) will not be subject to other requirements set out in KAMaRisk. In accordance with the grounds of the law, shareholder loans will be exempt from other requirements to meet the practical needs of corporate finance, private equity, venture capital and financial structuring through special purpose vehicles.11
Draft additional supervisory act (Aufsichtsrechtergänzungsgesetz – FinErgWohn)
In June 2015, the Financial Stability Committee (Ausschusses für Finanzstabilität) recommended the creation of a legal basis allowing BaFin to introduce minimum requirements for the credit financing of purchases of residential real estate (including, inter alia, the minimum amount of own funds that must be provided and the minimum debt repayment rates), if such rules are considered necessary in the future. In this way, the risks to financial stability resulting from excessive debt and price bubbles in the real estate market should be limited.12
On the basis of this recommendation, the Federal Ministry of Finance (Bundesministerium der Finanzen – BMF) published the supplementary supervisory bill (Aufsichtsrechtergänzungsgesetz – FinErgWohn)13 in order to prevent potential risks that may arise in the context of overvaluations in the residential real estate markets for financial stability.
Impact on all commercial creditors in the residential real estate sector
In order to avoid regulatory arbitrations and distortions of competition, all commercial creditors in the residential real estate sector (i.e. banks, insurance companies and investment management companies) will be subject to the new regulations. Thus, the new macroprudential rules also apply to loan funds. As a result, the new regulations entail changes in German banking law (Kreditwesengesetz), the German Investment Code (Kapitalanlagegesetzbuch) and the Insurance Supervision Act (Versicherungsaufsichtsgesetz).
Restrictions on new loans
The bill provides for certain instruments allowing the German financial supervisory authorities to specify additional criteria for creditors when granting new loans in order to avoid an imminent threat to financial stability.
In accordance with the draft law, the BaFin could for example
- restrict the maximum ratio of loans to the real estate value concerned (Loan-To-Value);
- measuring debt services by income;
- limit the ratio of total debt to income (Debt-Service-To-Income);
- determine loan repayment terms (amortization requirement).
The preconditions for such restrictions are threatening risks to the operational capacity of the financial system and to financial stability based on the BaFin assessment and the assessments of the German Central Bank (Bundesbank).
Exemptions for renovation, small loans, follow-up financing and social housing
According to the draft law, loans for the renovation of housing will not be subject to the complementary law of supervision.
Also, the BaFin can exempt certain types of loans and sectors from a general decree restricting residential real estate loans, for example:
- small loans (de minimis limit);
- creditors may be allowed to grant a certain amount of new loans which will not have to comply with prescribed restrictions;
- Complementary financing and the promotion of social housing can also be exempted from a general decree of the BaFin.