AIFMD II: New regulations for Fund Managers in prospect – European harmonised regime for Debt Funds (really?)

The Amending Directive to the Alternative Investment Fund Managers Directive (Directive (EU) 2024/927 – AIFMD II) entered into force on 15 April 2024. The 24-month transposition period generally ends on 15 April 2026; amendments concerning reporting shall not take effect until 16 April 2027.

The German government draft of the fund market strengthening act (Fondsmarktstärkungsgesetz – FoMaStG-E), mainly implementing AIFMD II, has been published. As the German government will be re-elected earlier than initially planned, it is unclear as to whether the current government will pass the FoMaStG-E in its current form.

One major objective of AIFMD II is the European harmonisation of regulations for Debt Funds – was it successful?

Introduction

Directive 2011/61/EU (Alternative Investment Fund Manager Directive – AIFMD) is the fundamental and comprehensive regulatory regime for managers of alternative investment funds (AIF) domiciled in the EU and in third countries (Fund Managers) who manage AIF or wish to market AIFs in the EU. AIFMD was transposed into German law through the German Capital Investment Code (Kapitalanlagegesetzbuch – KAGB).

Nearly ten years after the AIFMD came into force and following various interpretative decisions by the European Securities and Markets Authority (ESMA), the draft amendment to the AIFMD was published.

One of the most exciting regulatory areas of AIFMD II is the introduction of regulations for AIFs that grant loans (loan originating AIFs) (Debt Funds). In addition, the catalogue of ancillary services that a Fund Manager may provide alongside its main activity (management of AIFs) will be expanded. 

AIFMD II also introduces changes in the following areas, amongst others:

• liquidity management tools for open-ended funds, 
• requirements for licensing/registration and outsourcing,
• reporting obligations,
• disclosure obligations vis-à-vis investors,
• third-country marketing rules and
• requirements for the depositary.

With the FoMaStG-E, the German legislator kicks off the implementation of the requirements of AIFMD II.

Loan Origination by AIFM

I. Current legal situation

AIFMD did not provide for any regulation of loan origination by AIFs or their Fund Managers for the account of AIFs. EU-wide requirements were only defined at EuSEF, EuVECA and ELTIF level. Besides this, the member states are responsible for regulations on loan origination. Accordingly, the regulations on loan origination by funds is a regulatory patchwork throughout the EU member states. 

In Germany, Debt Funds were introduced into the KAGB at the beginning of 2016 by the UCITS V Implementation Act (OGAW V-Umsetzungsgesetz) and flanked by corresponding amendments to exemptions in the German Banking Act (Kreditwesengesetz – KWG).

The origination of money loans (Gelddarlehen) constitutes regulated banking business (Bankgeschäft). Accordingly, the KWG exemption was amended in that Fund Managers are expressly permitted to grant money loans (Gelddarlehen) (for the account of AIFs they manage) as part of collective asset management (kollektive Vermögensverwaltung).

While shareholder loans may be originated by both, open-ended and closed-ended Special and Retail-AIFs, loan origination to third parties is only permitted for Debt Funds in the form of closed-ended Special-AIFs (geschlossene Spezial-AIF). 

The origination of loans primarily requires loan-specific risk and liquidity management in accordance with the requirements of BaFin’s minimum requirements for the risk management of fund managers (Mindestanforderungen an das Risikomanagement von Kapitalverwaltungsgesellschaften – KAMaRisk). In practice, this does not impose any significant additional requirements on Fund Managers with a full licence, as these Fund Managers are required to have a comprehensive risk and liquidity management system in place anyway. 

Subthreshold Fund Managers, on the other hand, must go one step further and, above all, implement credit-specific risk management (usually including segregation of duties) and – if the Debt Funds under management use leverage at fund level – liquidity management.

The origination of loans for the account of the AIF is subject to the following rules:

• Debt Funds may only borrow up to an amount of 30 % of their aggregated and cost-adjusted capital commitments (Investment Capital) (internal leverage).
• Loans must not be granted to consumers (Verbraucher) within the meaning of section 13 of the German Civil Code (Bürgerliches Gesetzbuch – BGB).
• Loans to one borrower must not exceed a maximum of 20 % of the Investment Capital (diversification). 

Unlike with respect to marketing of AIFs, the KAGB does not provide for a passporting regime for loan origination. A German Special-AIF under the KAGB may therefore not grant loans in other EU/EEA member states without further ado. Instead, the permission of origination loans is currently governed by national regulations. 

However, Fund Managers from EU member states and Fund Managers from third countries (for example Switzerland, UK or USA) are permitted to originate loans in Germany without a banking licence due to a special exemption in the KWG. Fund Managers from third countries may only originate loans for funds they manage in Germany if they have successfully passed a marketing notification procedure (Vertriebsanzeigeverfahren) with BaFin for marketing to retail investors – even if the shares / units in the AIF are not actually to be marketed in Germany. Background to this restriction is the protection of German borrowers, because Fund Managers from third countries are not always subject to comparable supervision as Fund Managers from the EU. A marketing notification procedure for the marketing of funds from third countries to German retail investors requires, for example, that funds and Fund Managers from the third country underlie effective supervision. This requirement does not apply to marketing to professional investors. The German legislator and BaFin want to appreciate the fact that the supervision of third-country Fund Managers may not be comparable with EU rules.

Further to the above, a third-country Fund Manager is also not subject to any further provisions of the KAGB with regard to loan origination. 

However, due to the high requirements for marketing to retail investors, the exemption from the banking licence is practically not attractive for third-country Fund Managers.

II. Changes introduced by AIFMD II for Debt Funds and implementation (FoMaStG-E)

1.    Introduction

The demand for a European harmonised framework for loan origination by funds is nothing new. ESMA had already outlined in its opinion (Key principles for a European framework on loan origination by funds) in April 2016 which aspects should be considered when developing a EU-wide set of rules for loan origination. 

AIFMD II aims to establish such harmonised regulatory framework for Debt Funds. 

Firstly, the AIFMD II defines loan origination or the granting of a loan as the granting of a loan: 

• "[either] directly by an AIF as the original lender [...]
• [or] indirectly through a third party or a special purpose vehicle which originates a loan for or on behalf of the AIF, or for or on behalf of an AIFM in respect of the AIF, where the AIFM or AIF is involved in structuring the loan, or defining or pre-agreeing its characteristics, prior to gaining exposure to the loan".

A loan originating AIF is an AIF,

• "whose investment strategy is primarily to originate loans or
• whose originated loans granted have a notional value that represents at least 50 % of its net asset value"

AIFMD II also provides – similar to Germany law – for a regulation of loan origination by Debt Funds on two levels, Fund Manager level and loan level. 

Further, AIFMD II explicitly addresses the intention of a EU-harmonised loan origination by Debt Funds and their Fund Managers.

With the FoMaStG-E, the German legislator adopts the requirements of AIFMD II almost exactly as introduced by AIFMD II.

Unfortunately, the new significant term "loan" has not been defined to clarify uncertainties such as the inclusion of convertible loans under the KAGB; so far, there only exists an administrative practice of BaFin in that convertible loans are also "money loans" (Gelddarlehen) within the meaning of the KAGB. 

2.    Regulation of the Fund Manager

a)    AIFMD II

For Fund Managers that manage Debt Funds, AIFMD II requires the implementation of effective policies, procedures and processes for the granting of loans, the assessment of credit risk and the administration and monitoring of its credit portfolio, which must be reviewed at least once a year. This is already required under German law.

b)    KAGB / FoMaStG-E

The German legislator introduces a new section 29a para. 1 KAGB, which mirrors the wording of AIFMD II.

The newly introduced section 29a KAGB consolidates the requirements of AIFMD II regarding loan origination. This is welcomed as, currently, these requirements are scattered within the KAGB.

3.    Regulation of loans

In respect of the regulation of the loans, AIFMD II introduces internal leverage limits, risk diversification requirements and further restrictions, the latter of which shall be regulated by the EU member states themselves. These restrictions are also to be implemented by the FoMaStG-E almost 1:1 as introduced by AIFMD II.

a)    Internal leverage limits

aa)    AIFMD II

AIFMD II introduces new leverage limits – i.e. the debt-financed proportion of the Debt Fund's Investment Capital. Internal leverage is to be limited to 175% for open-ended AIFs and 300% for closed-ended in respect of loans granted to third parties; the leverage limits do not apply to shareholder loans. 

bb)    KAGB / FoMaStG-E

The internal leverage limits introduced by AIFMD II are significantly higher than those currently applicable under German law – the KAGB’s current internal leverage limit for Debt Funds in the form of closed-ended Special-AIFs is 130%.

The FoMaStG-E adopts the internal leverage limits exactly as introduced by AIFMD II – thereby allowing more than double the internal leverage for closed-ended Special-AIFs.

b)    Risk diversification

aa)    AIFMD II

Art. 15 para. 4a AIFMD has been amended by AIFMD II in that it now stipulates that a Fund Manager must ensure that

"where an AIF it manages originates loans, the notional value of the loans originated to any single borrower by that AIF does not exceed in aggregate 20% of the capital of the AIF where the borrower is one of the following:

a) a financial undertaking within the meaning of Article 13 para. 25 [Solvency II Directive],
b) an AIF or
c) an [undertaking for collective investment in transferable securities – UCITS]."

This 20% limit applies no later than 24 months after the first subscription and ends with the commencement of the liquidation phase. Additionally, the 20% limit may be temporarily suspended if the AIF's capital is increased or reduced.

bb)    KAGB / FoMaStG-E

Currently, section 285 para. 2 no. 3 KAGB already provides for a diversification limit of the same amount. However, this limit applies to every type of borrower. The German legislator wanted to ensure minimum diversification and thereby prevent the Debt Fund from experiencing significant value loss in case of default of a single loan. 

The FoMaStG-E follows the AIFMD II here as well. Accordingly, the 20% limit will be restricted to the aforementioned types of borrowers. In addition, the FoMaStG-E adopts the grace periods as well as the rules for the end of the period in which the limit applies, and the temporary suspension of the 20% limit. 

Overall, the more flexible design of the regulation compared to the previous legal situation is realistic and therefore welcomed.

c)    No loan origination to certain persons/entities

aa)    AIFMD II

To avoid conflicts of interest, AIFMD II prohibits loan origination to the following persons/entities:

• Fund Manager or staff of that Fund Manager;
• AIF’s depositary;
• outsourcing companies and
• generally, entities within the same group as the Fund Manager.

bb)    KAGB / FoMaStG-E

The KAGB does not address this. However, Fund Managers (including registered/subthreshold Fund Managers) who originate loans for the account of their AIF are already subject to specific requirements under the KAGB and the KAMaRisk to avoid conflicts of interests. In practice, loans to the aforementioned persons/entities are often an issue from a conflict of interest perspective under the current legal framework. 

The FoMaStG-E also provides for a 1:1 implementation by prohibiting loan origination to the abovementioned persons/entities. In this respect, the FoMaStG-E has at least a clarifying effect.

d)    Loan origination to consumers

aa)    AIFMD II

AIFMD II expressly allows the member states to prohibit loan origination by Debt funds to consumers.

bb)    KAGB / FoMaStG-E

Currently, loan origination to consumers is prohibited by section 285 para. 3 KAGB. This was implemented for consumer protection reasons. 

The FoMaStG-E also provides for such prohibition. However, the FoMaStG-E is contradictive at one point since section 29b para. 1 no. 1 KAGB speaks of "loans granted to consumers" in connection with the risk retention described further below. However, in light of the intended prohibition of consumer loans, this wording is confusing, and hopefully does not find its way into the final wording of the law. 

e)    Secondary market and risk retention

aa)    AIFMD II

AIFMD II aims to prevent Debt Funds from originating loans with the sole purpose of selling them immediately to third parties on the secondary market. Therefore, AIFMD II prohibits such "originate-to-distribute strategies". Additionally, AIFMs shall ensure that the Debt Funds they manage generally retain 5% of the notional value of the loans they originate and subsequently transfer to third parties.

bb)    KAGB / FoMaStG

Such rules currently do not exist in German law.

The FoMaStG-E rightly adopts both provisions.

f)    Cross-border activity

With AIFMD II, the EU legislator aims to enable Debt Funds to serve as sources of alternative financing for the real economy (especially for small and medium-sized enterprises).

However, AIFMD II does not contain an explicit provision regulating cross-border loan origination, i.e. to create exemptions for Debt Funds to engage in loan origination in another member states without triggering local banking licence requirements. However, recital 13 states:

"Common rules should be laid down to establish an efficient internal market for loan origination by AIFs, to ensure a uniform level of investor protection in the Union, to make it possible for AIFs to develop their activities by originating loans in all Member States [...]"

This could serve as the basis for the long-awaited (de facto) lending passport. 

It would mean a significant change for the private debt sector if, EU member states, when transposing AIFMD II, were to introduce – as already existent in German law – an exemption from any existing licensing requirements for loan origination. German law does not need to be amended in this respect. However, it would be desirable if the German legislator was to add a clarifying addition to the explanatory comments stating that Germany presumes a harmonised regime for loan origination by Fund Managers, i.e. a licence-free loan origination "in a member state of the European Union or in another state party to the Agreement on the European Economic Area". This clarification was suggested during the legislative procedure, however, so far it was not implemented in the FoMaStG-E.

III. Conclusion

The current regulatory patchwork for Debt Funds is likely to get a more uniform picture with the implementation of AIFMD II. As a result of a process that has been ongoing for years, it is welcomed that the EU legislator seeks to establish a unified legal framework for Debt Funds. The clear intention of the EU legislator to enable cross-border loan origination by Debt Funds is a great sign. 

In principle, German regulatory law already reflects many of the requirements of AIFMD II. Where this is not yet the case, the FoMaStG-E adopts almost 1:1 of the changes introduced by AIFMD II, however, at the same time it also opts for both, at some points stricter and at some other points more flexible solutions. 

It is hard to understand why the German legislator did not follow the suggested clarification of the possibility of cross-border loan origination, especially since the legislator's intention to strengthen the German fund market and domicile is not only evident from the name of the law, but also explicitly stated in the rationale of the FoMaStG-E.

It is now those EU member states’ turn where loan origination requires a banking licence and where it is not permitted for Debt Funds from other jurisdictions to originate loans on a cross-border basis without a banking licence. A harmonised European regulation of Debt Funds only does not entirely work as long as the member states handle the issue of a possible banking licence requirement or exemptions for Debt Funds differently.