New rules will come into effect in Germany next week which will bring some much needed clarity to an issue that has vexed fund managers for many years, affecting both domestic and international private equity and debt fund managers. There is, however, a price to pay for this clarity, and some new restrictions will bite upon private equity funds in particular, which could affect the structure of deals in the future.
European debt fund managers always have to analyse whether they need a banking licence to lend money to companies in a particular country, and the rules are not (yet) harmonised across the EU. In the UK, the position has always been very clear: a licence is not required. But in Germany, and some other EU countries, the picture has been somewhat uncertain. From next week, following the introduction of debt fund legislation in Ireland and Italy, Germany will make its position clear, at least for certain
funds. The new rules will allow loan origination by German and other European Alternative Investment Funds whose managers are authorised under AIFMD, without the need for a banking licence. For fund managers based outside of the European Union, these new rules will only apply if they are fully AIFMD compliant.
However – and with consequences for the private equity and venture capital industry as a whole – the new rules come with new requirements for funds making loans to German borrowers, including shareholder loans, a common financing mechanism for buyout funds in particular. In general, leverage at the level of the fund is restricted, and there are diversification restrictions meaning that no more than 20% of the fund (after deducting fees, costs and expenses borne by fund investors) can be lent to
any one borrower. However, for shareholder loans, this diversification limit is increased to 50% of fund commitments if the fund satisfies one of the following three criteria: the borrower is a subsidiary of the fund; the loan is subordinated; or the loan is no more than twice the amount of the equity stake held by the fund in the borrower. No limit at all will apply for subordinated shareholder loans if the fund itself does not borrow more than 30% of fund commitments. In addition, all fund managers
wishing to lend to German borrowers will need to comply with risk management and liquidity rules not unlike those applying to banks.
So, in general, these changes helpfully clarify that for qualifying debt funds no banking licence is required in Germany, and this will give an incentive for such funds to meet the qualifying criteria. Buy-out funds, however, will need to navigate the new restrictions on shareholder loans and, although the rules are not onerous, some structures may be affected going forward. Current structures should not be afffected as loans made before 18 March 2016 will be grandfathered, but will still need to be counted
in future when calculating investment limits.