The Secondary Credit Market Act – a new regulation for the German NPL market (effective since 30 December 2023)

Introduction

On 13 October 2023, the German Federal Ministry of Finance published the government’s draft of the Secondary Credit Market Promotion Act (Kreditzweitmarktförderungsgesetz), which was adopted by the German Federal Government, to implement Directive (EU) 2021/2167 of 24 November 2021 on credit servicers and credit purchasers (Credit Servicers and Credit Purchasers Directive, or the Directive) into German law.

The aim of the Directive is to reduce high levels of non-performing loans (NPLs) in the European Union (EU) and prevent a potential future increase on original lenders’ balance sheets. In this respect, credit service institutions should be given the opportunity to sell non-performing loans to other players on efficient, competitive and transparent secondary markets. This objective is to be achieved by (i) harmonising the requirements for the authorisation of credit servicers, (ii) creating a uniform framework for credit purchasers and credit servicers, (iii) strengthening debtor rights and (iv) expanding banks' scope for action.

The Directive is part of the action plan for the reduction of non-performing loans in the EU and had to be implemented into national law by the Member States by 29 December 2023.

The Secondary Credit Market Promotion Act is an omnibus act that makes changes to numerous existing laws. However, its centrepiece is the new Secondary Credit Market Act (Kreditzweitmarktgesetz, short KrZwMG, or the Act).

With the KrZwMG, the German legislator is - for the first time - creating detailed obligations for purchasers and sellers of non-performing loans. The Act entered into force on 30 December 2023. Companies that have already provided credit services before this law comes into force will be granted a six-month transitional period. This means until the end of 29 June 2024 credit servicers may continue to provide their business under the previous framework conditions even without a licence procedure having been carried out and a corresponding licence granted.

Background to the Credit Servicers and Credit Purchasers Directive

Since the global financial crisis and the resulting decline in economic output, high levels of NPLs on the balance sheets of many European banks have been a key obstacle to a rapid recovery of the financial and real economy. The equity required by banks to grant new loans is tied up in risk provisioning for the high NPL portfolios resulting from the crisis.

With Regulation 2019/630, the EU had already introduced new provisions in the Capital Requirements Regulation (EU) 575/2013 (CRR), which obliged credit institutions to hold sufficient funds in the event, that loans are no longer paid as contractually agreed and to make it easier for credit institutions to develop comprehensive realisation strategies. The aim of the Credit Servicers and Credit Purchasers Directive is to create a standardised Europe-wide framework for the (simplified) sale of NPLs to other players while at the same time guaranteeing a high level of protection for the debtors concerned. This ultimately serves to deepen the banking and capital markets union and to reduce the risks posed to the stability of the European economic system by NPLs.

Main content of the Secondary Credit Market Act

The government draft of the KrZwMG primarily regulates the duties of purchasers and sellers of NPLs, the requirements for the provision of credit services and the supervision of credit servicers by the competent supervisory authorities. In particular, the Act creates an independent authorisation procedure for the provision of credit services relating to non-performing bank loans in Germany and regulates access to the German market for providers of credit services from other EU Member States and third countries.

It also contains regulatory requirements for, among other things, the business organisation and risk management of Credit Servicers and regulates their special regulatory duties. Both, for credit purchasers and credit servicers, the Act states principles of conduct towards debtors. For the purpose of supervision, the Federal Financial Supervisory Authority (BaFin) has been granted appropriate supervisory and information powers. Reporting obligations are imposed on credit institutions as sellers, credit purchasers as well as credit servicers s.

With the implementation of the Credit Servicers and Credit Purchasers Directive, credit servicers authorised in an EU Member State or EEA Member State also have the option of operating across borders in the EU or the European Economic Area (EEA) with the so-called European Passport.

Furthermore, the law is intended to establish a register of credit service institutions authorised in Germany or operating in Germany with a European Passport.

Serious violations of the legal obligations are to be penalised with fines or penalties.

Scope of application of the KrZwMG and definition of non-performing loan agreements

The KrZwMG only applies to the extent that non-performing loan agreements are affected. Non-performing loan agreements (NPLs) are loan agreements that are categorised as non-performing exposures within the meaning of Article 47a CRR. In particular, this includes receivables in relation to which the credit institution classifies the full fulfilment (without resorting to the realisation of collateral) as unlikely or the debtor is more than 90 days in arrears with a material liability.

However, the law is only applicable to sales of NPLs or assignments of loan receivables from NPLs if the loan in question was originally granted by a credit institution and the first sale or first assignment took place after 29 December 2023. The Act also does not apply in cases where the loans were granted by a credit institution that is not established in an EEA Member State.

Credit services within the meaning of the KrZwMG

The KrZwMG defines the term "credit service" in relation to the acquisition of a non-performing loan agreement or claims of the lender arising from this by a credit purchaser as

(1)       the collection and enforcement of due payment claims and other claims of the lender arising from the loan agreement,

(2)       the renegotiation of rights and obligations or other material terms and conditions under a non-performing credit agreement in accordance with the instructions of the credit purchaser, provided that the undertaking providing the service is not a credit intermediary within the meaning of the Consumer Credit Directive (Directive 2008/48/EC) or the Directive on credit agreements relating to residential real property (Directive 2014/17/EU),

(3)       the processing of complaints in connection with a non-performing loan agreement, and

(4)       informing the debtors of changes in interest rates, charges or payments due in connection with a non-performing loan agreement.

Credit servicers and credit service institutions

Credit servicer (Kreditdienstleister) are (i) credit service institutions within the meaning of the KrZwMG (Kreditdienstleistungsinstitute) and (ii), if they provide credit services for a credit purchaser, CRR credit institutions established in Germany or in another EU Member State or EEA Member State (i.e. credit service institutions engaged in the deposit-taking and lending business) and non-credit service institutions subject to supervision by a competent authority of an EEA Member State in accordance with Article 20 of Directive 2008/48/EC on credit agreements for consumers or Article 35 of Directive 2014/17/EU on credit agreements relating to residential real property, if they operate in that respective EEA Member State.

Credit service institutions are companies that provide a credit service in the name of the credit purchaser on a commercial basis or to an extent that requires a commercially organised business operation. In addition to companies organised as legal entities, this also includes partnerships and cooperatives. However, the following are not considered credit service institutions:

(1)       credit institutions established in Germany with a licence to conduct credit business in accordance with the German Banking Act (Kreditwesengesetz, short KWG) or CRR credit institutions established in another EEA Member State,

(2)       capital management companies authorised or registered in accordance with the provisions of the German Investment Code (Kapitalanlagegesetzbuch, short KAGB), EU management companies and internally managed investment companies within the meaning of the KAGB, as well as

(3)       non-credit institutions subject to regulatory supervision by a competent authority of an EEA Member State in accordance with the Directive on credit agreements for consumers or credit agreements relating to residential immovable property.

Credit purchasers

Credit purchasers are persons or companies who are not credit institutions authorised to provide credit and who acquire claims from the lender under a non-performing loan agreement in the course of their commercial or professional activities.

Authorisation procedure for the provision of credit services

The provision of credit services in Germany requires credit servicers to obtain written or electronic authorisation from BaFin. The documents required for this largely correspond to the requirements for a banking licence already known from the KWG (proof of reliability and expertise, suitable owners of significant shareholdings, viable business plan, etc.). A statutory review and decision period by BaFin have newly been introduced. BaFin will review the completeness of an application for authorisation within 45 days of its receipt. Within 90 days of receipt of a complete application, BaFin must inform the applicant company whether the licence will be granted or refused. If the licence is granted, BaFin is obliged to publish the licence in the German Federal Gazette (Bundesanzeiger).

If credit institutions authorised in Germany already have a licence to conduct lending business, these credit institutions do not require an additional licence to provide credit services. However, they must also fulfil the special obligations under the KrZwMG if they purchase or sell NPLs.

Lawyers also do not require a licence under the KrZwMG if they provide credit services as long as these exclusively relate to legal advice or representation in legal matters. As soon as the service provided by a lawyer also includes other credit services in addition to purely legal advice, the lawyer also requires a licence under the KrZwMG and must, in particular, provide evidence of the establishment of business operations geared towards the provision of credit services.

Transition period for existing credit servicers

Companies that were already providing credit services before the KrZwMG came into force may continue to do so without authorisation from BaFin for a further six months after the Act came into force (i.e. until the lapse of 29 June 2024), unless a decision on the application for authorisation has been issued beforehand.

If the company intends to continue providing credit services after the six-month transitional period has expired, it must notify BaFin of this intention within seven weeks of the Act coming into force (i.e. until the lapse of 16 February 2024) and submit the licence application with all the information and documents required for this within a maximum of another seven weeks (i.e. until the lapse of 5 April 2024).

In practice, an applicant will only be able to meet these tight deadlines with sufficient advance preparation. This is because extensive documentation must be submitted within the deadline, in particular to prove (i) the existence of a viable business plan, including a proper business organisation that ensures compliance with the organisational obligations newly introduced by the KrZwMG, (ii) the professional suitability and reliability of the managers and members of the supervisory bodies, and (iii) the reliability of holders of significant shareholdings.

No double supervision for credit servicers under the German Legal Services Act

With regard to the debt collection services that credit servicers provide for purchasers of NPLs in accordance with the KrZwMG, they are exempt from further supervision in accordance with the German Legal Services Act (Rechtsdienstleistungsgesetz, short RDG). However, if they also provide debt collection services for other companies that are not subject to the KrZwMG, they remain subject to supervision under the RDG.

European Passport for the cross-border provision of credit services

According to the KrZwMG, credit service institutions that have a licence from the competent supervisory authority have the option of providing cross-border credit services with the so-called European Passport. This authorisation for cross-border activities is granted in such a way that, on the one hand, authorised credit service institutions based in another EEA Member State can provide credit services in Germany (incoming) and, on the other hand, credit service institutions authorised in Germany can provide credit services in another EEA Member State (outgoing).

New regulatory duties for the seller when purchasing a non-performing loan

According to the KrZwMG, the credit institution as seller must provide a potential credit purchaser with information on the non-performing loan agreement or the lender's claims arising from it and on any collateral before concluding an agreement on the purchase of a non-performing loan agreement or the lender's claims arising from it so that the credit purchaser can draw their own conclusions regarding the value of the loan agreement or the claims arising from it and the probability of realising this value. Furthermore, credit institutions that transfer non-performing loan agreements or claims arising therefrom to a credit purchaser must provide BaFin and the Deutsche Bundesbank with comprehensive information on the credit purchases processed in the respective period every six months.

New regulatory duties for the credit purchaser when purchasing a non-performing loan

The legislator saw no need to subject credit purchasers to a separate authorisation requirement for the commercial acquisition of NPLs in the KrZwMG, as credit purchasers do not grant new loans, but merely purchase existing non-performing loan agreements or receivables from them at their own economic risk.

However, if the credit purchaser is not also a credit servicer, the credit purchaser must engage a credit servicer to perform credit services in connection with the non-performing loan agreement when concluding an agreement on the acquisition of a non-performing loan agreement, provided that the loan agreement was concluded with a natural person or a small and medium-sized enterprise (SME). Evidence of the appointment must be provided in the form of a written or electronic loan service agreement and the credit purchaser is obliged to notify BaFin and the Deutsche Bundesbank of the name and address of the credit servicer at the latest on the day on which the provision of credit services begins. The credit purchaser must also inform BaFin and the Deutsche Bundesbank of the appointment of the credit institution. If the credit purchaser in turn sells the NPL or claims arising from it to a new credit purchaser, the credit purchaser must notify BaFin and the Deutsche Bundesbank, in particular of the legal entity identification or identity of the new credit purchaser, its manager(s) and holder(s) of significant shareholdings as well as the number and volume of the loan agreements sold.

By requiring the appointment of a credit servicer even for the purchase of loan agreements concluded with SMEs, the German legislator goes far beyond the minimum protection required by the Directive, which only requires the appointment of a credit servicer in the case of the purchase of loan agreements concluded with natural persons.

The definition of SMEs includes all companies that (i) employ fewer than 250 employees and (ii) have either an annual turnover of no more than EUR 50 million or an annual balance sheet total of no more than EUR 43 million, whereby these thresholds are to be determined on the basis of the most recent annual financial statements.

When determining the number of employees, annual sales and annual balance sheet total, the corresponding key figures of affiliated companies are to be taken into account in full, while the key figures of partner companies are only to be considered proportionately according to the respective shareholding. An ‘affiliated company’ is a company over which another company exercises a controlling influence, in particular due to a majority shareholding. A ‘partner company’ is a company in which another company holds an interest of at least 25% and no more than 50%.

Extended duties for credit purchasers from a third country (non-EU/EEA) when purchasing a non-performing loan

If the credit purchaser is domiciled or has its registered office in a third country (non-EU, non-EEA), it must first appoint a representative domiciled in Germany who, in addition to the credit purchaser, is responsible for the fulfilment of the credit purchaser's obligations under the KrZwMG. In addition, such a credit purchaser must always appoint a credit servicer when acquiring non-performing loans against any type of debtor, i.e. also when acquiring loans against large companies (non-SME).

Supervisory powers of BaFin and the Deutsche Bundesbank

The KrZwMG gives BaFin and the Deutsche Bundesbank extensive new supervisory powers. Loan purchasers or their representatives, credit service providers, outsourcing companies and borrowers must, on request, provide the supervisory authorities with all information required to verify compliance with the provisions of the KrZwMG. The duties to provide information and submit documents also apply to holders of significant shareholdings of the aforementioned group of addressees as well as to persons or companies affiliated with them within the meaning of Section 15 of the German Stock Corporation Act (AktG).

In addition, BaFin may carry out inspections of credit purchasers, their representatives and credit service providers engaged in connection with NPLs, their branches and outsourcing companies at any time. This includes the right to access and inspect the business premises during regular operating and business hours.

Moreover, BaFin may send representatives to the annual general meetings, general meetings or shareholders' meetings and meetings of the supervisory bodies of the parties concerned in which BaFin's representatives are entitled to engage in the discussions. The supervised parties must also, at the request of BaFin, schedule meetings of the administrative and supervisory bodies and propose items for resolution.

Effects of the KrZwMG on the players in the NPL market

The KrZwMG will have far-reaching effects on all players in the market for NPLs once it comes into force and will therefore bring considerable change to the NPL market:

At the centre of the changes are the credit servicers, whose activities will in future be subject to a new licensing and supervisory regime if they are carried out on behalf of an NPL acquirer. The supervisory authorities may require not only credit servicers but also all holders of significant shareholdings in such credit servicers as well as the credit servicers’ outsourcing and affiliated companies to provide them with comprehensive information. The extensive audit rights of BaFin also open up the possibility of influencing the decision-making and organizational processes of the administrative and supervisory bodies. There is a risk of additional administrative expense in the form of the reporting obligations provided for in the KrZwMG. It is not unreasonable to expect that other EU Member States will implement the Directive with less administrative burdens. Since credit servicers from such other EU Member States will still be allowed to operate in Germany via the European Passport, the BKS (Bundesvereinigung Kreditkauf und Servicing e.V.) fears that credit servicers based in Germany could be disadvantaged resulting in smaller credit servicers being forced out of the market by large internationally active companies regulated outside of Germany. The short deadline for applying for a licence until the end of the transitional period will put additional pressure on existing credit servicers.

For credit purchasers, the effort and costs involved in acquiring NPLs are likely to increase significantly, regardless of whether they acquire entire NPL portfolios or only individual NPLs. In future, they will have to check whether the debtor is an SME and, if so, always engage a credit servicer licensed in Germany or in another EU/EEA Member State for a fee. Credit purchasers from non-EU/EEA Member States are obliged to engage a licensed credit servicer for every intended NPL acquisition, i.e. even if the debtor is a large company (non-SME). Furthermore, credit purchasers from third countries must appoint a representative based in an EU/EEA- Member State who, alongside the credit purchaser, assumes responsibility for the fulfilment of the new regulatory duties created by the KrZwMG. Credit purchasers (or their representatives) and, inter alia, the holders of significant shareholdings as well as persons or companies affiliated with them (within the meaning of Sec. 15 AktG) are also subject to the duty to provide information to the supervisory authorities. In particular, credit purchasers and their representatives should be prepared for the fact that BaFin has extensive audit rights under the KrZwMG, which entitle its staff to access business premises and even to convene and attend meetings of the administrative and supervisory bodies.

Finally, credit institutions must adapt their loan sales processes to the standard required by the KrZwMG, at least with regard to the sale of NPLs, when borrowers are natural persons or SMEs. Since involving a credit servicer will be mandatory for credit purchasers for loans granted to natural persons and SMEs, it can be cautiously expected that the increased burden on the purchaser will not tend to result in a larger number of bidders or higher bids, at least in transactions which concern only individual NPLs rather than entire portfolios.