07.02.2017 | KPMG Law Insights

Alternative Investments Legal – Are real estate funds shadow banks? – when the shadow banking regulations of the EBA Guideline take effect

Are real estate funds shadow banks? – when the shadow banking regulations of the EBA Guideline take effect

Due to the potential disruptive impact of shadow banks on international financial markets, the EBA Guideline states that special requirements must be taken into account when investing in vehicles that qualify as shadow banks. Increased attention is being paid to investment funds and securitization vehicles.

EBA Guideline

The financial crisis is derived not least from a shadow banking system. For Germany alone, the Bundestag’s Scientific Service registered in early 2016 in a report on the shadow banking system in Germany an increase in volume between the beginning of 1999 and the second quarter of 2015 of more than three times in nominal terms to around EUR 2.6 trillion. This is attributed to both increased shadow bank activity and a decline in assets in the banking sector (deleveraging).

In December 2015, the European Banking Authority (EBA) published its guidance on limiting exposures to shadow banks, which has been applicable since January 1, 2017 through a corresponding circular issued by the German Federal Financial Supervisory Authority (BaFin).

According to this definition, shadow banks are actors and activities in the financial markets that perform bank-like functions, especially in the lending process, but are not banks and are not subject to regulation for credit institutions. Significant focus is placed on securitization vehicles and alternative investment funds (AIF).

One challenge is likely to lie in the practical implementation of the definition of shadow banks. The EBA does not provide an exhaustive catalog of relevant entities or legal forms, but provides for a two-step identification of shadow banks.

At the first level, certain banking activities (including deposit-taking and lending business, guarantees) are mentioned. The second level enumerates certain exceptions that do not fall under the shadow bank definition, so that all remaining companies that pursue one of the activities listed in the specified list of actions qualify as a shadow bank. This applies, for example, to all special purpose entities that are not included in banking supervision at the consolidated level, as well as to alternative investment funds (AIFs) in the form of debt funds, and if they can raise significant leverage or acquire or extend loans. European Long Term Investment Funds (ELTIF) and European Venture Capital Funds (EuVeCa), for example, are explicitly excluded from the scope of application, as these vehicles do not have the shadow banking-specific risks inherent in them due to the corresponding EU regulations.

This definition is very broad and overshoots the mark. With regard to the applicability to real estate, infrastructure and private equity AIFs, for example, an important step has been taken in the guideline, as these typically do not take up “considerable” leverage within the meaning of the guideline and are therefore not initially considered to be shadow banks.

Internal financing structures of AIF

However, if an AIF extends shareholder loans to subordinated special purpose entities within its investment structure, such an AIF would also be a shadow bank according to the wording of the EBA Guideline, as it extends loans. However, this approach would not be in line with the objective of the EBA Guideline. This is designed exclusively to control systemic financial market risks. However, the fact that a fund’s internal financing is not structured via equity but via (equity-like) shareholder loans does not give rise to such financial market or other risks, so that shareholder loan structures should remain outside the scope of consideration. BaFin has not commented on this point.

However, a restrictive interpretation should also be considered with regard to securitization vehicles. In this respect, the European legislator has requested EBA in the CRR to take into account any possible impact on the real economy: “In developing those guidelines, EBA shall consider whether the introduction of additional limits would have a material detrimental impact on the risk profile of institutions established in the Union, on the provision of credit to the real economy or on the stability and orderly functioning of financial markets.”

This should also be seen in the context of the recent EU efforts to establish a Capital Markets Union, one of the aims of which is to return liquidity accumulated by investors to the market.

Consideration for investments in shadow banking vehicles

The EBA Guideline does not contain any direct requirements for shadow banks. Rather, the regulated financial sector should be restricted in its activities with the shadow banking sector through the creation of internal management and monitoring processes and the introduction of specific caps against shadow banks. In this respect, it is the investor side that is addressed.

Requirements for internal processes and management

The guideline calls for institutions to focus intensively on identifying, managing and monitoring exposures to shadow banks. To this end, qualitative requirements are placed in particular on the internal processes and necessary control mechanisms. Management must be actively involved.

Determination of limits

According to the principal approach, institutions should set individual limits in addition to an overall limit vis-à-vis all shadow banks. Selected information on the individual shadow bank should determine the level of the respective individual limit, including the degree of supervision of the shadow bank, financial information, financial situation, portfolio, vulnerability to asset price and credit volatility. Setting individual limits requires a correspondingly high level of transparency from the shadow banks and institutions involved.

If the principal approach is not applicable to all claims, for example because the information required in the principal approach is not available, the guideline provides a fallback approach. Provided that the basic requirements for internal processes are met, all non-transparent shadow bank exposures are to be allocated to a notional omnibus borrower with a specific aggregate limit of eligible capital. Since the fallback approach may have a detrimental effect on the potential total investments in shadow banking exposures compared to the principal approach, pressure is put on shadow banks to become more transparent.


In the case of investments that could qualify as shadow banks, the EBA guidelines and their organizational requirements, especially in their interpretation of the scope of application, must be lived with careful caution and in consideration of already existing regulations, and the corresponding investments must be reviewed in this regard. The EBA Guideline should focus on those vehicles that contain the risks it rightly notes. If an investment qualifies as a shadow bank, the relevant organizational requirements for holding such an investment must be taken into account. The shadow banking vehicle must comply with the resulting reporting requirements.

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