Let’s take a moment to remember the time after the financial crisis of 2007 and 2008: credit institutions tried at all costs to get rid of their huge non-performing-loan (NPL) portfolios. In our daily legal work, we repeatedly supported those institutions, explaining what was possible, how it could be done and, above all, what was not possible for the purchasers. However, the NPL market was never previously regulated.

What are NPLs?

As the name suggests, NPLs are loan receivables on a bank’s balance sheet that are no longer performing. According to the European Banking Authority (EBA), loans are classified as non-performing if interest or principal payments have been in arrears for at least 90 days, or if there are signs of imminent non-payment. In other words, the risk weighting is high.

In view of the ever-increasing capital requirements since the financial crisis, credit institutions cannot afford to hold NPLs. The capital ratios attributable to these loans are too high, and as a result, the portfolios are being sold off. The purchasers are entities that are not regulated themselves and are therefore not subject to capital and risk requirements – and are not allowed to make any new lending decisions. They acquire a portfolio for a fixed purchase price, manage the loans, collect receivables, realise collateral and wind them up.

This practice, which has been common for many years, is now being subjected to comprehensive regulation for the first time.

What is the NPL Directive?

The NPL Directive, (EU) 2021/2167, regulates the sale and provision of services for NPLs. In Germany, the directive was implemented on 30 December 2023 with the entry into force of the Act on the Secondary Market for Non-Performing Loans and Credit Service Institutions (Kreditzweitmarktgesetz – KrZwMG). The unwieldy-sounding law has far-reaching consequences for the NPL market.

The new law regulates:

• Credit institutions’ obligations as sellers of NPLs
• Purchasers’ obligations
• Requirements for providing credit services
• Supervision of credit service institutions, which are now subject to licensing requirements

Non-compliance with the new obligations is subject to penalties and fines. The law is flanked by technical regulatory standards that were adopted by the EU Commission, with REGULATION 2023/2083 on the Implementing Technical Standards (ITS) laying down the new disclosure templates to be used by EU credit institutions selling NPLs under the NPL Directive.

Activities that are now regulated

The Secondary Credit Market Act intends to make trading in NPLs easier and safer. The law does not apply to loans that were originally issued in a non-EU member state and were therefore not originally subject to EU regulation, unless a novation or replacement of the loan has taken place in the EU.

What are the credit servicer obligations?

“Credit servicing activities” under the new regulation are identified as:  

• Collecting or enforcing due payments from the borrower
• Renegotiating (with the borrower) any terms and conditions related to a creditor’s rights under the loan agreement, according to and in line with the instructions given by the purchaser
• Administering any complaints relating to a creditor’s rights under a loan agreement
• Informing the borrower of any changes in interest rates or charges or of any other payments due related to a creditor’s rights under the loan agreement

The provision of one of these services already triggers a licensing requirement, whereas other credit services are excluded from the requirements of the new regulation.

These activities will be distinguished from legal services in relation to NPLs, which are not regulated by this law. It is up to the member states to decide whether credit service providers can also collect receivables themselves and then transfer them to the purchaser. If that will not be permitted, the payment must go directly to the purchaser.

In Germany, credit services institutions can collect receivables, but they must have a separate escrow account with a credit institution. All funds received from borrowers must be credited to the escrow account in accordance with the agreements with the loan purchaser and held until they are passed on to the loan purchaser. These funds must be fully protected from the claims of other creditors of the credit services institution, particularly in the event of insolvency. Requiring such separation of funds is already standard because of other regulations in the financial sector.

Obligations for credit institutions selling NPLs

Credit institutions must observe extended information obligations when selling NPLs. Relevant information about the respective loans must be disclosed. Article 16(1) of the NPL Directive required the EBA to develop draft ITS specifying the templates credit institutions would need to use to provide information to credit purchasers regarding the sale or transfer of NPLs (for the purposes of financial due diligence and NPL valuation).

These templates have already been adopted by the EU Commission with REGULATION 2023/2083. The ITS contain templates – including both mandatory and non-mandatory data fields – that must be completed by the selling credit institution for each individual loan if the ITS apply. The ITS also include templates regarding the provision of information on counterparties and credit agreements, collaterals, guarantees and enforcement, mortgage guarantees and historical collections of repayments.

The templates are supplemented by a data glossary and completion instructions. In order to facilitate the exchange of information, credit institutions should provide the information in electronic and machine-readable form.

The ITS do not apply to sales of NPLs in the context of sales of branches, business lines or clients’ portfolios, or to sales or transfers of NPLs in the context of securitisations within the meaning of the EU Securitisation Regulation.

Furthermore, they do not apply to sales or transfers of NPLs in the context of derivative contracts, insurance or sub-participation contracts, or in the context of financial collateral arrangements or repurchase or securities lending transactions within the meaning of the EU Capital Requirements Regulation.

Credit institutions transferring NPLs to NPL purchasers must also comply with reporting obligations. In Germany, they must provide BaFin and the German Federal Bank (Bundesbank) with information on the loan purchasers twice a year.

What are the NPL purchaser obligations?

An NPL buyer must use a licensed credit service provider when acquiring an NPL or an NPL receivable if the borrower is a natural person or a micro, small or medium-sized enterprise (according to the SME definition). If the NPL purchaser appoints a credit service provider, the purchaser must inform the supervisory authority of the name and address of the credit service provider no later than the day of the beginning of the provision of credit services.

In addition, the NPL purchaser has regular notification obligations regarding the NPLs and claims arising from the NPLs, especially with regard to the volume and number of NPLs and the extent to which consumers are borrowers of NPLs.

How is the regulation handled?

Credit service providers that were already providing credit services before the Secondary Credit Market Act came into force may continue to operate in the market without a license for up to six months after it comes into force.

According to the German regulation, if a credit service provider intends to continue operating beyond this date, the provider must notify the financial authority within seven weeks of the Secondary Credit Market Act coming into force. An application for a license must be submitted to BaFin within the same period. BaFin already announced that these deadlines will be prolonged. However, it is still possible to submit information and documents for the license application until 5 April 2024.

The authorisation procedure for obtaining a license is standard in the financial sector. It is essential to prove that the managing directors are suitably qualified, that they comply with organisational obligations, in particular compliance and risk management (including money laundering obligations), and that ownership structures are in place.

The license is passportable, as are other licenses in the financial sector that exist because of EU regulation. Notification and reporting obligations apply upon receipt of the license.

How will new regulation change the NPL environment?

In view of the rise in interest rates, the real estate market crisis and the proliferation of disputes around the globe, it is reasonable to expect that the NPL market will rise again. The new regulations will significantly impact those who work with NPLs, and they should take swift action to ensure compliance with the new regulations.