March 5, 2015 The New German Investment Regulation (Anlageverordnung) An update to the GSK Update of June 30, 2014 Executive Summary > Privileges for investments in private equity funds > Clarification regarding closed-ended specialized real estate AIF > Appropriations with regard to open-ended specialized AIF with fixed investment conditions > Comparability test for investments outside the EEA 1. Introduction and background information In May 2014, the Bundesministerium der Finanzen (BMF) [German Federal Ministry of Finance] presented a first draft legislation of the revised Investment Regulation (AnlV). We introduced the envisaged changes in detail in our GSK Update of June 30, 2014. On February 25, 2015 the Federal Government passed the new Investment Regulation. Below, we would like to present a summary of the main changes in the adopted Investment Regulations over the draft of May 2014. 2. Distinction between closed-ended and open-ended investment funds Remarkably, the existing German regulatory understanding will still be applicable to the scope of the Investment Regulation with regard to the distinction between open-ended and closed-ended investment funds. It is based on the definition of open-ended and closed-ended investment funds as defined in Section 1 Subsection 4 and 5 of the Kapitalanlagegesetzbuch (KAGB) [German Capital Investment Act] in the version in force until July 19, 2014. In deviation from the understanding under the European regulation, an investment fund qualifies as open-ended only if investors are entitled at least once a year to return against disbursement of their shares or stocks in the investment funds. This constitutes a discrepancy with the evaluation under investment and insurance supervision law as to whether investment funds are open-ended or closed-ended. Irrespective of any potential concerns in this regard under European law, it is certainly hardly possible to comprehend the different qualifications from the perspective of market participants. 3. Privileges for investments in private equity funds In the new Investment Regulation, the investment in private equity funds is privileged in a number of respects compared to other fund investments: In contrast to all other fund investments, the new Investment Regulation provides for investments in private equity funds that even private equity funds can be acquired where the investment fund manager is registered only according to Section 44 KAGB. On the other hand, no such addition was made for any other fund investments (e.g. real estate funds, specialized AIF with fixed investment conditions). This indicates that other AIF, where the investment fund manager does not have a permit, but only a registration, are not permitted investment assets. Moreover, in case of investments via a private equity fund of funds is should not be necessary for the private equity target funds as such to meet the requirements under Section 2 Subsection 1 No. 13 b of the new Investment Regulations. Unlike in case of real estate funds and specialized AIF with fixed investment condi- 1
tions, like for other alternative investment funds according to Section 2 Subsection 1 No. 17 of the new Investment Regulations the lookthrough principle here does not apply. The resulting risk of circumvention should be regulated as part of the revision of the so-called Kapitalanlagerundschreiben [Capital Investment Circular Memorandum] by the Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin) [German Federal Financial Supervisory Authority]. Unlike all other types of investment funds, in case of private equity funds, even private equity funds managed by an investment fund manager domiciled in a full member state of the OECD which is not part of the EEA can be acquired, as long as the investment fund manager is subject to public supervision of investor protection and has a permit or registration similar to a permit under Section 20 KAGB or a registration under Section 44 KAGB (regarding comparability see below). With regard to closed-ended specialized real estate AIF, the first draft legislation of May 2014 was still inconsistent. According to the wording of the first draft legislation, only the acquisition of open-ended specialized real estate AIF and of closed-ended real estate AIF would have been permitted, but not the acquisition of closed-ended specialized real estate AIF. On the other hand, however, the reasons for the first draft legislation already indicated that in the future, closed-ended specialized real estate AIF should also be acquirable. Already in the GSK Update of June 5, 2014, in connection with the investment in open-ended and closed-ended real estate funds we had held the view that in the future, shares in closed-ended domestic specialized AIF will also be acquirable assets. In the version of the Investment regulation which has now been adopted, the above drafting error has been removed so that it now has become clear that in addition to open-ended, closed-ended specialized real estate funds are also acquirable assets. 5. Appropriations for open-ended specialized AIF with fixed investment conditions It remains to be seen if the previous additional requirements under insurance law, which so far applied only to specialized funds under the requirements set forth in the Capital Investment Circular Memorandum, will still apply to specialized AIF with fixed investment conditions according to No. 16. In detail, those are or respectively, were the following restrictions: Derivatives may be used in open-ended specialized AIF only pursuant to Section 197 Subsection 1 KAGB. In case of real estate funds, derivatives still may be used only for hedging purposes. Other investment vehicles pursuant to Section 198 No. 1 KAGB are restricted to 20%, other investment vehicles pursuant to Section 198 No. 1 through 4 to a total of 30% of the net asset value of the open-ended specialized AIF. 4. Clarification regarding closed-ended specialized real estate AIF Unsecuritized claims under loan agreements pursuant to Section 221 Subsection 1 No. 4 KAGB are restricted to 30% of the net asset value of the open-ended specialized AIF. Securities lending transactions must meet the requirements of Sections 200 to 202 KAGB with regard to security provision. Only up to 49% of the open-ended specialized AIF may be invested in fund of hedge funds according to Section 225 through 229 KAGB and in hedge funds according to 283 KAGB. Any distribution in kind, including without limitation a physical delivery of precious metals, must be excluded. Investment funds according to No. 16 must be transparent to be suitable for the restricted assets. A specific inclusion of the above requirements in the reasons for No. 16 which has been added since has 2
again been removed from the version now adopted, which could possibly indicate a future flexibilization. On the other hand, the government s reasons still state that by creating the provision in the new No. 17, investments in AIF have now become possible, which for example invest up to 100% in unsecuritized loans. This rather speaks against a broad interpretation of No. 16. In addition, shares in an open-ended AIF must be sufficiently fungible. Unlike in the draft version of May 2014, however, the legislator here does not provide any specific requirements, but leaves the details to the BaFin. According to regulatory practice by the BaFin so far, the required fungibility had to be determined depending on the fund s investments and meant that it had to be possible to redeem shares at least once per month (securities funds or respectively, funds with primarily liquid investments such as money market instruments and cash in banks) up to every six (real estate funds) or respectively, seven months (other special funds). In connection with private equity funds, where the investment fund manager is domiciled outside the EEA, in a full member state of the OECD, the comparability test has to be performed by the insurance companies themselves in their own responsibility, prior to the acquisition of shares or stocks. It is debatable which requirements will have to be applied to the comparability test of a merely registered investment fund manager domiciled outside the EEA; in particular it remains to be seen if the BaFin here, too, will consider compliance with the threshold relevant registration values under the AIFM Directive to be decisive (cf. in this regard our Update of June 30, 2014). The requirements of open-ended specialized AIF with fixed investment conditions under insurance supervision law therefore will continue to be stricter than the requirements under investment law according to the KAGB. However, at this stage this is not associated with any major changes to the content compared to the current legal situation. 6. Comparability test for investments outside the EEA The new Investment Regulations provide in various sections that domestic or EU investment funds of investment fund managers domiciled within the EEA which are subject to public supervision of investor protection and have a permit similar to a permit under Section 20 KAGB are equivalent to investment funds managed by a domestic investment fund manager. In connection with the investment in private equity funds, the reasons state that in case of investment fund managers domiciled within the EEA, comparability in principle applies because of the unified European scope of the AIFM Directive. This also applies analogously to European risk capital funds according to Section 337 KAGB and to European funds for social entrepreneurship according to Section 338 KAGB. 7. Conclusion Applying different definitions for classification as an open-ended or closed-ended investment fund for the purposes of investment supervision and for the insurance supervision must be taken into account in future investment fund evaluations. The extensive relaxations especially in the area of private equity funds can be traced back to the considerable efforts by the relevant industry representatives and as such must be welcomed. In particular investment fund managers in the private equity field have in many cases utilized the option of registration without full permit since the AIFM Directive has entered into force in the respective member states. Moreover, many funds of funds do in fact invest in not regulated private equity funds domiciled outside the EEA. Most of the standard private equity funds on the relevant market for institutional investors thus would no longer have been suitable as an investment under the Investment Regulations. It remains to be seen, however, how the BaFin will, as part of the announced supervisory 3
circular memorandum, restrict the associated circumvention options. However, it must be scrutinized why those welcomed relaxations were introduced only for investments in the area of private equity funds, since a corresponding extension in the area of e.g. real estate funds would also have met market demands. The clarifications regarding the suitability of closedended specialized real estate AIF are to be welcomed. It remains to be seen which requirements the BaFin will in the future place on the fungibility of the shares in an AIF and whether it will continue in future to maintain its previous further requirements under insurance law as regards specialized AIF with fixed investment conditions. Also with regard to the question of comparability of investments in third countries it probably has to be expected that the BaFin will substantiate in a future Capital Investment Circular Memorandum, when comparability can be assumed. For the time being there will remain a certain legal uncertainty. It remains to be seen in any case which potentially additional requirements or respectively, substantiations will result from the yet to be issued BaFin Capital Investment Circular Memorandum with regard to the new asset classes. Sascha Zentis Lawyer and Notary Public Frankfurt office zentis@gsk.de Dr. Timo Patrick Bernau Lawyer Munich office bernau@gsk.de 4
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