The Act Implementing the AIFM Directive

The Act Implementing the AIFM Directive FINANCIAL INSTITUTIONS ENERGY INFRASTRUCTURE, MINING AND COMMODITIES TRANSPORT TECHNOLOGY AND INNOVATION PHARMACEUTICALS AND LIFE SCIENCES Briefing December 2012 Summary The European Alternative Investment Fund Manager Directive (AIFM Directive) will regulate and affect the marketing of virtually all types of funds and their managers (e.g. mutual or closed-end, all traditional and alternative asset classes, all jurisdictions). This briefing explains the legal situation in Germany on the basis of draft legislation proposed by the German Federal Ministry of Finance dated 30 October 2012. The final version is expected to be published in the Federal Law Gazette in spring 2013. Pursuant to the AIFM Directive, it must be transposed into national law by 22 July 2013 at the latest. 1 Scope of investment law It is vitally important for asset managers, distribution channels and investors to understand clearly the scope of the future investment legislation transforming the AIFM Directive 1 and the (Consultation Draft of the) Act Implementing the AIFM Directive. 2 In addition to severe sanctions which may be imposed by the Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht BaFin), potentially affecting the reputations of parties subject to the AIFM Directive, its impact may involve claims for civil law damages, tax consequences and, in exceptional cases, even criminal penalties. Moreover, in future it will be more difficult to identify scenarios falling outside the scope of the investment legislation because the existing fund definition in the German Investment Act (Investmentgesetz InvG) which, at the fundamental level, has a wide scope but, in its more detailed application, is strictly limited by additional formal criteria will be replaced by a purely substance-over-form approach (the so-called material fund definition ) under the Capital Investment Code (Kapitalanlagegesetzbuch KAGB). 3 Such a definition had already been used before 2004, but even at that time, had caused significant difficulties in terms of its application. In what follows, both categories the formal and the material fund definition (cf. 1.1) are described as such. Ramifications of the new material fund definition under the KAGB (cf. 1.2) and its exceptions are explained in detail (cf. 1.3). Its effects on practically relevant scenarios are examined (cf. 1.4) and the determinants for future structuring are outlined (cf. 1.5). 1 Directive 2011/61/EU of the European Parliament and of the Council of 8 June 2011 on Alternative Investment Fund Managers and amending Directives 2003/41/EC and 2009/65/EC and Regulations (EC) No. 1060/2009 und (EU) No. 1095/2010, Official Journal of the European Union L 174/1. 2 Consultation Draft of an Act implementing Directive 2011/61/EC on Alternative Investment Fund Managers, (AIFM- Umsetzungsgesetz AIFM-UmsG) as of 30 October 2012. 3 The Capital Investment Code (Kapitalanlagegesetzbuch) (hereinafter Capital Investment Code or KAGB-E ) is published as Art. 1 of the Draft Bill.

1.1 Formal and material fund definitions and their respective backgrounds Under German law, there is no long-term consistency as regards the definitions that apply in the investment sector. Rather, the fund definition applicable at a particular time corresponds with the then prevailing regulatory doctrine. In times of strict regulation, the material fund definition tends to prevail, while in times of less stringent regulation the formal definition applies: By applying a substance-over-form approach, the material fund definition aims at avoiding all actual or alleged attempts to circumvent the law to the disadvantage of investors. The purpose of the formal fund definition, on the other hand, is to ensure legal certainty, leaving it to the discretion of product providers and investors to decide whether or not to put themselves within the scope of investment regulatory law. Hence, in view of the ongoing global financial crisis, the introduction of a material fund definition which is prescribed by the EU Directive and, thus, beyond the control of the German legislator, is not surprising. Until 2003, a purely material fund definition had existed under the former Foreign Investment Act (Auslandinvestmentgesetz AIG). The purpose of the material fund definition was to capture as many collective investment scenarios as possible, despite the high complexity of investment products existing outside Germany, for the purpose of investor protection and to thwart any attempts to circumvent the law. Also the Investment Modernisation Act of 2004 had initially applied a material fund definition. The current fund definition has been applicable since the end of 2007, when the Act Amending the German Investment Act (Investmentänderungsgesetz InvÄndG) added formal conditions to the fund definition. Under the current law, the fund definition comprises a material definition, which forms its basis, and formal restriction criteria overlaying and limiting it. The reason that was given for this change was to limit the scope of the InvG to open-ended funds or funds that are subject to investment supervision in their home state. 4 This has provided the investment sector with considerable legal certainty and has proved successful in practice. Following the financial crisis, the consultation draft of the Draft Bill focuses on (alleged) investor protection and aims to reach the widest scope of application possible by prescribing a material fund definition: 5... the Capital Investment Code uses a material investment fund definition in line with the requirements of the AIFM Directive. This means that any collective investment undertaking that collects capital from a number of investors with a view to investing that capital for the benefit of those investors in accordance with a defined investment strategy qualifies either as an undertaking for collective investment in transferable securities (UCITS) or as an alternative investment fund (AIF) and, accordingly, must meet the requirements under either the UCITS Directive or the AIFM Directive and, thus, also the requirements of this Act. A fund that does not meet the respective requirements is unlawful and constitutes prohibited investment business. 4 Cf. printed paper of Federal Parliament 16/5576, p. 56. 5 Draft Bill, p. 321. 02 Norton Rose December 2012

In line with the above objective, the term investment asset pool (Investmentvermögen) is introduced as a new generic term and is legally defined in section 1 sub-section 1 sentence 1 KAGB-E as follows: any collective investment undertaking other than an operationally active enterprise outside the financial sector that collects capital from a number of investors with a view to investing that capital for the benefit of those investors in accordance with a defined investment strategy. In section 1 sub-section 1 sentence 2 KAGB-E, undertakings for collective investment in transferable securities (UCITS) and alternative investment funds (AIFs) are defined as the two sub-categories of investment asset pools. As UCITS funds are strongly formalised and, by definition, cannot come into existence if not established by a licensed fund management company, the material investment definition will mainly affect AIFs. Due to the definition s wide scope, many scenarios involving asset management products may, in future, qualify as AIFs, subjecting them and their respective managers the AIFMs to supervision under the KAGB-E. If (possibly by reason of an error) such a situation is not identified, it may have drastic consequences for managers, distribution channels and investors. 1.2 Fund definition and the scope of the KAGB-E 1.2.1 Interpretation of the law The correct approach to the interpretation of the law is of particular importance, as the material fund definition in section 1 sub-section 1 sentence 1 KAGB-E is based on only very few criteria that are not clearly distinguished from each other. The relevant parts of the definition are: i. a collective vehicle (collective investment undertaking) ii. that collects money iii. from a number of investors iv. with a defined investment strategy, and v. in doing so, acts for the investors benefit vi. unless the vehicle is an operationally active enterprise outside the financial sector. Except for the definition of a number of investors in section 1 sub-section 1 sentence 3 KAGB-E, the above criteria are neither described in more detail nor further specified in any other way. Also, the legislative notes (Gesetzesbegründung) to the Draft Bill do not contain information beyond the statement that the widest possible scope of application should be created: 6 Sub-section 1 defines the term investment asset pool as the generic term for all funds irrespective of their legal form and irrespective as to whether they are open-ended or closedended funds. Thus, investment asset pools comprise both undertakings for collective investment in transferable securities (UCITS) and alternative investment funds (AIFs). The definition includes domestic UCITS and EU-UCITS as well as domestic AIFs, EU-AIFs and foreign AIFs. 6 Draft Bill, substantiation to section 1 sub-section 1, p. 362. Norton Rose December 2012 03

In the case of laws that implement a European directive, the focus is on a European lawcompliant interpretation. Thus, statements contained in the discussion paper of ESMA 7 dated 23 February 2012 Key concepts of the Alternative Investment Fund Managers Directive and types of AIFM (hereinafter referred to as Discussion Paper ) are of particular importance. A purely national issue impacts massively on the interpretation of the scope of the KAGB-E and the fund definition. According to section 307 no. 1 KAGB-E, anyone who performs the business of a capital management company as specified in section 20 sub-section 1 KAGB-E without holding a licence is punishable. Even AIF capital management companies that manage small special AIFs and conduct their business without being registered are subject to punishment according to section 307 no. 2 KAGB-E. Section 17 sub-section 1 KAGB-E provides that capital management companies are domestic undertakings whose business is aimed at, amongst other things, managing domestic investment asset pools. Consequently, whether or not an offence is committed is directly determined by the fund definition. According to the principle no penalty without a law of Article 103 sub-section 2 of the German Constitution (Grundgesetz GG), an individual must be made sufficiently aware whether and which behaviour incurs criminal liability. This means that, for constitutional reasons, the investment fund definition is to be interpreted narrowly. The constitutional principle takes priority over the will of the national legislator. Furthermore, a Community law-compliant interpretation reaches its limits here, as the AIFM Directive, even though not self-executing but mandatorily requiring transposition into national law, would be superseded by Article 103 sub-section 2 GG. Hence, a broad interpretation of the fund definition is not appropriate where criminal liability would be no longer sufficiently foreseeable. The aforementioned considerations drive the interpretation and definition of an investment asset pool (Investmentvermögen). 1.2.2 Criterion: collective investment undertaking The first criterion collective investment undertaking is not defined in the AIFM Directive. These words appear to be a reference to the UCITS Directive 8 where the term is also used, but not specified. The term may have to be understood in the sense of a collective investment vehicle. The following criteria are stated in clause 28 of the Discussion Paper: An AIF for the purposes of the Article 4 must be a collective investment undertaking which pools together capital raised from investors. A collective investment undertaking should have the purpose of generating a return for its investors through the sale of its investments as opposed to an entity acting for its own account and whose purpose is to manage the underlying assets with a view to generating value during the life of the undertaking. The above understanding refers to a form of organisation which allows the creation of a pool of assets with the possibility to allocate such assets to several parties involved. Hence, it serves, on the one hand, as differentiation from individual portfolio management and trust situations, where no joint asset pool is created but where an investor grants an individual authorisation, and, on the other hand, as differentiation from own profit-making situations. The latter alternative is closely related to, and discussed in, the paragraph on holding companies. 9 7 http://www.esma.europa.eu/system/files/2012-117.pdf. 8 Directive 2009/65/EC of the European Parliament and of the Council of 13 July 2009 on the coordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities (UCITS). 9 Cf. clause 1.3.1. below. 04 Norton Rose December 2012

Another aspect of the fund definition, i.e. that investors cannot directly access or control the assets of the fund, is stated in clauses 33 and 34 of the Discussion Paper. Accordingly, a managed account does not qualify as a collective investment undertaking as it lacks the element of collectivity and the holder in addition to the manager of the account retains or, in any event, may resume its power of disposal. This would also apply if a group of investors opened a joint account or securities custody account and an asset manager was granted authority with respect to the account. This will mainly be the case if the portfolio management is outsourced to an asset manager. Rather than the asset manager level, the collective investment undertaking is only created at the level of the outsourcing fund. This opinion is confirmed by section 36 sub-section 1 no. 3 KAGB-E, according to which an outsourced provider requires a licence for individual asset management or financial portfolio management. 1.2.3 Criterion: capital raising The wording of the criterion capital raising requires an activity on part of the investment asset pool. This means that processes of a purely passive nature are excluded from its scope. Hence, if several persons come together and actively pool money, this can conceptually no longer be considered as capital raising. The Discussion Paper also picks up another aspect by pointing out that any capital raising which is not intended to deliver an investment return or profit should not be considered an AIF, because the concept of capital raising has a commercial component. The example scenario given in the Discussion Paper is that a group of householders purchases a piece of neighbouring land to use it as a common area. 1.2.4 Criterion: number of investors As regards the criterion number of investors, section 1 sub-section 1 sentence 3 KAGB-E states that this criterion is met, if the investment conditions, the articles of association or the instrument of incorporation of the collective investment undertaking do not limit the number of possible investors to one single investor. Actually, the same criterion as the requirement of a collective vehicle is referred to here. Where a number of investors is conceptually excluded, only individual management can exist. In particular, wholly-owned group companies are thus exempt from the scope of the KAGB-E. However, in cases other than the clear cases of individuals or legal persons, the question of the definition of investor arises. In view of the fact that the KAGB-E s purpose is to cover only collective investment situations, the relevant criterion is whether the single investor acts as a single legal entity. This is affirmed in cases of joint ownership both with regard to commercial partnerships and civil law partnerships. But if a trustee acts as intermediary for several investors, the criterion of the single investor is not fulfilled. Clause 29 of the Discussion Paper describes a case where a representative acts on behalf of a number of investors. This is relevant, in particular, in the case of a trustee acting as limited partner a structure which is commonly used for closed-ended funds. Formally, a trustee who acts as limited partner is a single investor. But since, economically, the trustee is not to carry any rewards or risks itself, the Discussion Paper looks through the trustee to the investors. Norton Rose December 2012 05

Equally, a co-ownership by fractional shares presumably does not fulfil the criterion of a single investor. Accordingly, more than one investor should exist. However, a clear distinction is to be made here. If a co-ownership by fractional shares acts as investor with regard to an undertaking, more than one investor exists. But whether a co-ownership by fractional shares itself may be classified as an AIF is an entirely different issue. This cannot be affirmed, because, rather than being a collective vehicle, the asset manager acts for each individual co-owner directly. 1.2.5 Defined investment policy As another criterion, an investment asset pool is characterised by its compliance with is a defined investment policy. A collective investment vehicle requires that an investment strategy be followed. On page 11 of the Discussion Paper, the criterion defined investment policy is interpreted to the effect that the following prerequisites are to be met: the investment policy is to be fixed, at the latest, by the time an investor makes a binding commitment the investment policy is incorporated in the constitutional documents the investment strategy forms part of the contractual relationship between the vehicle and the investor determination of investment guidelines (asset categories, geographical regions, leverage, holding periods, risk diversification) that determine more precise criteria than the ones followed by an operating company pursuing a business strategy disclosure of the investment strategy to the investors disclosure and consent requirements in case of changes to the investment strategy. The Discussion Paper does not specify whether all of the above prerequisites have to be met. Instead, it must be assumed that an overall view is presented here and compliance has to be examined on the facts in individual cases. Another aspect of the criterion defined investment policy is the distinction between investment and non-investment strategies. The scope of investment law can only apply if the purpose of the collective vehicle is closely related to an investment purpose. Investment purpose means the purchase and passive holding of assets. An investment policy does not exist, however, if the purpose is aimed at other objectives in particular, production and services and if assets are not purchased or only purchased incidentally to serve purposes other than the mere holding. In a mixed profile situation, the focus is relevant. Only if the investment purpose has clear priority may a collective investment vehicle be assumed to exist. The question arising in this connection is the quantification of priority. A collective investment vehicle with an investment strategy may only be assumed to exist if at least 90 per cent of the overall objective focus is on the investment purpose, while non-investment purposes are irrelevant in comparison. For example, a construction project development company, which, in order to add value to project development, also acquires real property, does not qualify as an investment asset pool. The same should apply to film funds, provided the objective of the fund is to create a new film licence rather than to acquire one. 06 Norton Rose December 2012

1.2.6 Benefit to investors According to the legal definition of section 1 sub-section 1 KAGB-E, a major criterion of distinction between an investment asset pool and an operating company is investment to the investors benefit. However, this criterion poses considerable difficulties, because operating companies also ultimately intend to create value for their shareholders as is evident from the well-known and accepted concept of shareholder value. A conclusion may not be drawn from the distribution and reinvestment behaviour either, as this is not necessarily different between funds and operating companies. Both distribution and reinvestment are activities equally common to funds and operating companies. In any case, investor s benefit will not be held to exist if the vehicle s performance does not correspond with the investment instrument s value. This criterion also involves the definition of a unit in an investment asset pool. Although not the subject of discussion here, this definition must also be dealt with as these aspects are closely linked with each other. If the legal relationship with the vehicle does not reflect its performance i.e. the delta factor significantly deviates from 1 the vehicle does either not qualify as an investment asset pool or the legal relationship with the vehicle does not qualify as a fund unit: If an investor receives compensation for its investment which is independent from the vehicle s performance, the investment is a debt instrument. Here, it is irrelevant from the investor s point of view whether the vehicle qualifies as an investment asset pool or not, as the investor does not hold any shares in it. If the investor receives a multiple of the vehicle s performance, it does not qualify as an investment asset pool either; further or alternatively, the instrument does not qualify as a fund unit, but is to be attributed to the gambling and betting sector (and in such a case, enforceability under civil law depends on other factors). 1.2.7 No operationally active enterprise outside the financial sector In light of the vague definition of an investment pool, the legislator acknowledges that the definition could extend to numerous scenarios clearly outside the focus of the AIFM Directive. Therefore, the legislator has introduced a carve-out for operationally active enterprises (operativ tätige Unternehmen) outside the financial sector (Finanzsektor). The basic idea is that a vehicle allocating a relevant percentage of its resources to the production of goods should not be construed as an investment pool. However, apart from this basic proposition, the carve-out is difficult to interpret since there is neither a common understanding of an operationally active enterprise nor a specification for a financial sector. By way of example, if a sponsor establishes a vehicle generating value by the acquisition and refurbishment of a property in order to generate a capital gain upon disposal, such scenario should benefit from the carve-out. Since the vehicle will provide refurbishment services, it should be seen as operationally active. Norton Rose December 2012 07

1.3 Exemptions from the fund definition The AIFM Directive and the KAGB-E exclude a number of enterprises which are not considered to require supervision, or which are regulated in other ways, from the scope of the fund (manager) definition. The categories that are relevant in practice are discussed below. 1.3.1 Investment firms Section 2 sub-section 2 KAGB-E excludes investment firms and credit institutions from the scope of capital management companies: Investment firms authorised under Directive 2004/39/EC 10 and credit institutions authorised under Directive 2006/48/EC 11 are not obliged to obtain a licence under this Act to render investment services, such as individual portfolio management services to AIFs. In principle, this provision has only a clarifying purpose, because due to the absence of a collective investment character, the individual portfolio management does not fall within the scope of the AIFM Directive and the KAGB-E. 1.3.2 Family offices While the wording of the KAGB-E does not explicitly refer to family offices, family offices should be excluded from its scope according to recital 7 of the AIFM Directive and the explanation contained in the KAGB-E 12. Interestingly enough, according to recital 7 of the AIFM Directive, family offices are regarded as a sub-category of investment undertakings. This will normally not be the case. However, this consideration should not have an impact on the exemption as such. The exemption to the extent a family office can be considered an AIF at all is justified by a teleological reduction, because the family s connectivity ought to extinguish the conflict of interest usually existing within a group of unrelated individuals. It is mandatory, however, that no external fund raising 13 take place outside the family. The German translation, which refers to the avoidance of Fremdkapital (debt) is apparently based on a mistake. Accordingly, it is external capital, rather than debt 14, that must be excluded. On this basis, single family offices are clearly exempt from the scope of application. In case of multi family offices, an exemption from the scope of application should also be possible if certain requirements are met. 15 10 MiFID Directive, Official Journal of the European Union L 145/1 of 30 April 2004. 11 Banking Consolidation Directive, Official Journal of the European Union L 177/1 of 30 June 2006. 12 Draft Bill, p. 346. 13 AIFM Directive, English version, Official Journal of the European Union, L 174/1, Recital 7 reads as follows without raising external capital, while the German version is translated as ohne Fremdkapital zu beschaffen (without raising debt capital). 14 Although the translation mistake of the AIFM Directive s wording has made its way into the explanatory comments to KAGB-E, p. 346, it may be assumed that the actually intended content of the Directive should be transposed, considering that the legislator must be presumed to have intended only to implement the AIFM Directive. 15 For detailed information, cf. Krause/Klebeck, BB 2012, 2063 to be published in August. 08 Norton Rose December 2012

1.3.3 Holding companies Pursuant to section 2 sub-section 1 no. 1 KAGB-E, holding companies do not fall within the scope of capital management companies. A holding company is (freely translated) a company with shareholdings in one or more other companies, the commercial purpose of which is to carry out a business strategy or strategies through its subsidiaries, associated companies or participations in order to contribute to their longterm value, and which is either a company operating on its own account whose shares are admitted to trading on a regulated market in the Union, or a company not established for the main purpose of generating returns for its investors by means of divestment of its subsidiaries or associated companies, as evidenced in its annual report or other official documents. European and German legislators have been confronted with the issue of differentiating between holding companies with widespread interests and fund constellations. This is a challenge, as there are, at most, only marginal differences between a holding company and a long-term oriented private equity fund. Both achieve added value through the subsidiaries which they control and whose value they wish to increase in the long term. A differentiation from private equity funds is seen in the intended exit through the proposed sale of subsidiaries (targets). Indeed, this is a characteristic of private equity funds but it is not unique. Equally, industrial and financial groups might plan from the outset to sell subsidiaries in case adequate capital gains stand to be made. For this reason, the German legislator has provided for a formalisation to the effect that companies which operate for their own account and are listed on a regulated market are exempt from the scope of the KAGB-E. Accordingly, it is sufficient that the annual report and official documents do not contain any statement to the effect that the company s purpose comprises the adding of value through the sale of holdings in subsidiaries. 1.3.4 Securitisation According to section 2 sub-section 1 no. 7 KAGB-E, securitisation vehicles do not qualify as capital management companies. This is consistent with the implementation of recital 8 of the AIFM Directive. Freely translated, section 1 sub-section 19 number 32 KAGB-E defines securitisation vehicles as companies whose sole purpose is to carry out one or several securitisations within the meaning of Article 1 sub-section 2 of Regulation (EC) No. 24/2009 of the European Central Bank of 19 December 2008 concerning statistics on the assets and liabilities of financial vehicle corporations engaged in securitisation transactions (Official Journal L 15 of 20 January 2009, p. 1) and to carry out additional activities which are suited to fulfil this purpose. Norton Rose December 2012 09

Section 1 sub-section 2 of Regulation (EC) No. 24/2009 reads as follows: 2. securitisation means a transaction or scheme whereby an asset or pool of assets is transferred to an entity that is separate from the originator and is created for or serves the purpose of the securitisation and/or the credit risk of an asset or pool of assets, or part thereof, is transferred to the investors in the securities, securitisation fund units, other debt instruments and/or financial derivatives issued by an entity that is separate from the originator and is created for or serves the purpose of the securitisation, and: in case of transfer of credit risk, the transfer is achieved by: the economic transfer of the assets being securitised to an entity separate from the originator created for or serving the purpose of the securitisation. This is accomplished by the transfer of ownership of the securitised assets from the originator or through subparticipation, or the use of credit derivatives, guarantees or any similar mechanism; and where such securities, securitisation fund units, debt instruments and/or financial derivatives are issued, they do not represent the originator s payment obligations. The differentiation between securitisation vehicles and investment funds is particularly difficult, as both such enterprises are closely connected with each other. Most striking is the overlap in the case of Managed Collateralised Debt Obligations (Managed CDOs), whose fund character had already been hotly debated under the former AIG. However, this legal issue does not apply to the current situation, as the legislator has stipulated a clear exemption. According to the definition contained in the Regulation, it is sufficient to transfer the asset pool to a securitisation vehicle to avoid the applicability of the KAGB-E. However, the existence of credit risks (in which case special rules would apply) or a division into tranches is not required. Thus, managers of Managed CDOs are exempt from the definition of an AIFM. 1.3.5 Insurances According to recital 8 of the AIFM Directive and p. 368 of the Draft Bill, which, however, is not reflected in the KAGB-E, insurance contracts do not fall within the scope of the investment law. This is accounted for in the Draft Bill insofar as, in Article 26 amending the Insurance Supervisory Act (Versicherungsaufsichtsgesetz VAG), it provides for cases where an insurer invests in AIFs for the purposes of insurance contracts and, thus, also clarifies that the embedding of funds in insurance contracts (an insurance wrapper ) is not subject to the KAGB-E. 1.3.6 Joint ventures Pursuant to recital 8 of the AIFM Directive and page 368 of the Draft Bill, joint ventures are also excluded from the scope of the KAGB-E. A definition of the term joint venture, however, is not provided. In general, a joint venture is defined as the systematic cooperation of two or more parties each of which contributes to the achievement of a common objective. Correspondingly, if several parties come together to pursue a common purpose such as an investment purpose the KAGB-E does not apply. 10 Norton Rose December 2012

1.4 Scenarios Besides the aforementioned explicit exemptions and the exemptions which are at least mentioned in the explanatory comments to the law, there are further scenarios outside the scope of the KAGB-E. 1.4.1 Structured products Characteristic to structured products is that an issuer issues a cash instrument in which a (basic or complex) derivative is embedded. Often but not necessarily credit institutions act as issuers. Since, as a consequence of the financial crisis investors are not always permitted to have a (high) credit exposure to a single credit institution, single purpose vehicles (SPV) are also frequently used as issuers. Cases where credit institutions act as issuers obviously do not fall within the scope of the KAGB-E, as, due to their operating activities, credit institutions cannot qualify as an investment asset pool. Moreover, the KAGB-E does not apply to situations where a SPV acquires, for example, investment fund units, issues structured or hybrid products (delta-1 certificates or participation rights or certificates) with respect thereto, and then provides such investment fund units to investors as collateral against the possibility that the SPV fails to duly comply with its obligations under the certificates or other instruments. However, the fact that the KAGB-E does not apply to these cases certainly requires a more detailed explanation. As regards participation rights, the legislator has expressly provided for the non-applicability of the KAGB-E by amending section 1 sub-section 2 of the Capital Investment Act (Vermögensanlagegesetz VermAnlG) by Article 4 of the Draft Bill. The new wording is as follows (freely translated and amendments shown in italics): (2) Capital investments within the meaning of this Act are: 1 shares granting a participation in the profit or loss of an undertaking; 2 shares in a pool of assets held or managed by the issuer or a third party in its own name for the account of others (trust assets); 3 units in other closed-ended funds; 4 participation rights; and 5 registered bonds, which are not represented by securities within the meaning of the WpPG and not structured as shares in investment asset pools within the meaning of section 1 sub-section 1 KAGB. On page 559 of the Draft Bill, the above amendment is explained as follows (freely translated): This amendment ensures that the Capital Investment Act (Vermögensanlagengesetz) henceforth only applies to capital investments, which are not subject to the new provisions of the Capital Investment Code; this may apply, in particular, to participation rights and registered bonds. Thus, it is explicitly stated that, as a general rule, participation rights are not treated as fund units. Norton Rose December 2012 11

This position is confirmed also at the EU level, as structured products are subject to the Packaged Retail Investment Products Regulation (PRIPs Regulation 16 ) and it is, therefore, not considered to extend the scope of the AIFM Directive. The non-applicability of the KAGB-E to delta-1 certificates and hybrid instruments results from the fact that these instruments do not enable the investor to participate fully in the vehicle s performance, but instead give him the status of a creditor. Therefore, they do not constitute capital investments for the benefit of the investor. The future legal environment under the KAGB-E is likely to be quite similar to the situation that existed historically between 2004 and 2007 when a material fund definition applied. At that time, both the tax department of the Federal Ministry of Finance (Bundesfinanzministerium) 17 and BaFin 18 issued decrees pursuant to which fund-linked certificates were not to be construed as fund units. 1.4.2 Issuing entities in the context of group financing Issuing entities, which are often used in the context of group financing, do not fall within the scope of the KAGB-E either. The issuing entity (which is often either a Delaware LLC or Dutch BV) issues bonds that replicate the debt or equity capital performance of the domestic parent company. In principle, the statements made above on structured products apply mutatis mutandis, because in this situation also, no company shares, but only hybrid instruments, are issued. 1.5 Structural considerations In view of the changing environment, the asset management industry will have to decide whether to meet the requirements of the KAGB-E or change to other forms of capital investment products. In this context, in particular, the following criteria will be relevant: administrative expenses and costs incurred due to the AIFM Directive and KAGB-E, respectively, in particular, the costs of the mandatory depositary treatment of fund units and capital market products under Solvency II, as insurers are the most important group of investors and, therefore, their regulation is a decisive factor when determining the structure of investment products corporate law issues arising from legal action taken by limited partners if they are unsatisfied and tax treatment of investment products at fund and investor level; the tax burden depends on the asset class and the investor type and, thus, the potential for tax optimisation exists. 16 Proposal for a Regulation of the European Parliament and of the Council on key information documents for investment products, 2012/0169 (COD), http://ec.europa.eu/internal_market/finservices-retail/docs/investment_products/20120703-proposal_en.pdf. 17 Federal Ministry of Finance, tax guideline on investment taxation, dated 2 June 2005, annotation 9. 18 BaFin, decree on the regulatory adoption of the tax guideline on investment taxation, dated 22 August 2005. 12 Norton Rose December 2012

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