December 2012 AIFMD implementation in Germany: Draft Capital Investment Act revised Government draft addresses industry criticism Government draft of Capital Investment Act published On 12 December 2012, the government draft of the Capital Investment Act (Kapitalanlagegesetzbuch, CIA ) was published (the Government Draft ). As outlined in our Newsletter in July, the CIA implements the Directive 2011/61/EC on Alternative Investment Fund Managers ( AIFMD ) into German law. The implementation is required by 22 July 2013. The CIA introduces a new and comprehensive legal framework for all German funds and the distribution of German and foreign funds in Germany and will replace the German Investment Act (Investmentgesetz). Extensive amendments to the first draft The Government Draft amends the first draft for discussion purposes, issued by the German Ministry of Finance on 20 July 2012 (the Discussion Draft ), with respect to crucial points and thereby addresses the partly vehement criticism which had been expressed after the publication of the Discussion Draft. The substantial amendments introduced by the Government Draft are: Table of Contents Extensive amendments to the first draft... 1 Overview of CIA product regulation... 6 Structure overview: Fund categories pursuant to the CIA and selected characteristics... 7 Simplified timetable with respect to the transition rules of the CIA... 10 Contacts... 11 Open-ended mutual real estate funds will not be abolished The Government Draft no longer provides for the heavily criticized abolishment of open-ended mutual real estate funds ( OREF ). This fund type will continue to survive as a product category. However, the liquidity requirements regarding the issuance and the redemption of units for OREF will be tightened. In the future, redemptions will only be allowed for investors once a year, subject to the expiry of a minimum holding period of 24 months, which will be applicable regardless of any threshold. The period between two redemptions must be twelve months. Furthermore, Investors need to serve a redemption notice to the fund s management company (Kapitalverwaltungsgesellschaft KVG ) twelve months prior to the relevant redemption day and the units need to be blocked by the custodian. In case an investor serves a redemption notice with less than twelve months notice prior to the relevant redemption day, the redemption New legal framework for funds in Germany 1
request would be binding nonetheless and should be treated as a redemption request for the next following redemption day, being a day nearly two years after such investor s redemption request. Such liquidity limitations would certainly need to be disclosed in the sales prospectuses of OREF. Furthermore, the issuance of new units will be limited to a maximum of four dates per year, which need to be fixed in the investment strategy of the OREF. The period between two issuance days needs to be at least three months and one of these issuance days needs to be the same day as the redemption day. The new provisions allow OREF which issue and redeem units only once a year. For this type of OREF, the possibility to trade them via a stock exchange will probably gain importance to improve the liquidity for investors. It remains to be seen whether the NAV per unit (as published by the KVG) will become less important than the stock exchange quotation for these OREF. Consistently, the fixed liquidity requirements on the fund level have been abolished as the investor liquidity has been restricted. The fund level liquidity needs to be sufficient at any point in time, based on the liquidity management calculations. The sufficient amount of liquidity will increase and decrease, depending on the proximity of the next redemption day. At the same time, the Government Draft provides for a grandfathering of existing investors, meaning investors already invested in an OREF at the time the CIA comes into force ( Existing Investors ). The current regime (as introduced by the German Act to Strengthen the Protection of Investors and to Improve the Efficiency of the Capital Market Gesetz zur Stärkung des Anlegerschutzes und Verbesserung der Funktionsfähigkeit des Kapitalmarkts AnsFuG ) regarding issuance and redemptions of units will continue to be applicable for those investors. The interaction of already existing and new provisions will probably result in a significant area of tension for a KVG. An Existing Investor whose redemption does not exceed EUR 30,000 per halfyear may redeem daily (as far as the contractual terms provide for daily redemptions). In comparison, units of new investors invested in the same OREF may only be redeemed subject to a minimum holding period of 24 months and after the expiry of such period subject to a redemption notice period of 12 months on a single day per year. This creates two groups of investors within the same product whose options with respect to redemptions could not be more different. Again, these risks will especially with a view to new investors certainly need to be disclosed in the sales prospectuses of OREF. Against this background, it is difficult to assess how the KVG will be able to act in the sole interest of the investors i.e. all investors in the fund (Sec. 26 para. 1 CIA). For example, a KVG may to protect new investors against redemptions of the Existing Investors be obliged to suspend redemptions (Sec. 98 para. 2 CIA) if portfolio devaluations are expected. New legal framework for funds in Germany 2
More flexibility for Special-AIF Eligible investors for Special-AIF The Government Draft addresses an issue created by the Discussion Draft, pursuant to which certain investors of special funds (e.g. German foundations, so called Stiftungen and municipalities) would not have qualified as professional investors. The newly introduced category of so called semiprofessional investors will be added to the list of investors eligible to invest in Special-AIF. To qualify as a semi-professional investor, investors need to make a commitment to invest a minimum of 200,000 Euro and confirm that they are fully aware of the risks associated with their investment. Furthermore, the fund manager needs to assess whether an investment is suitable for the relevant investor with respect to its expertise, experience and knowledge. Furthermore, the Government Draft clarifies that investors already invested in a Special-AIF at the time the CIA comes into force may continue to hold their investment in the Special-AIF without jeopardising the fund s status as a Special-AIF. We assume that the relevant point in time to assess whether an investor qualifies as (semi-) professional investor is the time of subscription. This should also apply to structures with capital calls, as the Government Draft references to the point in time when the investors becomes contractually obliged. In case the qualification as (semi-) professional investor falls away at a later point in time, the fund s status as Special-AIF should not be jeopardised. Unlike the German Investment Act (which is being replaced by the CIA), the CIA does not reference to the actual status of the fund s investors but only to the fact that the investors of a fund are limited contractually to (semi-) professional investors. Eligible assets The eligible assets for Special-AIF are no longer limited. Open-ended and closed-ended Special-AIF have full flexibility regarding investments in any type of assets and are not limited to mainly invest into (non-) financial instruments as it had been stipulated by the Discussion Draft. As a consequence, KVGs have full flexibility to structure Special-AIF as closedended or open-ended funds. For private equity funds, this clarifies that private equity participations are eligible irrespective of whether a certain participation qualifies as (non-) financial instrument. In practice, closed-ended Special-AIF may there- New legal framework for funds in Germany 3
fore acquire all types of participations in companies that are currently typically acquired by private equity funds. More flexibility for closed-ended Mutual-AIF Eligible assets The catalogue of eligible assets for closed-ended Mutual-AIF is expanded significantly. Tangible assets are eligible without limitation. Furthermore, private investors will be able to invest directly into private equity funds in the form of closed-ended Mutual-AIF, as interests in non-listed companies were added to the eligible assets of this fund type. Pursuant to the Discussion Draft, fund of funds structures would have been required for private investors to invest into private equity. The limitation to 49 per cent of the total AIF value for investments in securities has been removed. Debt and intangible assets like licences and copyrights will still not be eligible investments for closed-ended Mutual-AIF. Leverage The leverage limitation for closed-ended Mutual-AIF is being raised from 30% to 60% of the AIF s total value. Minimum investment The minimum investment threshold for investors in closed Mutual-AIF that are not risk diversified is being lowered from 50,000 Euro to 20,000 Euro. Risk diversification means pursuant to the CIA an investment in at least three tangible assets where each have equivalent acquisition risk or the spreading of the investment risk is ensured. AIF which do not satisfy these criteria are not risk diversified and the minum investment threshold set out above will apply. An exemption applies for Mutual-AIF which are invested in private equity: such private equity Mutual-AIF always need to adhere to the principle of risk diversification. Tax efficient structuring of an Investment-KG Under the Government Draft, limited partners may be appointed as manager of an open-ended or closed-ended Investment-KG (special forms of a German limited partnership introduced by the CIA). The Discussion Draft previously required the management to be exercised exclusively by the General Partner. The Government Draft allows structuring of an Investment-KG which would not be subject to trade New legal framework for funds in Germany 4
income tax, based on the current tax regime, the draft of the amended German Investment Tax Act and further tax regulations. Transitional provisions The Government Draft also provides for amendments and clarifications of the transitional provisions. Transition period for the administration and distribution of new AIFs prior to licencing of business operations KVGs which were already engaged in licensable activities pursuant to the CIA prior to the CIA coming into force may until 21 January 2015 manage and distribute new AIFs without a licence if the application for such licence is filed with the German Financial Supervisory Authority by 21 July 2014. In practice, this means a substantial improvement for asset managers. Based on the Discussion Draft, no new AIFs could have been established after 22 July 2013 and KVG licences would have needed to be obtained at short notice. Asset managers would now have more time for the implementation of the new requirements introduced by the CIA and the widely held concern that for a period no new products would have been launched has been addressed. Alternative depositaries For closed-ended AIF with no redemption right within the first five years after the commencement of investment activities by the fund and with a general investment focus on assets for which safekeeping is not mandatory or interests in unlisted companies, a trustee can be appointed as depositary. In performing its duties as depositary, the trustee needs to act within the scope of its business activities and needs to be subject to a mandatory registration or professional self regulation ensuring (through financial/professional guarantees) the effective performance of the depositary s duties by the trustee. Consequentially, auditors and similar professionals may be qualified to be appointed as trustee. Still no private placement exemptions The criticism regarding the lack of private placement exemptions in the Discussion Draft went unheard. Private placement means the non-public distribution to investors outside the scope of a placement regime. Following the commencement of the CIA, such private placements will not be possible in Germany. The placement regime of the CIA is applicable to every placement of units which qualifies as distribution within the meaning of the CIA. New legal framework for funds in Germany 5
Limited definition of distribution In comparison to the definition of distribution under the Discussion Draft, the Government Draft definition has moved closer to the definition of distribution pursuant to the AIFMD. Distribution to professional and semi-professional investors therefore requires an offering, placement or marketing on the initiative of the KVG or the (EU-)AIFM (as applicable). A placement on the initiative of an investor (so called reverse solicitation ) would consequentially not qualify as distribution pursuant to the CIA and the placement regime of the CIA would not be applicable. The German Financial Supervisory Authority (BaFin) may introduce guidelines to determine the definition of distribution in further detail. Distribution of Non-EU-AIF and by Non-EU-AIFM in Germany The Government Draft extends the possibilities for distribution of Non- EU-AIF in Germany and the distribution of EU-AIF by Non-EU-AIFM in Germany, as facultatively provided by the AIFMD. The following two further possibilities are introduced: distribution of Non-EU funds by KVGs and EU managers to professional and semi-professional investors in Germany and distribution of EU funds by Non-EU managers to professional and semi-professional investors in Germany. Overview of CIA product regulation The CIA leads to a new categorisation of German funds. The Government Draft slightly amends this categorisation. The following overview of the new product categories updates the overview attached to our previous newsletter dated 31 July 2012. The amendments are highlighted in red. New legal framework for funds in Germany 6
Structure overview: Fund categories pursuant to the CIA 1 and selected characteristics Characteristics Open-ended/ Close-ended Eligible Investors Permissible Vehicles German UCITS German Investment Funds German AIF Open-ended Open-ended Close-ended Mutual UCITS Special-AIF Mutual-AIF Special-AIF Mutual-AIF Professional Investors Semi-professional Investors Private Investors Contractual form (Sondervermögen) Investment Stock Corporation with variable capital Eligible Assets Securities (Sec. 193) Money Market Instruments (Sec. 194) Bank Deposits (Sec. 195) Fund Units (Sec. 196) Derivatives (Sec.197) Other Investments (Sec. 194) Professional Investors Semi-professional Investors Contractual form (Sondervermögen) Investment Stock Corporation with variable capital Open-ended Investment Limited Partnership No catalogue of eligible assets but must invest predominantly in financial instruments (Sec. 249 para. 1) Market value must be assessable Non-controlling participations in private companies Special case: Open-ended Special-AIF with fixed investment strategy (Sec. 284) Professional Investors Semi-professional Investors Private Investors Contractual form (Sondervermögen) Investment Stock Corporation with variable capital Fixed catalogue of eligible assets, depending on permitted fund type, which consists of (Sec. 214): Mixed Funds (Sec. 219) Other Funds (Sec. 221) Hedge Fund of Funds (Sec. 225) Real Estate Funds (Sec. 231, 234, 253) No real estate investments permitted! Professional Investors Semi-professional Investors Investment Stock Corporation with fixed capital Close-ended Investment Limited Partnership No catalogue of eligible assets but must invest predominantly in financial instruments (Sec. 253 para. 1) Market value must be assessable Professional Investors Semi-professional Investors Private Investors Investment Stock Corporation with fixed capital Close-ended Investment Limited Partnership Tangible assets (in particular real estate, ships, aircrafts, renewable energy, trains, electromobiles, containers) PPP-Companies Interests in unlisted companies (Private Equity) Interests in closed-ended German and foreign Mutual-AIFs and Special-AIFs Securities within the meaning of Sec. 192 to 195 (max. 49%) Derivatives, for hedging purposes only No direct private equity investments! Risk Diversification Required investment and issuer restrictions General principle of risk diversification no special restrictions on eligible assets or issuer limits Required depending on fund type, special restrictions on eligible assets and issuer limits apply Risk diversification not required Risk diversification in principal Exemption if each investor invests a minimum of EUR 50.000 20.000 1 References to Sections refer to sections of the CIA. Amendments included in the government draft of the CIA in comparison to the draft CIA dated 20 July 2012 are highlighted in red. New legal framework for funds in Germany 7
Characteristics Open-ended/ Close-ended German UCITS German Investment Funds German AIF Open-ended Open-ended Close-ended Mutual UCITS Special-AIF Mutual-AIF Special-AIF Mutual-AIF Exemption not applicable for closedended Mutual-AIF investing in private equity (Sec. 262 para. 1 2) Leverage Short-term borrowing up to 10% (Sec. 199) Short-term borrowing: No borrowing limitation BaFin can impose limits (Sec. 211, 274) Exceptions for open-ended special AIF with fixed investment strategy short-term borrowings up to 30% Short-term borrowing up to 10%, for Other Funds up to 20% Real estate funds: borrowings up to 30% (Sec. 254) Short-term borrowing: No borrowing limitation BaFin can impose limits (Sec. 211, 274) Unclear to what extent closed-ended special AIFs can enter into long-term borrowing Borrowing up to 30% 60% (Sec. 263) when investing into real estate borrowings up to 50% (Sec. 252) Distribution Documentation: Prospectus and key investor information document EU-passport for distribution to professional and retail investors within EC/EEA (Sec. 312) Distribution must be notified to BaFin BaFin response within 20 days (Sec. 321) Documentation: Information obligations towards investors pursuant to Sec. 307 EU-passport for distribution to professional investors within EC/EEA (Sec.331) 2 Distribution must be notified to BaFin BaFin response within 40 20 days (Sec. 316) Documentation: Prospectus and key investor information document EU-passport for distribution to professional investors within EC/EEA (Sec.331) 2 Distribution must be notified to BaFin BaFin response within 20 days (Sec. 321) Documentation: Information obligations towards investors pursuant to Sec. 307 EU-passport for distribution to professional investors within EC/EEA (Sec.331) 2 Distribution must be notified to BaFin BaFin response within 40 20 days (Sec. 316) Documentation: Prospectus / securities prospectus with additional information and key investor information document EU-passport for distribution to professional investors within EC/EEA (Sec. 331) 2 Other Special requirements for Existing open-ended real estate funds Special rules for private Special rules for private equity funds (Sec. 2 Sec. 297 does not provide for a passport for distribution to semi-professional investors; in this respect the AIFMD implementation by the relevant member state will be crucial (Art. 43 para 1 AIFMD). The German law-maker has included the possibility to be passported for distribution to semi-professional investors in Germany (Sec. 289). New legal framework for funds in Germany 8
Characteristics Open-ended/ Close-ended German UCITS German Investment Funds German AIF Open-ended Open-ended Close-ended Mutual UCITS Special-AIF Mutual-AIF Special-AIF Mutual-AIF hedge funds (Sec. 283) benefit from unlimited grandfathering equity funds (Sec. 287 ff.) 225 para. 7, 256 ff.) period (Sec. 314) New issuance and redemption rules for OREF: 24 months minimum holding period 12 months notice period for redemptions permitted is: one redemption day and up to four issuance days per year AnsFuG redemption rules continue to apply for Existing Investors New legal framework for funds in Germany 9
Contacts Contacts: Alexander Vogt Partner +49 69 71003-414 alexander.vogt@linklaters.com Markus Wollenhaupt Partner +49 69 71003-117 markus.wollenhaupt@linklaters.com Rocco Beck Managing Associate +49 69 71003-342 rocco.beck@linklaters.com Dr. Daniel Voigt Managing Associate +49 69 71003-357 daniel.voigt@linklaters.com This publication is intended merely to highlight issues and not to be comprehensive, nor to provide legal advice. Should you have any questions on issues reported here or on other areas of law, please contact one of your regular contacts, or contact the editors. Linklaters LLP. All Rights reserved 2012 Linklaters LLP is a limited liability partnership registered in England and Wales with registered number OC326345. It is a law firm authorised and regulated by the Solicitors Regulation Authority. The term partner in relation to Linklaters LLP is used to refer to a member of the LLP or an employee or consultant of Linklaters LLP or any of its affiliated firms or entities with equivalent standing and qualifications. A list of the names of the members of Linklaters LLP and of the non-members who are designated as partners and their professional qualifications is open to inspection at its registered office, One Silk Street, London EC2Y 8HQ, England or on www.linklaters.com and such persons are either solicitors, registered foreign lawyers or European lawyers. Please refer to www.linklaters.com/regulation for important information on our regulatory position. We currently hold your contact details, which we use to send you newsletters such as this and for other marketing and business communications. We use your contact details for our own internal purposes only. This information is available to our offices worldwide and to those of our associated firms. If any of your details are incorrect or have recently changed, or if you no longer wish to receive this newsletter or other marketing communications, please let us know by emailing us at marketing.database@linklaters.com. Mainzer Landstraße 16 60325 Frankfurt am Main Telephone +49 69 71003-0 Facsimile +49 69 71003-333 www.linklaters.com New legal framework for funds in Germany 10