I OVERVIEW OF RECENT ACTIVITY
2015 was another record year for the German Fund industry. Despite growing volatility, in particular within the equity markets, the number of investment funds grew from 5,410 (2014) to 5,649 (2015) and assets under management increased from €1,421 trillion (2014) to €1,743 trillion (2015). During the same period, the number of registered UCITS2 or alternative investment funds (AIF)3 management companies (KVGs) increased from 142 (2014) to 218.4 At the end of 2015, there were 24 German hedge funds with total assets under management of approximately €2,85 billion; the number of fund of hedge funds was reduced to zero.5 The number of non-German funds also increased significantly: 10,513 UCITS (9,003 in 2014), 1,324 EU AIFs (609 in 2014) and 168 non-EU AIFs (92 in 2014) were admitted for public distribution in Germany in 2015.6
In order to improve investor protection following some massive scandals in the grey capital market area involving, inter alia, closed-ended funds, the German legislator decided to extend the mandate of the German Federal Financial Services Supervisory Authority (BaFin) to include product intervention rights for the protection of investors from overly complex products or aggressive advertising. The new legislation also affects prospectuses for certain investments, including funds not regulated under the German Capital Investment Code (KAGB), while at the same time introducing specific privileges for crowd financing.
European long-term investment funds (ELTIFs) designed specifically for pension administrators, insurers, foundations, municipalities and other entities facing regular and recurrent liabilities are off to a slow start. Very few ELTIFs have been registered in Germany since the ELTIF Regulation7 entered into force in December 2015.
Other topics currently being discussed in the German fund industry are the implementation of UCITS V, the preparation for Markets in Financial Instruments Directive (MiFID) II (in particular distribution fees), pension pooling (facilitated by the possibility to merge contractual type funds with investment limited partnerships), loan funds and a complete overhaul of the German investment tax regime – some of these topics will be addressed in this chapter.
II GENERAL INTRODUCTION TO the REGULATORY FRAMEWORK
i Definition of captured asset management activities
The asset management activities covered by this chapter can be divided into collective asset management (i.e., the management of investments in collective investment schemes (funds)) and individual asset management (i.e., the management of individual accounts). Before the implementation of the AIFMD8 into German law on 22 July 2013, the German fund industry was categorised into regulated funds and non-regulated funds. Regulated funds, which were always open-ended, were subject to comprehensive product regulation and ongoing supervision under the German Investment Act (InvG). Non-regulated funds were established under general corporate law and were typically closed-ended. They were subject to statutory prospectus requirements, but were generally not subject to prudential supervision and product regulation. With the implementation of the AIFMD through the KAGB in July 2013, the scope was extended to all collective investment schemes in Germany, save for certain exceptions specified in the KAGB. Nonetheless, open-ended and closed-ended funds are still subject to different regulatory requirements under the KAGB.
ii The KAGB as the central piece of legislation
The central piece of legislation for German investment funds is the KAGB. The KAGB contains a comprehensive, single statutory framework for all collective investment schemes in Germany, covering both undertakings for UCITS and AIFs within the meaning of the AIFMD. Unlike the AIFMD, which is limited to the regulation of alternative investment fund managers (AIFMs) and AIFs distributed to professional investors, the KAGB also regulates AIFs that can be distributed to retail investors. Furthermore, also different from the AIFMD, the KAGB contains specific investment restrictions for German AIFs.
The range of collective investment schemes regulated as AIFs under the KAGB is very diverse and includes both funds for institutional investors (i.e., German special funds) as well as the various types of non-UCITS open-ended funds accessible to private investors.
The KAGB also governs many previously unregulated German collective investment schemes in the grey (i.e., unregulated) capital market. These funds may invest in a wide variety of asset classes, including real estate, ships, containers, wind and solar energy parks, and film rights. Due to the illiquid nature of their assets, they are typically closed-ended. These funds usually have the legal form of a partnership and are often structured to provide particular tax benefits for their investors.
Special funds form a very important part of the fund industry in Germany. Traditionally, special funds have been open-ended, regulated investment funds limited to non-natural persons (i.e., institutional investors including financial institutions, corporates and other institutional investors, such as foundations or churches). German insurance companies constitute the single most important investor category; this institutional investor group holds a significant part of its restricted assets and technical reserves via German special funds. Under the KAGB, the scope of eligible investors for German special funds was broadened to cover professional investors and semi-professional investors. The category of professional investors is derived from the AIFMD and includes professional investors within the meaning of Annex II of MiFID9 and those investors upgraded to professional investor. The category of semi-professional investors is not foreseen in the AIFMD. It includes certain public law bodies as well as investors investing at least €10 million into the relevant AIF, and investors investing at least €200,000 and additionally fulfilling certain qualifications regarding investment expertise, experience and knowledge. Thus, the KAGB has also given certain private investors access to German special funds.
Owing to the limited circle of potential investors, the regulation of special funds has always been significantly lighter than for public mutual funds. Because of the well-calibrated balance of regulation and product flexibility, the German special fund has, over decades, gained enormous importance for the management of institutional assets in Germany. Attempts by foreign legislators to copy the German special funds regime, such as the introduction of the Luxembourg specialised investment funds, have not had a noticeable adverse impact on the attractiveness of German special funds.
Special funds are necessarily AIFs under the KAGB because they do not qualify as UCITS, although a special fund may adhere to the investment restrictions applicable to UCITS. The KAGB provides for three types of open-ended special funds:
- a a largely liberalised form of special funds subject essentially only to the general principle of risk diversification and the requirement to invest only in assets whose market value can be determined;
- b special funds with fixed fund rules, which essentially take over the regulation of special funds as previously recognised; and
- c special funds qualifying as hedge funds, which is only a negligible phenomenon in Germany.
Special funds with fixed fund rules are limited to a catalogue of assets specifically permitted under the KAGB, as are German mutual funds. However, most quantitative investment limitations mandatory for public funds can be waived for special funds. The general principle of risk diversification, however, must always be observed. In line with the AIFMD requirements, the German legislator introduced as a new requirement an offering document for German special funds. While the administrative effort in setting up a German special fund has thus become somewhat more cumbersome under the KAGB, special funds can still be established in a very timely fashion. In particular, their fund rules do not require approval by BaFin, even though the KAGB requires that the fund rules of special funds must be filed with BaFin.
In addition to open-ended special funds, the KAGB also governs closed-ended special funds. Private equity funds set up in Germany must necessarily be organised as closed-ended special funds, and are then subject to the particular disclosure and notification requirements as well as the asset-stripping rules foreseen by the AIFMD.
Open-ended public funds
Regulated mutual funds were originally established by the German legislator as open-ended investment products for private investors. Despite the increasing variety and complexity of mutual funds, the main objective of their regulation is still investor protection. The fund rules must comply with the statutory requirements of one of the permissible fund types under the KAGB, including the qualitative and quantitative investment restrictions applicable to the relevant fund type.
The most common fund type for open-ended mutual funds are UCITS. The legal provisions applicable to German UCITS are essentially limited to the implementation of the requirements under the UCITS Directive.
The permissible non-UCITS open-ended fund types under the KAGB include:
- a real estate funds, which invest mainly in real estate and real estate companies;
- b ‘mixed funds’, which resemble UCITS but may also invest a limited portion of their assets in non-UCITS compliance target funds;
- c ‘other funds’, which, apart from UCITS eligible assets, may also invest in non-UCITS compatible target funds, unlisted corporate participations, precious metals and loans, and may also be established in the particular form of a microfinance fund; and
- d funds of hedge funds.
Single hedge funds are permissible only as special funds.
Closed-ended public funds
The KAGB permits the establishment of closed-ended funds not only for professional (and semi-professional) but also for private investors. However, it added product regulation of closed-ended funds to the mere manager regulation required by the AIFMD. Closed-ended public funds are restricted to an exhaustive list of eligible assets. This list is broad and covers, inter alia, financial instruments such as securities, certain investment funds and participations in companies, as well as physical assets such as real estate, ships and superstructures, aircraft, renewable energy facilities, electric powered vehicles and containers; however, it is a conclusive catalogue, and does not allow closed-ended funds to invest in any other type of assets. Furthermore, closed-ended funds targeting private investors must only invest in derivatives for hedging purposes and must generally be invested according to the principle of risk diversification, which requires an investment in at least three assets that are essentially evenly distributed, or an investment providing for a diversification of risk (e.g., real estate due to the tenant structure). The requirement of risk diversification does not apply if the minimum investment is at least €20,000.
Apart from the KAGB, there are a few other German statutes tailor-made for specific types of funds that do not provide for prudential regulation but rather offer certain benefits, typically tax benefits, to funds established in accordance with the relevant statutory requirements. The Act on Corporate Participation Companies of 1986 and the Act on Venture Capital Companies of 2008 were both designed to promote the establishment of German private equity and venture capital funds by offering certain tax benefits for funds established under the relevant statute. Neither statute has gained significant importance. The same is true for the German REIT Act: it was introduced in 2007, at present, only three German REITs are listed.
iii Discretionary asset management
Discretionary asset management relating to financial instruments is an investment service subject to a licensing requirement under the German Banking Act (KWG). Besides banks and financial services institutions licensed under the KWG, UCITS- and AIF management companies licensed under the KAGB can also be authorised to provide discretionary asset management services as an ancillary activity; in addition to the licensing, solvency and organisational requirements under the KWG, they must then observe rules of conduct derived from MiFID and implemented in the German Securities Trading Act.
iv Regulator: BaFin
BaFin is the competent regulator for German banks (i.e., deposit-taking credit institutions and e-money-institutions), financial services institutions (i.e., investment firms within the meaning of MiFID as well as leasing and factoring companies), insurers (including regulated pension funds) and UCITS- and AIF management companies. When supervising deposit-taking credit institutions, BaFin cooperates with the European Central Bank and the German Central Bank. It also cooperates with the German Central Bank when supervising financial services institutions but is the sole regulator for insurers and UCITS- and AIF management companies.
III COMMON ASSET MANAGEMENT STRUCTURES
Contractual funds (in contrast to corporate type funds) do not have a legal personality and must be managed by a KVG licensed under the KAGB (or passported non-German investment management companies: see below). The KVG is obliged to manage the contractual fund in its own discretion, subject always to the limitations of the KAGB and the relevant fund rules. The KVG is generally not subject to instructions by investors. Particularly in the case of special funds, which often only have one institutional investor, the KVG will typically establish an investment committee in which the investor and the KVG, and potentially the depositary, are represented. The investor can influence the management of the special fund by exercising its voting rights in this investment committee. However, from a legal perspective, the investment committee has an advisory function only.
The assets belonging to a contractual investment fund are either legally owned by the KVG as trustee for the investors of the fund or by the investors themselves (as co-owners of the portfolio assets). The fund assets must be held in safe custody by a depositary. In the case of UCITS, the depositary is also responsible for administering the issuance and redemption of fund shares. Typically, fund shares are not issued to investors in physical, but are certificated in a global certificate deposited with the German central securities depositary, Clearstream Banking AG. By the end of 2016, all bearer fund shares must be certificated in a global certificate without the right to demand actual securities. In accordance with the German legal framework for the safe custody of securities under the Safe Deposit Act, investors hold a fractional interest in the global certificate corresponding to their investment in the fund under a multi-tier deposit structure starting with the bank maintaining their securities account and ending with Clearstream Banking AG.
With the exception of German UCITS, which can be managed by non-German UCITS management companies, and German AIFs limited to professional and semi-professional investors, which can be managed by EU-licensed AIFMs, regulated German contractual funds can only be managed by external German KVGs. Such external German KVGs can only be established as a stock corporation, a limited liability company or a limited partnership whose only general partner is a limited liability company, and must have a minimum capital of €125,000 plus 0.02 per cent of the amount of assets under management exceeding €250 million, but in any case at least an amount equivalent to one quarter of its preceding year’s fixed overhead. They must at least have two managing directors who are qualified for investment business (i.e., collective asset management and risk management), as well as sufficient personnel to conduct their business. In addition, each KVG must establish a supervisory board (or an advisory board in the case of a limited partnership) of at least three members, one of whom must be an independent board member unless the KVG exclusively manages special funds. The KVG may outsource functions, including the portfolio management or the risk management (but not both in relation to the same fund), subject to certain limitations under the KAGB. In particular, the portfolio management may only be delegated to an entity that is licensed to perform asset management activities and subject to effective supervision but does not simultaneously act as depositary for the respective investment fund. While generally all functions except controlling functions may be delegated, the KVG must retain sufficient personnel to control the delegated functions, and the scope of the delegations must not result in the KVG becoming a letter-box company.
Investment stock corporations
Under the KAGB, German investment funds can also be established in corporate form, namely in the form of an investment stock corporation. The KAGB provides for two varieties of investment stock corporations: those with variable capital as the legal form for open-ended funds, and those with fixed capital as the legal form for closed-ended funds.
Investment funds in corporate form play only a minor role in Germany. The vast majority of German regulated funds are established in contractual form. The investment stock corporation with fixed capital was originally introduced in 1998, but was abolished in 2004 because it was so unattractive due to its unfavourable tax regime that, until 2004, no such stock corporation was ever established. With the KAGB, this legal form has been reintroduced into German investment law, together with an amendment of the German Investment Tax Act doing away with the previous unfavourable tax regime.
The investment stock corporation with variable capital was only introduced as a legal form for German regulated funds in 2004. Originally, it was designed in particular as a legal vehicle for hedge funds, which were introduced as a new mutual fund type at the same time. In 2007, the legislator introduced further changes that also allow the establishment of investment stock corporations with different sub-funds without cross-liability. German investment stock corporations can be established as self-managed corporations or as investment stock corporations managed by an external investment management company. In the latter case, the investment stock corporation essentially only serves as a corporate shell, whereas the operational and control functions (portfolio management, risk management, etc.) are situated in the investment management company.
Investment limited partnerships
Besides contractual type funds and investment stock corporations, the KAGB permits investment limited partnerships as an additional legal form for German investment funds. Like investment stock corporations, investment limited partnerships can be set up both as open-ended or as closed-ended investment limited partnerships. Investors participate as limited partners in the investment fund, and their liability is generally limited to the amount of capital contributed by them to the investment fund.
IV MAIN SOURCES OF INVESTMENT
i Open-ended funds
The vast majority of the total assets under management in German funds of €1,743 trillion is invested in special funds (€1,316) while merely €427 billion are managed in public mutual funds.10 The biggest investor groups in special funds are and were historically insurers and pension vehicles.
ii Closed-ended funds
Whereas for many decades the German industry association for what used to be the regulated fund industry, the German Investment Funds Association (BVI), collected and published data on assets invested in German regulated funds, no comparable, reliable data exists for the so-far unregulated, typically closed German funds. The industry association for closed-ended funds, the BSI Bundesverband Sachwerte und Investmentvermögen eV (BSI), collects and publishes data on German closed-ended funds. For 2015, the BSI reported newly placed equity capital in German closed-ended retail funds of only €521 million (€81 million in 2014) and in closed-ended special funds of €1.027 billion (€592 million in 2014).11 In comparison, the total of net inflows in German public and special funds in the same period amounted to €146.1 billion (€91.3 billion in 2014).12
iii Discretionary asset management
Reliable data on the German market for individual discretionary asset management is even more difficult to obtain than for closed-ended funds, as there is no central industry association collecting relevant data from all market participants. According to data published by the BVI, as of 31 December 2015, KVGs managed €378 billion (€362.6 billion in 2014) of assets on the basis of discretionary asset management agreements outside of funds.13
V KEY TRENDS
The financial crisis and the low interest rate environment has forced German institutional investors focusing on fixed income investments to look out for other investments promising more attractive returns at appropriate risk levels. In this context, many institutional investors have increased their asset allocation to real estate, including investments in real estate loans. Generally, there is a high demand for a large variety of debt investments outside the securities markets (commercial loans, commercial real estate loans, trade finance). There have also been a number of high-profile transactions involving investments by institutional investors in infrastructure, in particular in energy grids.
In the area of special funds, the trend towards master funds with different segments managed by different asset managers under outsourcing agreements is still continuing. Segmented special funds account for the most inflows into special funds by far. Segmented master funds allow investors to strengthen the specialisation of the fund management by appointing different asset managers with special expertise for different types of investments. Topics of continuing relevance are the requirements for own credit risk assessment and the use of internal ratings under CRA III.
The UCITS V-Implementation Act, which became effective in March 2016, not only implements the UCITS V-Directive but also introduces rules for the granting of loans by KVGs. Unlike in other EU member states, the granting of loans to any borrowers, not only consumers, generally requires a banking licence in Germany. The same applies where the term of a loan is substantially amended after the acquisition of a loan receivable (which in itself does not require a banking licence) in such a manner, effectively requiring a further credit decision (e.g., prolongation, change of interest rate or repayment terms). Since March 2016, closed-ended special funds may grant loans to non-consumers in a maximum amount of 30 per cent of their net assets and undrawn commitments, subject to further restrictions. In the case of loans to portfolio companies controlled by the relevant KVG, loans may also be made up to the same maximum amount by closed-ended public funds and up to 50 per cent of that amount on behalf of closed-ended special funds. Open-ended special funds may also grant loans to portfolio companies under the same conditions and with the same restrictions as closed-ended special funds, but may not make loans to other borrowers. In addition, the aforementioned rule that substantial amendments of a loan agreement following the acquisition of loan receivables does not apply to AIFMs managing closed-ended funds or open-ended special funds; this is particularly important for open-ended special funds that are no longer required to divest of loan receivables that they would have retained given the possibility to restructure the loan.
VI SECTORAL REGULATION
The biggest group of investors in German funds, namely, insurers, are themselves subject to investment restrictions under the Insurance Supervisory Act. With effect from 1 January 2016, these investment restrictions were significantly altered by the implementation of the Solvency II Directive.14
The Investment Regulation for the Investment of Restricted Assets of Insurance Companies – applicable before the implementation of the Solvency II Directive to all insurers – has been newly promulgated in April 2016, with substantially the same rules as before, but now only governs the investments of technical reserves of small insurance companies (defined primarily as non-liability-, credit- or bonding insurance with an annual gross written premium income of €5 million or less), pension life insurers and death benefit insurers. The Investment Regulation contains an exhaustive list of eligible assets. Each investment by a German insurance company must be allocable to one of the items in this catalogue to qualify as an eligible investment, except for investments under an opening clause generally limited to 5 per cent of the technical reserves. Furthermore, the Investment Regulation since March 2015 allows investments of up to 7.5 per cent of the technical reserves in EU AIFs managed by EU AIFMs without any specific investment restrictions applicable to such AIF under the Investment Regulation.
By contrast, insurers not subject to the Insurance Regulation must follow the prudent person principle of the Solvency II Directive, in other words they shall only invest in assets whose risks can be properly identified, measured, monitored, managed, controlled and reported and appropriately taken into account in the assessment of the overall solvency needs of the insurer. In lieu of the catalogue of eligible investments set out in the Investment Regulation, the insurers must establish their own internal investment catalogue to ensure that all investments meet the test of security, quality, liquidity, profitability and availability.
The German pension system is traditionally characterised by a strong public pension pillar that is a pay-as-you-go system financed by employees, employers and governmental subsidies. Apart from this, there is a wide variety of occupational pension schemes, each with its own regulatory framework, including:
- a direct pension promises, where the employer promises certain pension payments to the employee. In recent years, many German companies have established contractual trust arrangements (CTAs) to take their pension liabilities off their balance sheets. CTAs are generally not subject to statutory regulation or investment restrictions;
- b direct insurance schemes, where the employer takes out a life insurance policy for the employee and pays the premiums;
- c pension life insurers are specialised life insurance companies, and as such are regulated as insurance companies whose investments are subject to the Investment Regulation;
- d pension funds, which can be established as stock corporations or mutual pension fund associations and whose investments are limited by an executive regulation similar to the Investment Regulation for insurance companies; and
- e support funds, which are unregulated pension schemes not subject to statutory investment restrictions.
iii Real property
Historically, the main majority of real estate funds in Germany were open-ended. Starting in the autumn of 2008, at the height of the financial crisis and shortly after the fall of Lehman Brothers, a growing number of open-ended real estate funds suffered liquidity crunches and could no longer satisfy redemption requests. None of these funds recovered from this shock and, for the first time in the history of open-ended real estate funds in Germany, such funds had to be liquidated and this was a long and painful process for their investors, whose only alternative was to sell their fund units at an organised market with a substantial discount. As a consequence, the legislator changed the redemption rules and effectively created semi-opened real estate funds, and established a mandatory lock-up period of 24 months as well as the requirement to notify the AIFM of a redemption with a period of 12 months (although these periods can be overlapping).
By contrast, the market of closed-ended real estate funds continues to be relatively small, even after they became subject to regulation with the implementation of the AIFMD. In the past, closed-ended real estate funds were often established to finance a single asset. Despite the fact that a non-diversified closed-ended fund can only target the retail public if the minimum investment is €20,000, the risk diversification requirements under the KAGB for closed-ended public funds not meeting this threshold continue to be significantly lower than for open-ended public funds invested in real estate.
iv Discretionary asset management
The business of discretionary asset management is subject to a licensing requirement under German law only if it relates to financial instruments. The management of real estate, therefore, does not require any licence under German law. If the management of real estate also includes the investment of rent or other income in financial instruments, a licence for discretionary asset management is generally required.
A growing number of open-ended special funds are established as ‘master funds’, in other words, relatively large funds segmented into a number of ‘virtual funds’ (not to be confused with sub-funds in an umbrella fund structure). These segments, while not legally constituting individual funds, are for all practical purposes treated like separate funds, and their management is commonly delegated to an external portfolio manager who must be licensed for the purpose of discretionary asset management. Such a delegation is possible not only for German KVGs, banks and financial services institutions holding the requisite licence, but also for requisite non-German EU service providers holding an EU-passport. This is also a growing market for non-EU asset managers (e.g., US managers supervised by the Securities and Exchange Commission, who can perform asset management services for these funds on a cross-border basis under the ‘passive services exemption’ (also referred to as ‘reverse solicitation’); under this exemption, otherwise licensable financial services can be provided in Germany by non-EU service providers if the client relationship was established exclusively upon the client’s (or its agent’s) initiative. In the case of special funds, non-EU asset managers are frequently selected by investment consultants (acting for the special fund investor) who approach these managers with a request for proposal.
v Hedge funds
In 2004, the German legislator introduced a regulatory framework for single hedge funds and funds of hedge funds as additional fund types into the InvG. The initial hopes and expectations by some lobbyists and market participants regarding the development of a significant German hedge funds industry have, however, not materialised. With the introduction of the KAGB, German single hedge funds can no longer be established as public funds, but had to be converted to special funds limited to professional or semi-professional investors. At present, there are only 24 German single hedge funds and no fund of hedge funds at all.
vi Private equity
German-based private equity funds have traditionally been non-regulated vehicles. With the implementation of the AIFMD in Germany, managing and distributing private equity funds in Germany generally has become subject to regulation under the KAGB. So far, however, Germany has not been a very prominent jurisdiction for the establishment of private equity funds, and this has not changed as a result of their regulation under the KAGB.
VII TAX LAW
While the transposition of the AIFMD into German law occurred on time (on 22 July 2013), the corresponding German Investment Tax Act (InvStG) became effective only in December 2013.
Under the InvStG, investment funds established under the InvG are exempt from corporate income tax and trade tax, so that the taxable income from the investment fund investments is – although determined on the level of the investment fund – subject to taxation exclusively on the level of the investor. Each German tax-resident investor is therefore generally subject to individual or corporate (as the case may be) income tax (and potentially trade tax) on the income received, and either distributed or deemed to be distributed by the investment fund as if he or she had received such income directly from the same source as the investment fund (provided that the fund complies with the very detailed information and publication requirements imposed by the InvStG). In this case, different tax regimes apply to income sourced from different underlying sources, such as dividends, capital gains and income from leasing.
Non-German tax-resident investors receiving proceeds from German investment fund units are only subject to limited taxation with respect to certain elements of the income they derive from a German investment fund. Generally, the German individual or corporate (as the case may be) income tax they owe for such income is settled by a deduction of German withholding tax from the distribution or deemed distribution of these investment fund’s earnings, in particular from the distributed German-source dividend income received by the investment fund (withholding tax also applies to income from the leasing, and, under certain circumstances, capital gains from the disposal of German situs real property). Depending on the investor’s tax residence, such withholding tax may be reduced and refunded to the investor based on a tax treaty between Germany and the investor’s jurisdiction.
As a consequence of the broadened concept of investment fund under the KAGB, the new InvStG has established two tax regimes, namely one for ‘investment funds’ in a narrower tax sense and a different regime for ‘investing companies’. To qualify as an investment fund, the respective fund must meet certain tax-specific requirements as set out in the InvStG (such as compliance with particular asset eligibility criteria). For these privileged investment funds, essentially the same tax regime known from the past for regulated investment funds applies. All other funds qualify as investing companies and are, depending on their legal form, classified either as ‘partnership investing companies’ or as ‘capital investing companies’. Contrary to privileged investment funds and personal investing companies, capital investing companies are subject to German corporate income tax and trade tax. In addition, the income distributed by the capital investing company (but not any income retained at the level of the capital investing company) is subject to individual or corporate (as the case may be) income tax (and potentially trade tax at the level of the German or non-German tax-resident investor). If a fund no longer qualifies as an investment fund in the narrower tax sense and is, consequently, deemed to be transformed into an investing company, the investors will be treated as if they had exchanged their units in the old fund against units in the investing company; this exchange might give rise to a taxable capital gain. Investors in regulated investment funds set up under the (old) InvG regime, however, benefit from a transition period until 1 January 2018 (i.e., they remain subject to the tax rules for ‘investment funds’ in a narrower sense even if they do not (yet) comply with the narrower asset eligibility criteria introduced by the reformed InvStG).
It should be noted that a comprehensive reform of German investment tax legislation is intended to be launched on 1 January 2018. The corresponding law was passed by the German parliament on 9 June 2016, but still needs the consent of the Second German Chamber. This new regime will abolish the (only recently introduced) distinction between investment funds (in the narrower sense) and investing companies. Broadly speaking, a uniform regime will apply to all public mutual funds under the KAGB, irrespective of their investment criteria (but a tax regime similar to the ‘old’ regime for investment funds in the narrower sense will continue to apply for special funds). Under the new regime, German and foreign investment funds will become subject to German corporate income tax (but not necessarily to German trade tax) with respect to certain German-source income items. In addition, investors will have to include in their tax base for (corporate) income tax and, possibly, trade tax purposes a certain lump-sum minimum yield as well as distributions made by the fund (in excess of the minimum yield). In order to avoid an economic double taxation of income generated by an investment fund, investors in certain types of investment funds may benefit from partial exemptions when calculating the tax base of distributions or the minimum yield.
The implementation of the AIFMD caused a paradigm shift for Germany’s investment fund industry. The dichotomy between regulated and non-regulated funds, which had been a key feature of the asset management industry in Germany for decades, was substantially abandoned, as traditionally non-regulated funds were introduced to comprehensive regulation and supervision. While there were few changes for investment management companies that managed investment funds subject to regulation under the previous regulatory regime, the newcomers to regulation, in particular managers of closed-ended funds, faced a significant change of their business model, which will likely lead to a consolidation of this market.
In March 2016, the UCITS V-Directive was implemented in Germany. The new rules increase liability for depositaries in line with the AIFMD and even beyond (as the liability for sub-custodians cannot be contractually limited). For German depositaries, there will be no changes in this respect, as the KAGB already provided for the same depositary liability in relation to AIFs and UCITS. The introduction of remuneration rules for UCITS managers also brought about few changes in practice for the German investment fund industry, as most German KVGs manage both AIFs and UCITS. In addition, the KAGB was amended to permit the granting of loans by German funds (see Section V, supra). There appears to be a high demand for loan funds by institutional investors in Germany, which can, however, potentially also be satisfied by non-German EU AIFs and even third-country AIFs. Furthermore, these non-German funds (in the case of third-country AIFs only if they are admitted for public distribution to semi-professional or private investors in Germany) also benefit from the banking licence exemption when granting loans as part of their collective investment activities, and may therefore not only compete with German KVGs for German investors but also for German borrowers.
The introduction of the European Market Infrastructure Regulation has subsequently created administrative challenges for many investment management companies, in particular with respect to the reporting requirements towards trade repositories. The transition to central counterparties (CCP)-clearing of derivatives under the European Market Infrastructure Regulation as well as collateralisation of non-CCP-cleared derivatives will remain an important topic for KVGs for the foreseeable future.
Furthermore, MiFID II and MiFIR will bring about numerous changes for discretionary asset managers but also to KVGs. KVGs are not only affected by MiFID if they provide the ancillary service of discretionary asset management, but also in their capacity as product providers for distributors who themselves are subject to MiFID II when distributing investment funds. As of the date hereof, the German implementing legislation regarding MiFID II has not yet been finalised
Further developments to be watched are the discussion about shadow banking (in particular in connection with money market funds), as well as the proposal by the Financial Stability Board (FSB) and the International Organization of Securities Commissions for a methodology to identify non-banking non-insurer global systemically important financial institutions that also specifically addresses investment fund managers. The latter initiative in particular met with violent criticism by market participants, which apparently moved the FSB to reconsider its proposal and to first conduct a thorough analysis of the regulatory regimes for investment funds globally in order to ascertain whether they can actually cause systemic risks.
It will remain important for investment fund managers to monitor the changing regulatory landscape of their various investor groups. Tailor-made special funds can provide valuable instruments, for example, for insurers to assist them in meeting the requirements of the Solvency II-Directive or for banks meeting the requirements of the liquidity coverage ratio, especially in light of the negative interests charged by the European Central Bank.
It is envisaged that the key information document (KID) will be replaced by a European-wide Packaged Retail and Insurance-based Investment Products (PRIIPs) KID by the end of 2019. The BVI has criticised several inconsistencies in the draft regulation (to become effective by the end of 2016) and suggests a delay in order to remedy these deficiencies.15
Finally, investment funds are important building blocks of the Action Plan on Building a Capital Markets Union.16 Topics to look out for over the coming two-to-three years are revisions of the regulations for pan-European venture capital fund of funds and multi-country funds (as well as a study on tax incentives for venture capital and business angels), a coordinated approach to loan origination by funds, modernisation of the Prospectus Directive (relevant in particular for closed-ended funds), adjustment of the Solvency II calibrations for insurers’ investment in infrastructure and European Long Term Investment funds and a review of European-wide cross-border distribution of investment funds (including a study on discriminatory tax obstacles to cross-border investment funds by pension funds and life insurers).
1 Thomas Paul and Christian Schmies are partners at Hengeler Mueller. We would like to thank Mathias Link, counsel at Hengeler Mueller, for his contribution on taxation.
2 Companies managing investment funds in accordance with the UCITS Directive 2014/91/EC.
3 Alternative investment fund managers within the meaning of the Alternative Investment Fund Managers Directive (AIFMD) 2011/61/EC.
4 Source: Annual Report 2015 of the German Federal Financial Services Supervisory Authority, p 252.
5 Source: Annual Report 2015 of the German Federal Financial Services Supervisory Authority, p 254.
6 Source: Annual Report 2015 of the German Federal Financial Services Supervisory Authority, p 252.
7 Regulation (EU) 2015/760 of the European Parliament and of the Council of 29 April 2015 on European long-term investment funds.
8 European Alternative Investment Fund Managers Directive 2011/61/EC.
9 European Markets in Financial Instruments Directive 2004/39/EC.
10 Source: Annual Report 2015 of the German Federal Financial Services Supervisory Authority, p. 252, 31 December 2015.
11 Source: bsi Bundesverband für Sachwerte und Investmentvermögen e.V.; the stated figures relate only to members of this association.
12 Source: Annual Report 2015 of the German Federal Financial Services Supervisory Authority, p. 253.
13 Source: BVI 2016, Daten, Fakten Perspektiven, p. 12.
14 Directive 2009/138 of the European Parliament and of the Council of 25 November 2009 on the taking-up and pursuit of the business of Insurance and Reinsurance (Solvency II).
15 BVI 2016, Daten, Fakten Perspektiven, p. 30.
16 Communication from the Commission to the European Parliament, the Council, the European Economic and Social Committee and the Committee of the Regions (COM(2015) 468 final).