The Federal Ministry of Finance (BMF) issued a draft ordinance for the amendment of the Investment Ordinance (Anlageverordnung – AnlV) and the Pension Fund Capital Investment Ordinance for consultation (“Amendment Ordinance”) on 27 May 2014. The Amendment Ordinance has been expected for some time, as the current version of the Investment Ordinance from 2011 refers to the Investment Act, which was superseded by the Capital Investment Code (Kapitalanlagegesetzbuch – KAGB) in July 2013. In the following, reference is only made to the Amendment Ordinance as far as it covers the Investment Ordinance for insurance undertakings (“AnlV-E”). The planned changes in the Amendment Ordinance are in principle intended to apply mutatis mutandis to the Pension Fund Capital Investment Ordinance.
In places, the Amendment Ordinance goes well beyond the changes required to comply with the KAGB. As it stands, the Amendment Ordinance could have a significant impact on the allocation of the restricted assets of insurance companies. This paper provides an overview of the proposed changes and submits them to an initial critical evaluation.
It should also be noted that the statement of grounds for the Amendment Ordinance contains important indications that present themselves as regulations. These are expected to be included in the prospective explanatory circular of the Federal Financial Supervisory Authority (BaFin).
1. Investment in investment funds
The Amendment Ordinance provides for investments in investment funds to be divided into five categories. These are described in the following diagram.
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a. Special provisions for real estate and private equity funds
The acquisition of shares in real estate funds is governed by the revised Section 2(1) no 14c), while for the acquisition of shares in regulated private equity funds a new investment provision is introduced, which forms part of the participation quota.
b. Distinction between UCITS-compliant and “other” investment fundsa. Special provisions for real estate and private equity funds
Outside of these special provisions, the Amendment Ordinance also introduces a distinction between UCITS funds (Section 2(1) no 15), open-ended special AIFs, which are comparable to UCITS with regard to the eligible assets and the options for redemptions (Section 2(1) no 16) and other AIFs (Section 2(1) no 17, “Other AIFs”). Whereas in principle no quota is proposed for the first two fund types, the Amendment Ordinance contains a combined upper limit of 7.5% of the restricted assets for Other AIFs, including direct and indirect investments linked to hedge funds and commodity risks (the “AIF quota”). For UCITS and open-ended special AIFs with UCITS assets and corresponding options for redemption, a look-through must be applied to the indirectly held assets.
2. “Other AIFs”
The Amendment Ordinance departs from the existing scheme for investment in open-ended investment funds. According to the current version of the Investment Ordinance, open-ended EEA investment funds (with the exception of hedge funds) are essentially transparent with regard to their allocated quotas. The Amendment Ordinance now plans for a division between special AIFs that are UCITS-compliant or UCITS-comparable, at least with regard to the eligible assets and the options for redemption, on the one hand, and Other AIFs on the other. According to the Amendment Ordinance, in future only for units in UCITS funds and open-ended special AIFs which are comparable to UCITS funds with regard to eligible assets and options for redemption there will be no Fund-related restriction of quotas.
Units in all other regulated EU investment funds issued by a management company with its seat in the EEA (Other AIFs) may only be acquired up to the new cumulative 7.5% AIF quota – unless the special provisions for private equity funds (Section 2(1) no 13b) AnlV-E) and real estate funds (Section 2(1) no 14c) AnlV-E) apply (see below). This is initially true whether these Other AIFs are open-ended or closed-ended, or retail or special AIFs.
As a result, German domiciled Special AIFs with fixed investment requirements (Section 284 KAGB) that are not comparable to UCITS with regard to eligible assets fall within this new AIF quota, in particular those investing in loans, commodities and tangible assets.
Furthermore, the acquisition of open-ended real estate retail funds in accordance with Section 2(1) no 17a) is expressly not permitted. Real estate funds in the form of retail AIFs may only be acquired as closed-ended vehicles in accordance with the new Section 2(1) no 14c) AnlV-E.
The statement of grounds for the Amendment Ordinance indicates that, for the purposes of calculating diversification quotas, no look-through is to take place in the case of Other AIFs in accordance with Section 2(1) no 17 AnlV-E as these are already subject to the (narrow) AIF quota.
Participations in companies and real estate held in AIFs in accordance with Section 2(1) no 17 AnlV-E do not therefore additionally count against the so-called participation or real estate quota. In the case of real estate, in fact, it must be noted that real estate held indirectly through AIFs in accordance with Section 2(1) no 17 AnlV-E may not be allocated to the real estate quota, which commonly is desired by investing insurance undertakings.
In accordance with the Amendment Ordinance, the issuer limitations that apply to closed-ended Other AIFs are different from those for open-ended Other AIFs (see also below under 8.). For closed-ended Other AIFs, the limitation per issuer of 1% of the restricted assets of the investing company applies (Section 4(4) sentence 1 AnlV-E). For open-ended Other AIFs, this limit is not applicable. An Other AIF is “open-ended” if it redeems its shares at least once a year.
The approach of dividing between special AIFs that are UCITS-compliant or UCITS-comparable, at least with regard to the eligible assets and the options for redemption, on the one hand, and Other AIFs on the other, could cast doubt on the concept of the “master” special fund. This will generally not be UCITS-compliant or UCITS-comparable, so investments held via master special AIFs (with fixed investment rules) would fall within the AIF quota. This is because these special AIFs are typically unable to observe the requirements applicable to UCITS with respect to eligible assets and redemption deadlines. As long as no further amendments are made during the ongoing consultation process in this regard, this means that investments in open-ended Special AIFs with fixed investment rules within the meaning of Section 284 KAGB will be negatively affected both by the new Investment Ordinance and by the latest amendments to the Investment Tax Act (InvStG).
On average, insurance companies invest around 30% of their restricted assets via special funds.
Investments in alternative investment funds using closed-ended forms of collective investments, which were previously assigned to the 15% participation quota, would now fall within the AIF quota.
3. Real estate funds
According to the Amendment Ordinance, the eligible asset class of “closed-ended real estate funds” (currently Section 2(1) no 14c) AnlV) would no longer exist. Instead, investments in open-ended and closed-ended real estate funds will be permitted in the case of special AIFs managed by an investment management company with license under Section 20(1) KAGB (or equivalent foreign AIFMD regulated investment management companies) and which invest directly and indirectly in real estate as defined in Section 231 KAGB and in real estate companies as defined in Section 235 KAGB.
The reference contained in an earlier discussion draft to all requirements of real estate retail funds in the KAGB (Sections 230 to 260 KAGB) no longer applies. However, this means that the reference to the liquidity investments in accordance with Section 253 KAGB as eligible assets has also ceased to apply. Clarification would be welcome here, as it is hard to perceive that real estate funds, particularly open real estate funds, should not be permitted to invest in liquid assets.
In the case of real estate funds of funds, the target funds must also meet the requirements of Section 2(1) no 14c) AnlV-E.
According to the explanatory note from the BaFin on the concept of an investment fund within the meaning of the KAGB, any active real estate management such as the running of a hotel should fall outside the scope of the KAGB .
The acquisition of units in closed-ended, unregulated real estate AIFs, previously allowed within the participation quota, would no longer be possible in the future in view of the special requirements for private equity funds and “Other AIFs”.
4. Private Equity Funds
The Amendment Ordinance proposes splitting the concept of participations in companies two ways. It introduces investments in closed-ended AIFs (Section 2(1) no 13b) AnlV-E). However, they must invest directly or indirectly in assets covered by Section 261(1) no 4 KAGB, investments in unlisted companies or in “other equity-equivalent instruments”. They must also be regulated funds, i.e. funds based in the EEA or OECD area and managed by a regulated investment management company based in the EEA/OECD area.
It is unclear which “de-minimis rule” for other investments is applicable, if any. In this respect, we assume in any case that liquid assets are permissible. In addition, the statement of grounds for the Amendment Ordinance does not yet concretely specify the meaning of the term “other equity-equivalent instruments”. We assume that this term in any case includes mezzanine and other subordinated debt instruments.
Shares in typical private equity fund structures, such as Delaware LP, may in future no longer be an eligible investment (nor can such investments be allocated to Section 2(1) no 13a) AnlV-E). The special rules for regulated private equity funds (Section 2(1) no 13b)) and for Other AIFs (Section 2(1) no 17) take precedence.
With regard to AIFMD-regulated private equity funds of funds, in accordance with the statement of grounds for the Amendment Ordinance, an investment in a regulated fund of funds vehicle is only considered eligible, if all the target funds meet the requirements of Section 2(1) no 13b) AnlV-E. The present market environment typically does not comply with these requirements. In the event of investment in target funds that do not meet the requirements, acquisition as an Other AIF might be possible within the AIF quota.
5. Infrastructure, loans and loan funds
As part of the public discussion in advance of the Amendment Ordinance, a new quota for infrastructure funds had been anticipated.
In fact, there is no explicit quota for infrastructure funds in the AnlV-E. However, the statement of grounds for the Amendment Ordinance refers in the case of two investment classes to the possibility of investing in infrastructure:
a. Secured loans
The option to invest in loans has been expanded by the introduction of Section 2(1) no 4c) AnlV-E. Accordingly, loans to companies based in the EEA or in a full member country of the OECD, except for financial institutions, are now permitted as long as these loans are sufficiently materially or contractually secured. The statement of grounds for the Amendment Ordinance indicates that the company must have at least a speculative-grade credit rating. This permits, among other things, the acquisition of loans from infrastructure companies and of “high-yield corporate loans”.
b. Loan funds
The current BaFin circular on the Investment Ordinance specifies a limit on unsecured loans for Special funds of 30% of the value of the fund. The statement of grounds for the Amendment Ordinance makes it clear that Other AIFs (within the AIF quota) may invest up to 100% in unsecured loans. In particular, this should allow for investments in infrastructure debt funds.
6. Participations in group companies
The quite rigid ban on investments in group companies, which, according to the wording of the applicable Investment Ordinance, applies in all cases except those of specific investments specified in Section 2(4) no 3 AnlV (holding structures for non-Group companies, real estate and renewable energies), is re-defined appropriately. In future, the ban will not apply if the insurance company is only a passive shareholder in a company without affecting the company’s business or conducting ongoing product development.
7. European risk capital funds and funds for social entrepreneurship
European risk capital funds in accordance with Section 337 KAGB and European funds for social entrepreneurship in accordance with Section 338 KAGB are only available for acquisition in accordance with the statement of grounds for the Amendment Ordinance within the scope of the opening clause.
8. New diversification quota for alternative investments
The previous diversification quota of 5% for direct and indirect investments in hedge funds is replaced by the new AIF quota of 7.5% of restricted assets. Direct and indirect investments in Other AIFs are included in the calculation of the AIF quota. In addition, direct and indirect investments in structured products whose returns or repayments are tied to hedge funds or commodity risks are also included.
The AIF quota, like the special quota of 5% for secured loans (Section 2(1) no 4c) AnlV-E), is set off against the so-called risk capital investment quota of 35% of restricted assets.
The reduced issuer limitation of 1% of restricted assets will also include stocks and shares in closed “Other AIFs”. If, on the other hand, they invest in suitable target investment funds, the 1% quota relates to the calculated target investments.
9. Transitional regulations
Retail open ended real estate funds acquired before 8 April 2008 may remain part of the restricted assets and may be allocated to the real estate quota through Section 2(1) no 14c) AnlV-E.
The new requirements for private equity funds in accordance with Section 2(1) no 13b) AnlV-E enter into force from the date of announcement of the Amendment Ordinance. Investments that have already been made until such date are to be allocated to the participation quota in accordance with Section 2(1) no 13b) AnlV-E and may be held to maturity.
Other AIFs (within the meaning of Section 2(1) no 17 AnlV-E) acquired before the Amendment Ordinance entered into force may be assigned to the investments in accordance with Section 2(1) no 16 AnlV-E until 31 December 2019 as long as no new units in the Other AIFs (and no new “non-qualifying” investments in the Other AIFs) are acquired.
10. Consultation procedure
The consultation procedure ended on 27 June 2014. A publication of the final version is expected later in 2014.
The revision of the Investment Ordinance is to be welcomed, in so far as it merely adjusts the provisions to match those of the KAGB and the AIFM Directive. However, as far as the investment universe for insurance companies is to be restricted for no sound economic reason, we oppose the proposed changes, particularly in light of the present low interest rates and the associated slump in investments. Nonetheless, in the medium term the main focus will be on the requirements of “Solvency II”.
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