General introduction to the regulatory frameworki 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 AIFMD 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 German Capital Investment Act (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 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. Owing 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
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 MiFID II and those investors upgraded to professional investor. The category of semi-professional investors is not included in the AIFMD. It covers 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 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;
- special funds with fixed fund rules, which essentially take over the regulation of special funds as previously recognised; and
- 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 legislature 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 the Federal Financial Supervisory Authority (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.Public fundsOpen-ended public funds
Regulated mutual funds were originally established by the German legislature 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 types of fund 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:
- real estate funds, which invest mainly in real estate and real estate companies;
- funds of hedge funds;
- 'mixed funds', which resemble UCITS but may also invest a limited portion of their assets in non-UCITS compliant target funds; and
- '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.
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) investors, 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 (which has been repealed) 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, but at present only five German REITs exist.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 II 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), e-money-institutions, financial services institutions (i.e., investment firms within the meaning of MiFID II 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.