Originally published July 8, 2009

Keywords: German Federal Financial Supervisory Authority, Grey Capital Market, BaFin-report, German Securities Trading Act, WpHG, German, foreign corporate entity

The German Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht, "BaFin") submitted a report on the "Grey Capital Market" to the German parliament's finance committee on June 10, 2009. The BaFin-report makes several proposals aimed at improving investor protection in the Grey Capital Market (the "BaFin-report").

The BaFin-report targets the regulation of a market segment subject to a fairly low level of regulation in Germany while, at the same time, the European Union is launching an initiative for a new regulatory framework regarding the same subject matter.

Pursuant to Sec. 2 Subsection 1 No. 2 of the German Securities Trading Act (Wertpapierhandelsgesetz, "WpHG"), interests in any German or foreign corporate entity, partnership and other undertaking constitute securities only if such interests are comparable to stocks. The identical provision can be found in sec. 1 Subsection 11 Sentence 2 No. 1 of the German Banking Act (Kreditwesengesetz, "KWG").

Interests in closed-end funds are typically not structured in such a way as to be comparable to stocks.

Accordingly, neither the distribution nor the issue nor the management1 of such interests is subject to the provisions of the WpHG and KWG. The respective activities are for all practical purposes unregulated in Germany2.

However, there are signs that the liberal German environment for closed-end funds will be subject to considerable change in the foreseeable future. On April 30, 2009 the European Commission put forward a proposal for a directive on Alternative Investment Fund Managers ("AIFM-directive").

Pursuant to the AIFM-directive, the management of collective investment schemes (funds), as well as the marketing of interests in such funds within the EU will be subject to member state authorization. At this stage, exemptions are only provided for with regard to fund managers with less than EUR 100 million of assets under management (or with less than EUR 500 million of assets under management in the case of unleveraged funds and a lock-in-period of at least five years). (For details see also Draft Directive on Alternative Investment Fund Managers)

The directive sets out certain requirements as to the fund managers' proficiency, risk-controlling and reporting obligations. The reporting obligations include, in particular, the provision of detailed information on the assets in the respective funds, as well as on their risk assessment. Additional requirements apply to funds engaged in short selling and to funds using a high level of leverage.

Pursuant to the proposed directive, the marketing to natural persons is subject to authorization by the member states, which may stipulate further requirements for these purposes. Authorization under the provisions of the AIFM-directive alone does not authorize marketing to natural persons.

Fund managers established in third countries are subject to special authorization requirements. In particular, authorization will require an effective exchange of information in tax matters between the respective third country and the EU-member state, where the interests are to be marketed. Furthermore, the fund manager is subject to supervision in its country of establishment, which is equivalent to supervision within the EU.

Implementation of the AIFM-directive shall be effected by 2011. However, it remains unclear what kind of transitional provision will apply. The directive is still part of political discussions and amendment recommendations by the various associations.

The BaFin-Report does not feed into this discussion, but proposes the extension of the scope of national regulation within the existing regulatory framework.

The BaFin proposes to accommodate partnership interests, as well as all undertakings for collective investments within the term "financial instrument" or, as the case may be, "security" within the meaning of Sec. 1 Subsection 11 KWG and Sec. 2 Subsection 2b WpHG in order to improve investor protection by subjecting the marketing of interests to supervision.

Accordingly, any service rendered by a third party with regard to the issue, marketing and management of interests in closed-end funds would qualify as financial service and require authorization pursuant to Sec. 32 Subsection 1 KWG.

BaFin proposes to set up a decentralized supervision modeled on the supervision of insurance marketing, however, to increase the requirements pursuant to the German Trade, Commerce and Industry Regulation Act (Gewerbeordnung) for these purposes.

At a hearing of the German parliament's finance committee on July 1, 2009, all experts unanimously recommended to subject interests in closed-end funds to the provisions of the KWG and WpHG. However, the Association of Closed-End Funds (Verband geschlossene Fonds, "VgF") favors registration requirements of offerors and a material inspection of sale prospectuses instead. In spite of BaFin claiming that it would lack the resources to scrutinize sales prospectuses for yet another asset class, there are indications that there will be a proposal for a law (introduced by the Federal Ministry of Finance) after the general elections in autumn driving in the direction proposed by the VgF.

Any specific actions, however, will be implemented in the next parliamentary term.


1. Unless such management constitutes financial asset management pursuant to Section 1 Subsection 1a Sentence 2 Number 11 KWG.

2. Unless, with regard to interests in foreign closed-end funds, such interests constitute foreign investment interests within the meaning of Section 2 Subsection 8 and 9 of the German Investment Act (Investmentgesetz – "InvG").

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