I Financial Market Adaptation Law
On 8 April 2014, the German Federal Cabinet approved a government draft on the legislation to adapt the laws on the financial market ("Financial Market Adaptation Law"). It is not to be expected that the adoption of the Financial Market Adaptation Law will take place before early July 2014.
The aim of the government draft is to adapt the German Capital Investment Act (Kapitalanlagegesetzbuch, "KAGB") to be in-line with the specifications of the European Commission on open-ended and closed-ended funds as laid down in its draft Delegated Regulation of 17 December 2013 ("Delegated Regulation Draft") as well as generally adapting some of the wording of the KAGB. The assent of the European Parliament to the Delegated Regulation Draft, on which the KAGB amendments are based, is currently still outstanding.
The main elements of the draft are:
- Introduction of a new definition for open-ended / closed-ended funds ("AIF"). This is of relevance as different rules apply for open-ended / closed-ended AIFs (including grandfathering).
- Unlike before, the new definition foresees that AIFs who grant a right to termination in their articles of association prior to liquidation – irrespective of the frequency – are deemed open-ended within the meaning of the law.
- With regard to the grandfathering of closed-ended AIFs who have not made any investments after 22 July 2013, the grandfathered status will not be lost if during the period of 5 years from the date of the initial investment no redemption is possible.
- Possibility to conduct investment advice, portfolio management, fund related custody business and investment brokerage on a cross-border basis in Germany by non-German EU AIFMs, who are in possession of an AIFM license from their EU home member state.
II Details of the changes
1. Distinction between open-ended and closed-ended AIFs
Arguably, the changes to the distinction between open-ended and closed-ended AIFs can be regarded as the most important changes. The changes are in particular critical as specific transitional and product rules apply to closed-ended AIFs.
a. Status Quo: Current definition closed-ended AIF
The current distinction between open-ended (Section 1 para. 4 no. 2 KAGB) and closed-ended (Section 1 para. 5 KAGB) AIF is based on a proposal by the European Securities and Markets Authority ("ESMA"), pursuant to which open-ended funds are all those AIFs whose shares or interests are redeemable at least once a year. All other AIFs, who do not qualify as being open-ended, are considered closed-ended AIFs.
b. New definition for closed-ended AIF pursuant to the Delegated Regulation Draft
The European Commission however did not endorse the proposal and submitted a proposal of its own. The compromise proposal now included in the Delegation Regulation Draft foresees that an AIF will already be considered to be open-ended if it allows for the repurchase or redemption of its shares or units prior to the commencement of its liquidation phase or wind-down (Article 1 Number 2 Delegated Regulation Draft). If this happens at least annually or substantially less than annually is not of importance anymore. Should the articles of association foresee a right of termination after, for example, seven years, the AIF would under the new definition be considered to be an open-ended AIF. The definition that an AIF is closed-ended if it is not open-ended will not be changed (Article 1 Number 3 Delegated Regulation Draft).
In order to prevent that a retroactive application of the new definition leads to the loss of the grandfathering status for closed-ended AIFs (who were fully invested prior to 22 July 2013), Article 1 Number 5 of the Delegated Regulation Draft provides for an exemption to the abovementioned definition. According to the exemption, for purposes of the transitional rules, AIFs shall be considered as closed-ended AIFs whose shares or units, prior to the commencement of its liquidation phase or wind-down, can be repurchased or redeemed after an initial period of at least 5 years from the date of the initial investment during which redemption rights are not exercisable.
c. Consequential amendments to the KAGB
Due to the changes to the distinction between open-ended and closed-ended AIFs in Section 1 para. 4 number 2 KAGB, additional consequential amendments needed to be made to provisions whose legal consequences are linked to the definition of open-ended / closed-ended AIF,
- Grandfathering: The exemption stipulated in Article 1 Number 5 Delegated Regulation Draft, which is of great importance to closed-ended AIFs falling under the grandfathering provisions of Section 353 para. 1 KAGB, will be transposed into the newly established Section 352a KAGB. For the purposes of this provision, AIFs are deemed closed-ended if their shares or units, prior to the commencement of their liquidation phase or wind-down, can be redeemed only after an initial period of at least five years.
- Grandfathering: Section 353 KAGB will be supplemented by paragraphs 9 to 13. Pursuant to Section 353 para. 9 KAGB, domestic closed-ended AIFs which were incepted between 22 July 2013 and the coming into effect of the new law, will remain to be treated as closed-ended AIFs; they will however need to abide to the rules for open-ended AIFs with regard to the frequency of valuations and the calculation of share value. This takes into consideration that BaFin, on the basis of the existing definitions, has already registered fund managers ("AIFM") and has approved investment terms.
- Transitional provision: AIFs who have received marketing authorization and which were established prior to the Financial Market Adaptation Law and would under the existing law be considered closed-ended, but under the new laws are deemed open-ended, will remain to be treated as closed-ended AIFs provided their articles of association are amended accordingly within six months of the new laws coming into effect. The sales documentation needs to also contain a reference to the amendments. The same applies to approved investment terms pursuant to Section 267 KAGB.
- Transitional provision: With regard to the partial grandfathering for closed-ended AIFs who are still investing but not marketing after 22 July 2013 (Section 353 para.4 KAGB), the new definition of Section 352a KAGB shall apply (see above). Excluded from this are the provisions on liquidity management and frequency of valuations, where the new definition of closed-ended AIF already applies.
As the assent of the European Parliament to the Delegated Regulation Draft is currently still outstanding, the German legislator merely references the respective provisions of the Delegated Regulation Draft in its newly worded Section 1 para. 4 number 2 KAGB (Definition of open-ended AIF) and newly introduced Section 352a KAGB (Adaptation of the transitional and grandfathering provisions).
2. Proposed amendments with regard to managers operating on a cross-border basis
a. Admissibility of cross-border service of specific MiFID-services in Germany via EU pass
Until now the AIFMD did not foresee that specific MiFID-services, other than the collective portfolio management and marketing of own AIFs, could be provided under the EU pass (cf. FAQ of the European Commission, ID 1144).
This will now be corrected. Articles 4 and 33 of the AIFMD shall in the future also entail the provision of the MiFID-services of investment advice, portfolio management, fund related custody business and investment brokerage (Article 6 para. 4 AIFMD) under the EU pass.
In light of the envisaged changes to the AIFMD, the German legislator has also already included amendments in its Financial Market Adaptation Law. Section 53 KAGB (management of EU AIFs by German AIFM) and Section 54 KAGB (cross-border supply of services and establishment of EU-branches) will be amended so as to include the services mentioned in Article 6 para. 4 AIFMD in the EU pass.
b. Applicability of marketing provisions for retail investors?
Inexplicable are the, without any explanation, proposed amendments to Section 54 para. 4 sentence 3 KAGB with regard to the marketing of domestic Spezial-AIF. By including a reference to the marketing and transparency provisions for retail AIFs and UCITS (Sections 294, 302 to 308), these would also become applicable for the marketing conducted by domestic Spezial-AIF. This is even more true when taking into account that the respective provision with regard to the marketing by German AIFMs, Section 295 para. 5 KAGB, will be corrected and will clarify that insofar only Sections 307 and 308 KAGB, i.e. the provisions for marketing to professional investors (directly implemented from the AIFMD), shall be applicable. The included reference would mean a significant disadvantage compared to German AIFMs, which is inexplicable and in violation of European law.
Changes to the definition of a closed-ended AIF at such a late point in time are more than unfortunate. The exemption provisions are thus rather complex. It is to be hoped that no gaps will become apparent and that the regulators will be reasonable in their approach and interpretation in an area which is difficult to handle for the industry.
It is, however, most welcomed that the legislator has quickly implemented the envisaged amendments to the AIFMD, pursuant to which the MiFID-services (investment advice, portfolio management, fund related custody business and investment brokerage), are now deemed to be covered by the EU pass.
The proposed amendment to Section 54 para. 4 sentence 3 KAGB for EU AIFMs seems in violation of European law. We assume that this is merely a drafting error and will keep you posted.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.