Germany: Draft Of A New Investment Ordinance

The Federal Ministry of Finance (Bundesministerium der Finanzen, "BMF") published today for consultation purposes a draft regulation amending the investment ordinance ("AnlV-E"). The purpose of the proposed regulation is to adapt the capital investment rules, which are relevant for insurance companies, pension funds and other pension institutions, to the altered legal framework due to the implementation of the AIFM-Directive into the German Capital Investment Act (Kapitalanlagegesetzbuch, "KAGB"). While there are some minor improvements with regard to investments in debt instruments, the AnlV-E in essence foresees a significant tightening of the investment conditions for insurance companies and pension funds.

The most important changes are:

  • Investments into private equity ("PE") funds only qualify for the equity quota if the fund is an EU or foreign (OECD) fund, which is managed by a management company having its registered seat in an EEA or OECD member state and which is in possession of an AIFM-license (or in the case of an OECD resident manager, an equivalent license). The same applies to PE fund of funds.
  • Additionally, private equity fund of funds now will only qualify for the equity quota if both the fund of funds and the underlying target funds have their registered seat in any EEA or OECD member state and both fund of funds and underlying target funds are managed by managers who meet the requirements above.
    PE funds which are managed by small (merely registered) management companies as well as venture capital ("VC") funds and funds with third-country managers, which are not in possession of an equivalent license, will in the future only be eligible for investment via the "opening clause" (fallback basket for non-eligible investments).
  • Closed-ended real-estate funds qualify for the real estate quota if they invest in real estate assets (properties, real estate companies etc.) and are managed by an AIFM licensed management company having its registered seat in any EEA member state.
  • All closed-ended Spezial-funds which do not qualify for the real estate or PE-quota may now be acquired under the newly introduced alternative asset class if they are managed by an AIFM licensed management company (these funds for example may invest up to 100% in non-securitized loan obligations).
  • Investments in loans to companies having their registered seat in any EEA or OECD member state, which are not in possession of an Investment-Grade-Rating (so called High-Yield-Corporate loans), are eligible if a sufficient level of security exists. These companies must at least be in possession of a Speculative-Grade-Rating. This extension of the possibility to invest into corporate loans is in particular intended to facilitate the granting of loans to infrastructure companies.
  • Grandfathering: Until the new regulation comes into effect, investments made may be allocated to the equity quota, even if they will not be able to meet the new requirements.

Pursuant to the AnlV-E the following quota shall apply with respect to participations in funds (which meet the criteria of the respective category):

  • AIF with a UCITS-strategy, which in essence may be acquired in accordance with the existing rules;
  • AIF with a private equity-strategy, which are generally eligible for acquisition within the equity quota (15% of the restricted assets)(conditions see below under A.I.1);
  • AIF with a real estate-strategy, which need to be added to the real estate quota (25% of the restricted assets) (conditions see below under A.I.2);
  • AIF with an alternative strategy, for which a new quota in the amount of 7,5% of the restricted assets applies (conditions see below under A.I.3);
  • AIF under the opening clause (5% of the restricted assets).

A. IN DETAIL

I. Eligibility of fund participations

1. Private Equity funds (§ 2 para. 1 sentence 1 no. 13 lit. b) AnlV-E)

According to the AnlV-E, participations by insurance companies in private equity funds are possible within the so called equity quota, if:

  • they invest directly or indirectly in company participations or comparable equity-like investments;
  • their manager has its registered seat in an EEA or full-membership OECD state, is subject to an investment supervision in such state and is in possession of an AIFM license.

Special cases (until now falling under PE funds):

  1. Mezzanine funds

    The aforementioned rules principally apply to traditional private equity funds, whose investment strategies are aimed at acquiring participations in non-listed companies, but also to mezzanine funds who invest in equity-like investments.
  2. Infrastructure funds

    Not explicitly included under the PE-quota are infrastructure funds. Our understanding of the current practice of the insurance supervision is however that infrastructure funds are mostly treated equal to private equity funds with respect to their eligibility for the equity quota. Nonetheless, a clarification in the Investment Ordinance or issued in a circular note by the German Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht, "BaFin") would be helpful.
  3. PE-Fund of funds

    The equity quota, according to the explanatory comments in the AnlV-E, shall remain available for PE-fund of funds. However, the underlying target funds must then also meet the requirements which are applicable to direct investments in underlying funds (requirement of establishment and management license).
  4. VC-funds, PE-funds with "small" managers and third-country-manager funds

    Pursuant to the explanatory comments in the AnlV-E, funds not meeting the requirements set out above (i.e. funds managed by sub-threshold managers, VC funds as well as funds managed by third-country managers without a comparable license) may only be acquired via the "opening clause" (i.e. the fallback basket for non-eligible assets).

2. Real Estate funds (§ 2 para. 1 sentence 1 no. 14 lit. c AnlV-E)

Participations in closed- and open-ended Spezial-real estate funds (whereby "Spezial" indicates that the fund only has semiprofessional and professional investors) shall, also under the new AnlV-E, remain eligible for acquisition under the real estate quota of the restricted assets, if:

  • they invest directly or indirectly in acquirable immovable property and rights in accordance with § 231 para. 1 no. 1 through 6 KAGB as well as § 235 para. 1 KAGB (i.e. properties, leaseholds, usufructuary right with regard to properties and real estate companies);
  • they are German or comparable EU-AIFs ("comparable" may mean that the fund itself also must be subject to investment supervision);
  • its manager has its registered seat within an EEA member state, is in its home state subject to a public supervision to protect investors and has obtained an AIFM license;
  • In case of fund of funds structures, underlying target funds must also meet the same requirements, i.e. be situated in an EEA member state and be managed by a manager with registered seat in an EEA member state and having obtained an AIFM-license.
  • Detailed requirements shall be determined by way of circular note issued by BaFin.

3. Alternative Spezial-funds (§ 2 para. 1 sentence 1 no. 17 AnlV-E)

Alternative Spezial-investment funds, which do not follow a private equity, real estate or UCITS-strategy within the meaning above (i.e. securities funds), may in the future be acquired within the new quota for alternative strategies (max 7,5% of the restricted assets). Requirement is also that these funds are German or EU-AIFs, its manager has its registered seat in the EEA, is in its home state subject to a public supervision to protect investors and has obtained an AIFM license.

4. Spezial-funds (§ 2 para. 1 sentence 1 no. 16 AnlV-E)

Insurance companies currently use for a big portion of their capital investments German Spezial-fund structures, which typically are structured as class-exempted special funds (open domestic Spezial-AIF with non-variable investment conditions within the meaning of the new investment law.)

The Spezial-fund structure must be comparable to UCITS both with regard to eligible assets as well as with regard to redemption rights. In addition, their manager must have its registered seat in an EEA member state, be subject to a public supervision for the protection of investors in such state and must have in its possession an AIFM-license. It therefore principally remains that under certain circumstances, an investment in a closed-ended fund is eligible, namely if the participation in the closed-ended fund qualifies as security (§ 193 para. 1 sentence 1 no. 7 KAGB).

Underlying target funds must also adhere to the same requirements, meaning they will also need to be comparable to UCITS with regard to eligible assets and redemption rights and need to have their registered seat in an EEA member state and be managed by an AIFM-licensed manager having its registered seat in an EEA member state.

II. Investments in loans (§ 2 para. 1 sentence 1 no. 4 lit. c) AnlV-E)

The AnlV-E expands the possibilities to invest in loans to undertakings as set out below:

  • the undertaking has its registered seat in an EEA- or OECD member state;
  • the undertaking must at least be in possession of a Speculative-Grade-Rating;
  • the loans are sufficiently secured, contractually or in rem.

With this expansion, the facilitation of granting loans to infrastructure companies, newly established undertakings as well as undertakings with a credit rating below Investment-Grade-Rating (so called High-Yield-corporate loans) shall be achieved.

III. Miscellaneous

The use of group subsidiaries as a participation platform for private equity investments will be amended insofar as in the future only passive participations, where no possibility to exert influence on the operational business exists, will be eligible. Until now it was merely necessary to limit the purpose of the company to hold interests in non-group companies. On the other hand, the new rules enable participations in group companies, which invest directly in infrastructure facilities or debt.

B. GRANDFATHERING (§ 6 AnlV-E)

Grandfathering is in particular foreseen for funds which fell under the equity quota until the new Insurance Ordinance takes effect. These PE funds may continue to be attributed to the equity quota, even if they do not meet the altered criteria for PE-fund investments.

For a transitional period, open Spezial-funds which have been duly acquired prior to the coming into effect of the new regulation but do not meet the altered requirements, may be attributed to the new asset class of domestic open Spezial-AIF until 31 December 2019. During this transitional period, no allocation to the quota for alternative investments will be made.

C. CONCLUSION

While the facilitations with regard to debt investments are welcomed, the AnlV-E is highly problematic with regard to private equity funds and PE-fund of funds. German insurance companies and pension funds will be severely restricted in their PE-investments. There is considerable need for action in this respect.

D. NEXT STEPS

The official consultation process began with today's publication of the draft regulation. The consultation period will end on 27 June 2014. Please do not hesitate to send us your comments and proposed amendments for a statement to the BMF.

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.

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