EXECUTIVE SUMMARY
On November 25, 2011 the "Act Reforming the Laws on Intermediaries for Financial Investments and on Investment Products" passed the Bundesrat (upper house of the German Parliament) without objection. The Act will enter into force in the most important parts six months after publication in the Federal Law Gazette (i.e. expectedly in mid-2012).
The Act contains important new rules for closed-end funds which currently fall under the Sales Prospectus Act (so-called "retail funds"). Funds for institutional investors (minimum commitment of Euro 200,000 or more) are also affected by parts of the Act, in particular by the new definition of financial instruments (point 6 below).
We last reported on the draft of the Act now passed in our client memorandum of February 22, 2011.
The most important proposed changes compared to the current legal framework (highlighted: compared to the draft of February 2011) are:
- Introduction of an "Investment Products Act" ("VermAnlG") replacing the existing Sales Prospectus Act ("VerkProspG").
- Reform of the rules for sales prospectuses for retail-funds, in
particular:
- Amendment and extension of the minimum information in sales prospectuses.
- Introduction of a new information leaflet for investment products ("package slip").
- Amendment of the review process by the German Financial Supervisory Authority ("BaFin") (extended review competence and prolonged time limit).
- Introduction of BaFin review of supplements to sales
prospectuses and special revocation right for investors in case of
supplements.
- Reform of the prospectus liability rules and abolishment of the short limitation period for prospectus liability claims. This change is likely to concern non-retail funds, too.
- Additional reporting requirements for retail funds, including requirement to set up a management report (Lagebericht) and mandatory audit of annual financial statements.
- Qualification of interests in closed-end funds as
"financial instruments" under the Securities Trading Act
("WpHG") and the Banking Act ("KWG").
This will also apply to closed-end funds in the
institutional segment. The main consequences are:
- Placement of closed-end funds will be subject to same or similar rules applicable to placement of securities ("MiFID standard", including obligation to give investor tailored investment advice, disclosure of fees, record on investment advice).
- Certain activities concerning closed-end funds would fall under a KWG licensing requirement as banking operations or financial services in future. However, the Act contains a system of exemptions which generally releases sponsors/ initiators, managers and nominees of closed-end funds from the licensing requirement. It is still unclear, however, how fund-of-funds and their managers will be treated under the KWG.
- Independent intermediaries for interests in closed-end funds still do not require a KWG license but only a license pursuant to the Industrial Code ("GewO"). This licensing requirement will also apply to intermediaries (placement agents) in the institutional segment.
DETAILS OF THE CHANGES
1. VermAnlG replaces VerkProspG
The current VerkProspG will be replaced by the new VermAnlG. The new name makes it clear that the scope of application comprises only closed-end funds and related products (so-called investment products").
The contents of the VermAnlG are identical with those of the VerkProspG in most parts, in particular with regard to the scope of application: The VermAnlG is applicable to closed-end funds in the retail segment. Excluded from the obligation to publish a prospectus are closed-end funds with a minimum commitment per investor of Euro 200,000 or more (Sec. 2 No. 3 c) VermAnlG).
2. Changes of the Rules on Prospectuses
The provisions of the VermAnlG (as is the case under the current VerkProspG) mainly concern the setting up and the BaFin review of sales prospectuses for closed-end funds. Additionally, certain provisions of the VermAnlG concern the operations of the fund itself, in particular in the area of reporting (see Sec. 4 below).
The VermAnlG is supplemented by the already existing Sales Prospectus Decree ("VerkProspV") which contains the minimum information requirements for sales prospectuses. The VerkProspV will be amended in several points by the Act.
- Minimum Information in Sales Prospectuses
The statutory minimum information for sales prospectuses pursuant to the VerkProspV will be amended and extended in several points, e.g.:
- Additional information on the costs of the investor (including liability risks and additional contribution obligations)
- Additional information on intermediaries' fees
- Additional information on the founding partners of the fund, e.g. on past insolvency proceedings
- Extended information on the planning status of blindpool funds, in particular with a focus on the actual investments
- Obligation to print in full an agreement on the correct
application of funds.
- New Investment Products Leaflet
In addition to the sales prospectus, the investor shall receive a short and easily understandable information leaflet. The obligation to produce the information leaflet rests with the initiator of the fund. The information leaflet must not exceed 3 DIN-A4 pages and must contain in particular the following information (Sec. 13(2) VermAnlG):
- Investment strategy and investments
- Risks
- Expectations for repayment of capital and gains under different market conditions
- Costs and fees.
The information leaflet is not subject to review by the BaFin, but has to be filed to the BaFin nonetheless. The information leaflet has to be made available for download in an updated version anytime during the placement period. There are special rules on liability for errors in the information leaflet (Sec. 22 VermAnlG). - BaFin Review: Broader Scope of Review and Extended Time
Limit
The scope and procedure of the BaFin review will change in two points under the VermAnlG:
- The BaFin review will include "coherence and comprehensibility" of the information contained in the prospectus. This is an additional step to the current formal review of completeness. The result of the review is the "approval" of the sales prospectus and not anymore the "permission" to publish the sales prospectus (Sec. 8(1) VermAnlG).
- The time limit for the BaFin review will continue to be 20
working days. However, the deadline will not necessarily begin with
the filing of the prospectus, but only when the prospectus is
complete subject in the view of the BaFin. The time required for a
hearing process before the regular review will not be calculated
for the time limit. This proposal has raised concerns that the
review time could increase substantially (theoretically even
unlimited). The legislation now foresees that the hearing process
"should" be completed within 10 working days. This would
typically extend the review process to approx. 30 working
days.
- Publication of Sales Prospectuses
In future, sales prospectuses will be published by announcement in the electronic German federal gazette (instead of a supraregional Börsenpflichtblatt (newspaper recognized by the stock exchanges in Germany)). Until December 31, 2014, however, an additional announcement in a Börsenpflichtblatt will be required. - Supplements to the Prospectus
The VermAnlG retains the existing concept that important factual changes during the placement period have to be publicized in a supplement to the prospectus. The VermAnlG specifically rules that a supplement can also be made to correct an error which was contained in the prospectus from the very beginning (Sec. 11 VermAnlG).
In the final phase of the legislative procedure, two important amendments regarding supplements to the prospectus were made:
- The BaFin reviews and approves supplements to the prospectus (similar to the review and approval of the prospectus itself).
- If a supplement to the prospectus is published, all investors
who were admitted to the fund before have a right to revoke their
subscription(!). This drastic provision is mitigated by a very
short deadline for the declaration of the revocation of only 2
business days. Furthermore, practically it is not clear if
investors will even receive the information on the publication of
the supplement to the prospectus in time, as the supplement to the
prospectus only has to be published in the electronic Federal
Gazette.
3. New Rules on Prospectus Liability and Abolishment of the Short Limitation Period
The VermAnlG contains special rules for prospectus liability concerning closed-end funds. The current reference to the Stock Exchange Act ("BörsG") will be dropped. The new rules on prospectus liability closely follow the existing rules in the VerkProspG and the BörsG. As is currently the case, persons responsible for a prospectus and the so-called "persons behind the prospectus" are liable for the incorrectness or incompleteness of material information in the prospectus. Consequence of the liability is the obligation to redeem the interest and pay back the purchase price plus expenses (Sec. 21 VermAnlG).
The new rules on prospectus liability in the VermAnlG do not contain a special limitation period. At the same time, the reference to the short limitation period for prospectus liability claims pursuant to Sec. 46 BörsG has been dropped. This rule (which will be abolished at the same time) stated that prospectus liability claims are subject to a limitation period of one year beginning with the awareness of the incorrectness in the prospectus, but no longer than (i.e. regardless of the awareness) three years beginning with the publication of the prospectus.
In future, prospectus liability claims under the VermAnlG will be subject to the regular limitation periods pursuant to the BGB (three years beginning with the end of the year in which the claim arose and in which the creditor became aware of the facts supporting the claim.
- Implications for Non-Retail Funds
The short limitation period pursuant to Sec. 46 BörsG was until now also applied to prospectus liability claims in the case of non-retail funds. This analogy will not be possible anymore once Sec. 46 BörsG is abolished. It is therefore likely that the regular limitation period pursuant to the BGB will also be applicable to prospectus liability claims concerning funds for institutional investors. - Change of Six-Month Exclusion Period
Currently, the VerkProspG rules that prospectus liability claims can only be made by investors who have acquired their interest in the fund within six months from the beginning of the placement (so-called "preclusion"). The rule is controversial for legal policy reasons as it largely excludes prospectus liability claims of late subscribers.
Under the VermAnlG, the preclusion will apply only with effect from the end of the placement, but no later than two years after the beginning of the placement. But the sales prospectus must contain a highlighted reference to the preclusion rule (Sec. 7(2) 2 VermAnlG).
4. New Reporting Requirements
In addition to the rules concerning prospectuses, the VermAnlG also contains rules concerning the scope of the ongoing reporting of the fund:
In future, the fund must set up its annual financial statements according to the rules applicable for corporations (other than proposed in the earlier drafts of the Act, however, the rules for large corporations are not mandatory). This includes the obligation to set up a management report. The annual financial statements and the management report must be audited by a public accountant (Sec. 24, 25 VermAnlG).
5. Definition of Financial Instruments: Application of WpHG and KWG to Closed-End Funds
Interests in closed-end funds did until now not qualify as "financial instruments" within the meaning of the WpHG (Sec. 2 (2 b) WpHG) and of the KWG (Sec. 1 (11) KWG). Therefore, the investor protection rules under the WpHG (European MiFID standard) are currently not applicable to the placement of closed-end funds. Equally, licensing requirements pursuant to the KWG for certain activities in connection with the placement of financial instruments (e.g. investment intermediation and investment advice) do currently not apply to closed-end funds.
Both will change with the entering into force of the Act. In future, "investment products within the meaning of § 1 (2) VermAnlG" shall qualify as financial instruments pursuant to the WpHG and the KWG.
- Application of WpHG and KWG also to funds for
institutional investors
The general idea to qualify interests in closed-end funds as financial instruments under the WpHG and the KWG was already contained in the discussion draft of May 2010. At the time, however, the reference included only "investment products for which an obligation to publish a prospectus pursuant to Sec. 8f of the Sales Prospectus Act applies". This rule expressly excluded funds for institutional investors (which do not have to publish a prospectus, e.g. because their minimum commitment amount exceeds Euro 200,000) from the scope of the WpHG and the KWG. This restriction has, however, been dropped by the legislator.
The notion of financial instruments in the WpHG and the KWG was defined in a way that it encompasses retail funds as well as funds in the institutional segment. The definition of financial instruments in the WpHG and the KWG refers to "investment products pursuant to Sec. 1 (2) VermAnlG". That comprises all closed-end funds (whether or not they have a statutory obligation to publish a prospectus), while the exceptions from the scope of application of the VermAnlG for institutional funds are only contained in Sec. 2 VermAnlG and only refer to Sec. 6 to 26 VermAnlG. - Partnership Interests are still not
"Securities"
Also under the new Act, the German legislator retains the position that partnership interests will not be qualified as "securities" (but as financial instruments). Although MiFID expressly foresees the option to qualify partnership interests as securities the German law nonetheless still has the view that interests in partnerships do not equal shares and thus cannot be treated as securities. One of the consequences of such qualification is that the German Securities Sales Prospectus Act ("Wertpapierprospektgesetz") remains not being applicable to the offering of interests in closed-ended funds. - New Conduct Rules for Placements pursuant to the WpHG
or the Investment Products Placement Regulation
By qualifying interests in closed-end funds as financial instruments within the meaning of the WpHG, the rules for placements of such interests are significantly tightened. In principle, all organizational and conduct requirements under Article 6 of the WpHG will become applicable, including:
- Obligation to give tailored investment advice
- Disclosure of fees
- Record of investment advice must be kept
- Employees involved in investment advice, placement officers and
compliance officers must be sufficiently qualified and trustworthy
and have to be registered with BaFin.
The WpHG provisions only apply directly to the placement of fund interests to banks and financial service institutions. For so-called independent intermediaries (including placement agents) special rules apply under the Investment Products Placement Regulation, which is still to be passed. The respective rules will, however, be similar to the rules under the WpHG. - License for Intermediaries (GewO / KWG)
Investment intermediation and investment advice concerning financial instruments require a license under the KWG. The extension of the definition of financial instruments to interest in closed-end funds would also subject the placement of such interests to a BaFin licensing requirement.
However, the Act exempts independent intermediaries from the definition of "financial service providers" (Sec. 2(6) No. 8 e) KWG). Effectively, independent intermediaries do not require a KWG license but continue to require a GewO-license only. The location of the licensing requirement – KWG or GewO – was highly disputed in the forefront of the Act.
The license required under the GewO will, however, in future be subject to stricter requirements. A special licensing requirement for "financial investment intermediaries" and "financial investment advisors" will be included in Sec. 34f GewO. In order to obtain the license, a professional liability insurance and evidence of expertise are required. Additionally, intermediaries will be registered with the Chambers of Industry and Commerce. This licensing requirement will also apply to independent intermediaries in the institutional segment (placement agents). - KWG-License for Other Functions?
As the Act changes the fundamental definition of "financial instruments", several functions currently performed by initiators and service providers of closed-end funds could trigger a licensing requirement. The Act does not contain a comprehensive general exception but a number of singular exceptions that cover certain typical activities that are rendered by third parties in connection with the issuing and management of closed-end funds.
The following will not require a license:
- Serving as a nominee
- Issuing of placement guarantees
- Investment intermediation and investment advice (see above)
- Placements of funds undertaken by the sponsor/initiator
For fund of funds and their managers, however, the situation is still unclear. The uncertainty lies in the fact that the management of a portfolio of financial instruments (and interests in target funds will become financial instruments through the Act) can fall under the rules for "investment management" (Anlageverwaltung) or "financial portfolio management" (Finanzportfolioverwaltung). The legal exemption in the KWG apparently targeting this situation is drafted in a way that is difficult to apply to the structure of fund of funds. Nevertheless, given the objective of the Act, the administration of a fund-of-funds (with a lower risk profile) should not require a license if even the administration of a directly investing fund does not require a license. The position of the BaFin on this question is still open.
6. Date of Application, Grandfathering
The new rules of the VermAnlG generally only apply to prospectuses which are filed to BaFin after the Act has entered into force (i.e. after mid-2012) (Section 32 (1) VermAnlG). This means that existing funds generally are protected by a grandfathering rule.
The stricter rules on the setting up and audit of annual financial statements and management reports (see 4 above) shall, however, also apply to existing funds if such funds are still being placed at the time of entering into force of the Act (i.e. presumably mid-2012). In this case, they apply to all business years from 2014 on.
Insofar as the amendment of the definition of financial instruments causes a licensing requirement under KWG, the license will preliminarily deemed to be granted if within one year after promulgation of the Act (i.e. presumably until end of 2012) a comprehensive application for license has been filed.
STATUS OF IMPLEMENTATION, OUTLOOK
The "Act Reforming the Laws on Intermediaries for Financial Investments and on Investment Products" has been passed by the Bundestag (lower house of the German Parliament), and the Bundesrat (upper house of the German Parliament) did not raise an objection. The Act should be published in the German Federal Gazette within the next weeks.
Even after it has been passed, the new Act raises a number of questions of application that need to be solved in practice. Of particular importance will be which position BaFin takes with regard to potential licensing requirements. Furthermore, it is entirely open how the new provisions will work together with the national implementation of the AIFM directive.
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.
