Originally published 13 January 2008
Keywords: German Investment Act, foreign funds, German Financial Supervisory Authority, BaFin, Investmentgesetz, InvA, Germany, foreign pool of assets, Qualifying Assets,
On December 22nd, 2008 the German Financial Supervisory Authority (Bundesanstalt für die Finanzdienstleistungsaufsicht "BaFin") published circular 14/2008 (WA) ("Circular") on its interpretation of the scope of the German Investment Act (Investmentgesetz – "InvA") as amended on December 21st, 2007. The InvA governs the distribution of units in foreign funds in Germany. The Circular follows a draft which was published on the BaFin website on June 9th, 2008 (see Mayer Brown newsletter of June 2008). According to the InvA, a participation in a foreign pool of assets can be classified as a unit in a foreign investment fund subject to the InvA if the following criteria are met:
- The foreign pool of assets consists of certain assets as defined in section 2 para. 4 InvA ("Qualifying Assets"),
- the foreign pool of assets is composed according to the principle of risk diversification, and
- the shareholders have the right to redeem units or the foreign pool of assets is subject to a supervision by a public body (investment supervision).
Qualifying Assets (see (i) above) and Investment Restrictions
In determining the scope of the application of the InvA in terms of defining Qualifying Assets the Circular expands on an approach which had initially been introduced by the draft circular of June 2008.
According to the Circular, a foreign pool of assets can only be considered a foreign investment fund within the meaning of the InvA if more than 90 percent of such pool consists of Qualifying Assets. This general approach is modified by a set of investment restrictions which, according to the Circular, must be observed by the foreign pool of assets in order to qualify as a foreign investment fund within the meaning of the InvA. In brief and without purporting to be a complete list the restrictions are the following:
- For a foreign pool of assets that does not qualify as
Spezialfonds (a Spezialfonds is a fund that does not admit
individuals as investors) and if the pool of assets includes
investments in
- infrastructure companies and real estate, these investments must account for at least 60 percent of the value of the foreign pool of assets.
- unlisted securities and unlisted participations in companies; these investments must not account for more than 20 percent of the value of the foreign pool of assets.
- precious metals, derivatives and unsecuritized (unverbriefte)
loans; these investments must not account for more than 30 percent
of the value of the foreign pool of assets.
- For a foreign pool of assets that qualifies as a Spezialfonds (no individuals as investors) and that includes investments in unlisted securities and unlisted participations in companies, these investments must not account for more than 20 percent of the value of such a foreign pool of assets.
- For a foreign pool of assets that qualifies as a hedge fund for purposes of the InvA and that includes investments in participations in companies, such investments must not account for more than 30 percent of the value of the hedge fund.
For the purposes of the Circular, investments in closed ended funds are typically qualified as participations in companies. The Circular does not explicitly state whether these investment restrictions need to follow from compulsory regulatory stipulations or from the investment restrictions that the fund adheres to by virtue of its terms.
Risk Diversification (see (ii) above)
Within respect to the principle of risk diversification the Circular confirms the rule of thumb which, in the absence of clear guidance by BaFin, has been developed by advisors, according to which risk diversification may be given where the foreign pool of assets consists of more than three assets with different investment risk characteristics. Risk diversification is also present if the investments are made in other entities which are themselves risk diversified. Risk diversification must be pursued by the vehicle with commercial intent. Mere liquidity management, that dominates the investment objective, does not constitute intentional risk diversification. Risk diversification that is achieved merely as a result of other business objectives ("by chance") does not constitute risk diversification within the meaning of the InvA. This seems to be a useful specification of what used to be discussed in the context of diversification as "entrepreneurial influence" (see also below details provided by the Circular for private equity funds).
Redemption Right or Investment Supervision (see (iii) above)
The Circular further states that a redemption right within the meaning of the InvA exists if the majority of the holders of units in the foreign pool of assets can claim redemption of their units. Individual agreements with a minority of shareholders are irrelevant. In the view of BaFin, there is a presumptive redemption right if a repurchase vehicle is obliged to purchase the shares of the shareholders, provided that this repurchase vehicle has sufficient funds to ensure the payment of the redemption price. To fulfill the redemption right criteria it is not necessary that the shareholders can redeem their shares at any time. It is sufficient if the redemption right is exercisable at predefined dates, provided the investors have at least one redemption window during any two year period. The analysis is unaffected if there are caps on redeemable amounts, provided the cap serves the purpose of investor protection. This is significant for structures such as "evergreen"-structures where soft redemption rights are granted subject to substantial look-up periods and management discretion.
As an alternative to providing a redemption right, a foreign entity could still be classified as foreign investment fund within the meaning of the InvA if the foreign entity is subject to supervision by a public body in its country of residence (investment supervision). Pursuant to the Circular, the supervision requirement is not fulfilled if the supervision only ensures the integrity and capability of the market, serves only for the purpose of monitoring certain tax requirements or is for registration purposes only.
On the other hand, supervision in this context exists, inter alia, if the purpose of the supervision is to
- establish the solvency of an investment company; and
- to verify the reliability and capability of the management; and
- to monitor the ongoing compliance with applicable investment restrictions. In respect of this last requirement it is noteworthy that the draft of June 2008 had provided for each of the three purposes (alternatively) to be sufficient to assume a supervision in the meaning of the InvA. This has been changed to read as the purposes having to be pursued cumulatively.
Private Equity Funds
Private equity funds are specifically addressed in the Circular. They do not fall within the scope of the InvA, provided the funds acquire predominantly majority interests or blocking minority shareholdings and exert entrepreneurial influence over and above of the mere exercise of voting rights attached to the shares by taking management board seats in the portfolio companies.
In view of the restrictions for foreign investment funds on investments in unlisted participations (generally 20 percent of value) the extensive stipulations on entrepreneurial influences may prove to be redundant in practice.
Application
The Circular has come into effect upon its publication on the Bafin web-site on December 22nd 2008.
The Federal Ministry of Finance (Bundesministerium der Finanzen or "BMF") has been involved in the process since the definition of foreign investment funds under the InvA is decisive for the application of the Investment Tax Act (Investmentsteuergesetz or "InvTA"). It is expected that the stipulations of the Circular will generally be adapted by the BMF for fiscal purposes and will replace the so called "limited partnership exemption" granted under the circular issued by the BMF on June 2nd, 2005 (so called "Anwendungsschreiben") on the interpretation of the InvTA. It is not yet clear whether there will be a grace period for the application of the Circular for fiscal purposes.
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