Last week the AIFM Transformation Act (AIFM-Umsetzungsgesetz) which, inter alia, has replaced the German Investment Funds Act (Investmentgesetz) by the German Capital Investment Act (Kapitalanlagegesetzbuch – KAGB). At the same time, the German regulator for investment funds (BaFin) released an FAQ regarding the eligibility of assets for investment funds under the new law. The FAQ includes important statements regarding the eligibility of participations in private equity funds and other closed-end funds, which are of major practical relevance for specialized funds which insurance companies, pension funds and other institutional investors often use for their capital investments.
- In the FAQ, BaFin has confirmed its position regarding the eligibility of interests in closed-end funds for specialized funds also under the new regime. Accordingly, open-end domestic specialized investment funds typically used by institutional investors continue to be able to invest in closed-end funds.
- However, proposed tax legislation providing product regulation has to be considered. This product regulation would apply not only to foreign, but also to domestic investment funds and would have to be complied with in addition to the regulatory rules to keep the specialized funds' tax status, in particular their personal tax exemption. This new tax product regulation contains restrictions in connection with investments in closed-end funds which go beyond the regulatory rules.
- Nevertheless, indirect private equity investments and interests in other closed-end funds in principal continue to be eligible as additives of German specialized investment funds.
A significant number of institutional investors in Germany use open-end specialized investment funds for their investments. Participations in closed-end funds have become an increasingly important factor of the portfolio allocation of such specialized investment funds due to the situation of the financial markets during recent years.
In the context of the transposition of the AIFM directive into German law, the existing rules applying to open-end specialized investment funds before the reform have been included in the new act. Other than the old law which basically only contained rules applying to open-end funds, the German legislator merged rules for open-end funds and closed-end funds in the same act. The provisions regarding assets eligible for open-end funds have not been adjusted in that context. On that ground, there was a significant uncertainty in the market during the last couple of months as to whether open-end specialized investment funds under the new regime will be able to acquire interests in closed-end funds at all.
III. Investments in closed-end funds as securities or business participations
The BaFin department in charge of the supervision of investment funds has now clarified that interests in closed-end funds shall continue to be eligible assets for open-end specialized investment funds. Such interests can be acquired either as securities or as so-called business participations depending on individual product characteristics in each single case. Usually, a qualification as security is favorable in the light of the internal investment guidelines of most German investment companies. The criteria for their distinction remain unchanged under the new rules. In particular for funds of funds and in connection with master-feeder structures a qualification as securities is manageable in many cases. For regulatory purposes, the maximum portion of (unlisted) interests remains to be 20 % of the specialized fund's net asset value.
IV. Consequences of the expected tax product regulation
On 16 May 2013, the German Federal Parliament (Deutscher Bundestag) passed the AIFM Tax Adjustment Act (AIFM-Steuer-Anpassungsgesetz). However, for the time being the bill has fallen through during the further legislative procedure (cf. our client information dated 28 June 2013). Nevertheless, there is a realistic chance that the bill can still pass the legislative process before the end of the current legislative period and enter into force retroactively, as the case might be, as of 22 July 2013. The bill, as passed by the German Federal Parliament, provides a tax product regulation that is independent of any regulatory provisions. Such product regulation distinguishes between tax-free investment funds (Investmentfonds) and taxable investment companies (Investitionsgesellschaften). Only investment funds can claim a personal tax exemption. This tax exemption is essential for the specialized funds used by German institutional investors. Therefore, the tax product regulation is as important as the regulatory rules.
The following restrictions have to be considered in this context:
- Shares in corporations or other interests in closed-end funds which qualify as securities should be eligible assets for a German open-end specialized investment fund with no overall limit applying as long as they are listed on a stock exchange.
- Interests in closed-end funds established as corporations or interests that qualify as securities which are not listed on a stock exchange remain to be eligible. Up to 20 % of the specialized fund's net asset value can be invested in this category.
- Interests in closed-end funds established as partnerships which are considered as business partnerships for German tax purposes can only be acquired up to an amount equal to 10 % of the net asset value of the investing open-end specialized investment fund (so-called opening quota) unless such interests qualify as securities.
- Participations in a corporation can only be acquired up to less than 10 % of the capital of the target corporation irrespectively of a potential qualification as security. However, it has not yet been clarified whether this only applies to non-listed corporations or also includes listed corporations.
V. Pending implementation for purposes of German insurance company regulation
Many institutional investors using a German specialized investment fund are subject to German insurance companies regulation and as such subject to an oversight by either BaFin or the competent state authority (e.g. in the case of professional pension funds). Insurance companies regulation primarily concerns the participation of the institutional investor in the specialized investment funds. However, there are also some aspects of insurance companies regulation that have to be considered with regard to the portfolio investments made by the specialized funds. The BaFin department in charge of insurance companies regulation and oversight has not released any statement yet regarding the impact of the new investment fund rules on the specialized investment funds used by insurance company regulated undertakings. According to information received by us, such statement cannot be expected before 2014.
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.