Changes to investment rules for German pension funds may limit their ability to invest in alternative asset classes, Willis Towers Watson has warned.

The German supervisor BaFin is seeking to clarify investment guidelines and limits for Pensionskassen and Pensionsfonds, two of the main types of pension fund in Germany.

The limits were last amended in March 2015 to reflect the Alternative Investment Fund Managers directive and the German Investment Law, known as the KAGB.

However, subsequent BaFin circulars have still referred to pre-KAGB times. The supervisor has therefore put out two circulars for consultation until 31 January: one (in German) includes clarifications on new asset classes like high-yield loans, while the other (in German) relates to the use of derivatives and structured products.

Regarding the clarifications on investing in high yield loans, Sabine Mahnert, senior investment consultant at Willis Towers Watson, said she was worried the proposed changes could inhibit investments in such assets.

“While the new 5% high yield loan quota will facilitate investments in alternative credit, many loans funds on the market will fail to meet the criteria imposed,” she explained to IPE.

One hurdle is that funds holding loans rated lower than B- will not be eligible for the 5% quota.

“In addition, open-ended funds that also engage in loan origination will be classed as alternative investments and fall under the 7.5% quota applicable for these investments,” she added.

The 7.5% cap for alternative investment funds (AIF) only applies to small insurance companies and Pensionskassen.

Further, Pensionskassen and insurers can only invest in Spezialfonds – a form of institutional investment vehicle – containing alternatives if the share of loans in the form of “non-securitised investments” in each fund is below 30%. If 100% loans funds are included, these count towards the AIF quota of 7.5%.

Mahnert said it was “unfortunate” that many loan investments in the form of senior secured loans will count towards the 7.5% AIF quota as this was already a “collection basin” for all kinds of primarily alternative investments such as hedge funds.

Andreas Drtil, senior investment consultant with Willis Towers Watson, said there was a way around the restriction: “Investments in senior secured loans might fall under direct company shareholdings and rather be classified as private equity investments if there is an element of active loan origination and management as a business model.”

New restrictions for Pensionsfonds

For Pensionsfonds, the proposed amendments would introduce minimum rating requirements for loan investments, which has so far only strictly applied to insurers and Pensionskassen. These institutional investors are not allowed to investment below a rating of B-, as rated by one of the large agencies or according to their own credit assessment.

BaFin now “seems to want to apply this minimum rating requirement investments in AIFs that fall under the 7.5% quota”, Drtil added.

“Pensionsfonds are generally not subject to investments quotas but should limit their exposure to alternative investments in depending on their funding position”, Mahnert noted.

According to Mahnert, the inclusion of Pensionsfonds in this regulation “does not make much sense” as these pension vehicles are exempt from most of the regulator’s quantitative investment caps.

“If they are theoretically allowed to invest 100% in equities, why apply a rating restriction for fixed income investments in such portfolios?” asked Mahnert.

The BaFin circulars also include fresh requirements for consultants to increase their due diligence when choosing funds for their clients.

Additionally, the regulator will require Pensionskassen, small insurance companies, and Pensionsfonds to up their own risk management for their investments and either understand each asset class or get external help.

“This might make it a little bit harder for smaller institutions to invest in alternative asset classes,” noted Drtil.

Another circular (in German) recently published by BaFin focused on minimum requirements for risk management by German asset managers. It sets out some standards for companies to administer and manage not only securities but also loans.