Due to the Investment Modernisation Act, which has been in force since the beginning of this year, the German investment fund community has taken a step forward. For the German investment industry the new provisions boost the ability to create new products as well as the attractiveness of the local production base.
The German legislator has merged the provisions of the existing Investment Companies Act and the Foreign Investment Act. By doing so, Germany’s investment fund tax laws have been modernised and harmonised.
In line with the amended EU UCITS directive, the Investment Act abolishes the former classification of statutory fund types. Instead, it allows for a ‘Super-UCIT’ by listing a catalogue of asset classes generally permissible: these include securities, money market instruments, derivatives, bank deposits and investment fund units.
The Investment Act liberalises the provisions for permissible investments. One of the most important changes is the provision that UCITS funds may also invest in derivatives which are derived from securities, money market instruments, certain investment shares, recognised financial indices, interest rates, exchange rates or currencies. However, investments in derivatives based on commodities or precious metals are prohibited.
In line with UCITS requirements the investment company has to ensure that the market exposure of the funds may be not more than doubled by the use of derivatives. Further details are set out in a BaFin ordinance on employment of derivatives, for example, the choice between two approaches for the measurement of market risk, the so-called ‘qualified’ or the ‘simplified’ approach.
Funds which invest in all permissible asset classes could be termed as ‘super-UCITS’. This facilitates special ‘core-satellite portfolio strategies’, which are composed of index-linked funds (core) and actively managed funds or individual securities (satellite).
In particular, the new legislation allows the establishment of hedge funds (funds with additional risks) in Germany for the first time. The regulations make a differentiation between single hedge funds and funds of hedge funds.
Single hedge funds are not subject to investment restrictions, with the exception that they may not invest in real estate or real estate companies. Particularly, they can take out unlimited amounts of credit (leverage), invest in derivatives and engage in short selling. Unlike the other funds covered by the Investment Act, hedge funds may also invest in companies which are not traded on a regulated market (up to 30%). Single hedge funds are established as investment funds but are prohibited from public distribution and can only be marketed by way of private placement.
Funds of hedge funds are funds that invest in target funds as well as in bank deposits and money-market instruments (up to 49% of the funds assets) and in certain currency-hedging instruments. Permissible target funds include German single hedge funds and foreign hedge funds (which with respect to their investment policy are comparable to the investment requirements for German hedge funds). Target funds of countries which do not cooperate in international efforts against money laundering are excluded as investments. Funds of hedge funds are not allowed to engage in leverage or short selling.
A fund of hedge funds may invest not more than 20% of its assets in a single target fund and not more than two target funds of the same issuer, or of the same fund manager. Investments in target funds that themselves invest in other funds are prohibited. Moreover it is allowed to acquire all units of a target fund.
Up to last year, German law has only recognised the concept of an investment stock corporation with fixed share capital (close end fund similar to a UK investment trust). Due to this restriction and various tax disadvantages, no such investment stock corporation has been launched to date.
Using the French and Luxembourg SICAV as a model, the new Investment Act now also enables the formation of investment stock corporations with variable share capital. The taxation of shareholders in an investment stock corporation will be the same as for investors in investment funds of the contractual type.
In the future, investment funds will, in addition to the detailed sales prospectus, also need to prepare a simplified prospectus for better investor information, as foreseen in the UCITS directive.
The Investment Act also contains provisions designed to smooth and accelerate the approval process by the financial services regulation BaFin. Once implemented, this could be a major step in order to enhance the competitiveness of the German market place versus fund hubs such as Luxembourg or Dublin.
The Investment Act modifies requirements for outsourcing allowing for a liberal regime. Outsourcing is allowed if the rules for outsourcing under S25a (2) Banking Act – specified in circular 11/2001 by the BaFin – are fulfilled, and if the delegation does not hinder the investment company from acting in the interests of the unit-holder. Outsourcing of portfolio management follows the rules in the UCITS directive, so outsourcing of portfolio management to the depositary bank is prohibited. The manager must be licensed to perform asset management services and must be subject to effective public supervisions. This quality of supervision exists in all EEA member states, as well as in the US, Switzerland and Japan.
Moreover, the act permits, for the first time, the merger of investment funds, with the approval of BaFin. The funds have to comply with several requirements. For example, the funds must be managed by the same investment company in accordance with essentially similar investment principles and their fee structure must be comparable. The merger of funds is especially important in order to allow for a restructure of the fund products range in line with current investor requirements.
Regarding funds for institutional investors (Spezialfonds) there are only a few new regulations. In particular, the number of permissible investors was increased. Now, up to 30 investors (formerly 10) are allowed to invest in a single fund. Spezialfonds have various administrative benefits such as exemption from the prospectus requirement, from the requirement to calculate and to publish the net asset value daily. The merger of Spezialfonds requires only the prior approval of the unitholder rather than of the BaFin.
The Investment Tax Act is a part of the Investment Modernisation Act. It contains specific rules for the taxation of investment funds and replaces the tax rules formerly contained in the German Investment Companies Act and in the German Foreign Investment Act.
The essential modification in the provisions is the equalisation of tax consequences for domestic and foreign funds. This is of advantage to foreign funds in particular, because private shareholders now also benefit from the half-income procedure for dividends as well as in case of domestic funds. Generally, the provisions apply to funds as per the business year beginning after end of year 2003.
If a fund fails to meet the notification and disclosure duties, it will generally be subjected to penalty taxation. This means that all distributions will be taxed, as well as 70% of the difference between the first and the last redemption prices set in the calendar year. At least 6% of the last redemption price set in the calendar year must be reported.
In summary, going forward the new law will enable German fund managers to compete effectively with foreign investment managers both in the retail and institutional marketplace.
Rüdiger H Päsler is managing director of BVI Bundesverband Investment and Asset Management in Frankfurt