Interview - BVI: When special becomes alternative

Thomas Richter, CEO of the German Investment Funds Association, discusses the AIFMD, the future of Spezialfonds and opt-out models for occupational pensions with Barbara Ottawa

The EU’s Alternative Investment Fund Manager Directive (AIFM) has “turned Germany, virtually overnight, into the biggest market for alternative investments in Europe,” says Thomas Richter, CEO of the German Investment Funds Association (BVI). The reason for this is that the definition of alternative investment funds has been changed to include any funds not covered by the UCITS Directive. 

This has also transformed German Spezialfonds, long-established special vehicles for institutional investors, and property funds into ‘alternative funds’ under the EU’s definition. “We are talking about assets of some €1.2trn,” Richter says. “By volume, 80% of all funds in Germany qualify as alternative investment funds due to the expanded Directive.” The EU average is 30%.

In light of this, he calls the adaptation of the existing investment law and implementation of the AIFMD “a remarkable accomplishment”. Under the KAGB law, for the first time all fund managers are included under one legal framework, which is particularly challenging for former closed-end fund providers as they now have to adhere to the same rules that open-ended fund providers are subject to.

“Providers of closed-end funds are required to set up a risk-management system, including independent risk-controlling and stress tests. Whenever they use leverage, they have to monitor liquidity risks. In addition, new rules apply to financial reporting and the valuation of tangible assets,” explains Richter. 

For existing closed-end funds, which no longer issue new fund units, a transition period has been set and they can continue to be run under the old regulatory framework under certain conditions.

A recent survey by PwC, the German real estate association ZIA and the former closed-end fund association BSI showed that the German closed-end fund industry is well on the way to implementing the new regulations, and sees this as an opportunity for new products and business. But, at the same time, the industry fears the new reporting requirements and the costs of changing business structures.

The new KAGB is not the only regulatory change affecting the Spezialfonds market. Richter fears a secondary impact on the sector from the implementation of Solvency II to the insurance sector. Changes to capital requirements for institutional investors “do have an indirect effect by setting the framework for the investment behaviour of these institutional investors”, says Richter. “As a consequence, the fund industry may suffer some noticeable collateral damage.” 

From 2016, large insurers will be subject to the new legal framework of Solvency II under which they can take investment risk, as long as they can cover it with sufficient buffers. However, smaller insurers as well as Pensionskassen – to which the same investment regulation (Anlageverordnung) currently applies – will continue to fall under this legislation even after 2016. 

In its revision of the Anlageverordnung in the wake of the KAGB, the German Finance Ministry included further restrictions to investments. “In the future, the affected investor groups will only be permitted to invest in Spezialfonds up to a limit of 7.5% of their restricted assets,” explains Richter. “A higher limit may be permissible if a fund invests solely in UCITS-compliant assets.” Any exposure to equity investments, precious metals or unsecuritised loan receivables in the portfolio would lead to the Spezialfonds falling within the 7.5% quota. 

For smaller insurers and Pensionskassen it is important to be able to combine all investments in one single fund. “If the proposals regarding the investment regulation became a reality, this would severely restrict these options,” Richter says.

Quantifying the impact on the Spezialfonds business, Richter says some €250bn of Spezialfonds assets are managed on behalf of occupational pensions, although not all are Pensionskassen. He also says that of the €56bn in year-to-date fund inflows by July 2014, Spezialfonds accounted for €42bn: “Investment funds form the backbone of external pension plans’ capital investments and play a vital role in the funding of pension commitments.”

Solvency II will also introduce new reporting requirements that could present a challenge to managers: “For their reporting, investment management companies wishing to cater for all investor groups must take into account that the required equity capital is calculated differently depending on the investor group.”

To facilitate these calculations on an EU-wide basis the BVI – with the French and the UK fund industries – has prepared the draft of a joint data sheet on Solvency II reporting. 

“This is intended to facilitate the calculation of solvency capital and to support the data exchange for quantitative reporting and to ensure that investment management companies come to terms with the new requirements at an early stage. After all, in Germany some insurance companies will have to submit initial data to the Financial Supervisory Authority (BaFin) as early as 2015,” Richter says.

The CEO also believes the German occupational pension scheme sector urgently requires strengthening. He says the statutory entitlement to deferred compensation (Entgeltumwandlung), which was introduced in 2002, has not yet had the desired broad impact. Around 40% of employees subject to social security contributions are not yet entitled to any benefits from occupational pension schemes. “For this reason, we are advocating an opt-out solution. In fact, experiences with this type of model in the UK have been encouraging,” says Richter. 

However, he observes that the government does not even need to get involved here, as automatic enrolment can also be adopted by a sector or company, and many employers are already able to offer an occupational pension scheme on an opt-out basis. “A statutory obligation that locks employees in would be perceived as being an additional burden, similar to a tax,” Richter warns.

With a greater number of beneficiaries in the second pillar, the CEO would also like to see more support from politicians for fund-based occupational retirement to enhance competition. “To date, insurance-based structures dominate external plan arrangements,” he says. “We are lacking real competition between insurance and asset management solutions, which would involve diverse types of products and could bring cost advantages. Flexible and cost-transparent fund solutions could contribute vital momentum to such competition.” Indeed, the BVI has been lobbying for fund-based occupational retirement vehicles over recent years. 

As for pension pooling, which has been possible in Germany since 2013, Richter predicts that some time will pass before there is any real application. “The experiences of other countries have shown that it takes around two years to get such a project under way in practice,” he says. “Companies have to convince their employees and obtain binding information from the tax administrations of the source countries. Also, international companies are already able to use pension pooling in other European countries.”

Richter concludes: “It is not possible to transform an existing Spezialfonds into a pension pooling vehicle in a tax-neutral manner. This needs to change.”