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German Asset Management: The devil’s in the details

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Barbara Ottawa looks at the impact of legislative and regulatory changes on the German asset management industry

There “will be substantial changes” in the German asset management industry over the next few years and regulation will be but one of the drivers, according to Jörg Ambrosius, senior vice-president at State Street in Munich. This view is supported by a State Street survey of global asset managers including a subset of 30 German industry representatives.

“There are a considerable number of drivers primarily linked to changing demand from investors as they are becoming far more demanding and will need tailored solutions – it is all about outcome-oriented asset management,” says Ambrosius. One consensus is that asset managers with the greatest transparency will survive.

Carl-Heinrich Kehr, principal in the investment department at Mercer Germany, notes a “drifting apart” in the German asset management industry as “costs for regulatory requirements, research and ongoing management of a portfolio” could leave just a few large firms and a number of specialised boutiques in the market.

Ambrosius agrees, saying pressure is increasing in the mid-market segment. “In the space of multi-asset you must be much broader and on the other end of spectrum there will be smaller firms with only one asset class, which will be part of the multi-asset strategies of larger companies,” he adds. “Mid-size players will disappear because they are not large enough to continue to invest in the multi-asset space and they do not have enough focus on one asset class.” 

At a glance

• Investor demand looks likely to change the asset management market, with some predicting pressure on mid-sized firms.
• Regulation like the new KAGB, implementing the AIFMD, will lead to knock-on effects in years to come. 
• Increased regulatory costs will make pooled funds more attractive compared with Spezialfonds.
• Pensionskassen face a cap on alternative investments in the latest draft of the insurance law.

But Sabine Mahnert, senior consultant at Towers Watson Germany, takes a slightly different view. While a split into larger managers and boutiques has been predicted for almost a decade, she thinks boutiques of a certain size will probably survive. “Many boutiques start small but there comes a point when they have to reach a certain size to be able to find the necessary global return opportunities,” she says, predicting a future for mid-sized companies that focus on their core skills and avoid a proliferation of products or strategies outside of their specialist area. 

In the wake of the KAGB 

The KAGB (Capital Investment Act), which implements the Alternative Investment Fund Managers Directive (AIFMD) and its subsequent regulatory changes, will “not lead to major changes in the German asset management industry”, Kehr believes. 

He adds that the new regulations for former KAGs – now known as KVGs (Kapitalverwaltungsgesellschaften), and which include closed-end fund structures – lead to only marginally different fund terms, although re-registration has meant a massive one-off expenditure for providers.

“In Germany a lot of the things now introduced with the AIFMD were in place already under the legal framework before the KAGB. But what is really new is the increased liability for custodians,” Ambrosius says. He adds that for KVGs the impact is mostly in the administrative area but for closed-end fund providers it is “a completely new world”. 

However, according to the State Street survey, 60% of German asset managers think their regulatory risk will “strongly increase” over the next year.

Mahnert is convinced that the increased regulatory requirements introduced to the German fund business through the KAGB and the European EMIR regulation on derivatives will lead to a higher demand for open-ended pooled funds by institutions. “These vehicles will allow fixed costs due to regulatory requirements to be spread over a higher asset base,” Mahnert says. While major strategies with large volumes will still be covered mostly by Spezialfonds, pooled funds will be used for smaller allocations as “the hurdle to operate these in a Spezialfonds format has grown”.

Mahnert also says asset managers – especially foreign ones – are willing to set up pooled funds to be compliant with insurance supervisory law. “German providers have a smaller range of pooled funds for institutional investors as they have traditionally been more focused on Spezialfonds,” she notes. 

For Kehr, secondary regulations relating to the KAGB could represent a major obstacle. At the time of writing, the investment law and subordinate legislation that needs to be amended following the implementation of AIFMD had not yet been finalised. But Kehr foresees additional regulatory requirements that investors might not have expected, which will present obstacles to certain providers. One example is the German supervisor BaFin requiring non-EU investment fund companies to be registered in their home country before being allowed to sell their products in Germany. 

Pensionskassen worried about insurance law changes

The KAGB is not the only new regulation. As part of the preparations for the introduction of Solvency II, the German authorities must amend the investment regulations for insurers in the Insurance Supervision Act (VAG) and its subordinate investment directive (Anlageverordnung), which also applies to certain German Pensionskassen. “If the VAG is amended according to the most recent draft it would hit the occupational pensions sector very hard,” Stefan Oecking, partner in the retirement department at Mercer Germany, noted in September.

According to the draft of the revised investment directive available at the time of writing, a 7.5% cap on allocations to alternative investments would be introduced for insurance companies, including Pensionskassen. This would include non UCITS-compliant Spezialfonds. Affected investors would be given a transition period until 2019 to restructure existing Spezialfonds to avoid the cap. 

“Restrictions derived from Solvency II would be applied to Pensionskassen with no differentiation between insurers and the occupational pensions sector,” says Oecking, which would clearly hurt IORPs. And although Pensionskassen are exempt from some of the restrictions, they will at least be hit by higher administrative requirements and costs, he believes.

However, Kehr does not expect major changes to institutional portfolios following the implementation of the KAGB and later regulations, as the necessary adaptations will more likely be technical. “It could be that certain fund structures may no longer fall under the ‘UCITS-similar’ category,” he elaborates, which means they might fall under a different risk-assessment category. Also, investors could be allowed to buy structures like Irish Qualified Investor Schemes (QIS), if those are securitised. Kehr forecasts that many special cases will appear once the transition period for existing portfolios has expired in two or three years. 

Foreign woes 

Germany has implemented the AIFMD “relatively strictly” compared with other countries, notes Mahnert. German institutions can only invest in funds that are compliant with the KAGB and which have to conform to UCITS or fall under the AIF regulatory framework. “This means that the opportunity set for fund investments for German institutions is constrained versus jurisdictions that have taken a more liberal approach to implementing AIFMD.” 

At a European level, Mahnert sees a high level of willingness among managers to become AIFMD compliant, although some international players have exited the European market because of the new regulatory requirements. 

Ambrosius notes that many international providers wanting to get into Germany “still underestimate the level of country-specific regulation”, as the AIFMD has been implemented quite differently in the various member states.

However, despite the varying implementation of the AIFMD across Europe, Mahnert sees a trend towards greater transparency and that will make the German market more accessible to foreign providers. 

Too close for comfort?

There are still many uncertainties in the area of closed-end fund regulation. Ambrosius says some providers might start targeting institutional investors but that these plans are “still at a very early stage”. 

All KVGs must now appoint a custodian, and some analysts have claimed this creates a major new market. But Ambrosius is more cautious. “There is a major gap between providers, with some unable to satisfy the needs of institutional investors and it is also a question of scale.” So there will be new providers but their number will “not be massive”, he believes. 

In the closed-end fund sector – now subject to the new regulatory framework – Mahnert still sees “no major trend yet towards open-ended fund providers wanting to enter the new market”. However, demand for private market strategies is strong and it remains to be seen how the market will develop after still existing regulatory uncertainties are clarified.

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