New rules for Spezialfonds: Pandora’s box of opportunities
New rules for Spezialfonds lending could be a huge boost to Germany’s chronically underfunded infrastructure sector, says Thomas Richter
When it comes to funding of infrastructure projects through alternative financing, the German financial sector is catching up. In March, the German act implementing the pan-European UCITS V Directive was welcomed by the German Spezialfonds industry. Spezialfonds are an investment structure limited exclusively to institutional investors, allowing for a more lenient regulatory framework compared with mutual funds.
Contrary to what the name of the act may suggest, the law not only changed the rules for UCITS but also some of the rules governing Spezialfonds investments in loans. While open-ended Spezialfonds had already been able to invest without any restrictions into unsecuritised loan receivables, the act explicitly permits Spezialfonds to amend the loan terms, such as restructuring or extending the loan, even after purchase. Closed-ended Spezialfonds will be able to grant loans, albeit not to consumers, and only if the fund’s leverage is limited. In addition, special provisions also apply to risk diversification.
With interest rates in the euro-zone remaining low and a decision of a potential increase in the US on the horizon, the relaxation of the regulatory framework for loan funds comes at the right time. In a climate of low-yields, institutional investors are looking for long-term investments that will enable them to achieve their return objectives, particularly for pension funds and insurers who have to cover long-term payment obligations. The new act means that institutional investors will have considerably more options to participate in the loans market.
While this market totals over $1trn (€900m) globally, the US accounts for the bulk since the financing of companies and projects via loans has been well established since the 1980s. In Europe, this model only gathered momentum after the introduction of the euro. There is pent-up demand, especially in Germany, where banks have traditionally provided loans.
However, attitudes are changing. Institutional investors are increasingly interested in alternative loan finance. According to a recent survey, 35% of German pension funds are planning to expand their credit investments.
Loans generate comparatively high – and often stable – returns. In terms of corporate finance, for example, the total return of unsecu-ritised loans is higher than that of corporate bonds with comparable credit quality, maturity and volatility. Spezialfonds can acquire receivables from large-scale loans to companies primarily in the secondary market.
Senior secured loans are interesting from an investor’s perspective, such as in case of insolvency, where the default risk is considerably lower than that of unsecured exposure. Additionally, spreading the risk across a wide range of assets in a fund portfolio offers additional security to investors.
Another segment within the loan market that will become relevant to Spezialfonds is project finance. According to a comprehensive study by a commission consisting of representatives from the German federal states in 2012 shows that 20 per cent of the motorways and 41 per cent of the country’s federal trunk roads are in a critical state. Last year, the Fratzscher Commission set up by the German Federal Ministry of Economics (BMWi) put the investment backlog at between €90bn and €100bn.
The chronic underfunding of German infrastructure is complex. If the supply and demand were the only decisive factors, government and private backers would have co-operated far more extensively in the maintenance and upgrading of roads, bridges and public buildings. However, either because of debt levels or because of regulatory requirements, the federal government, the government of the German federal states, the municipalities as well as corporates and banks, find themselves unable to raise funds for the maintenance and upgrading of infrastructure. A feasible option for long-term sustainability would be for private investors to take their place, thus securing steady long-term revenues.
At the EU level, this need to develop alternative financing sources is being recognised, with the European insurance supervisor EIOPA submitting a proposal to the EU Commission as to how investments in infrastructure could be more attractive to insurance companies. EIOPA expects the Commission to act on its proposal. For insurance companies, this would mean relaxation of the capital adequacy requirements under Solvency II. Only recently, these requirements were eased by the adoption of special rules for infrastructure investments.
Likewise, things are moving in the right direction in Germany. In June, representatives from the federal states, the municipalities, BVI and other associations of the financial sector exchanged ideas at the BMWi on new fund models for the financing of public infrastructure projects. Financing via private capital offers opportunities for all parties involved, and with Spezialfonds the fund industry can make an important contribution to this. Thanks to the new rules for loan funds, Germany has taken an important step in the right direction.
Thomas Richter is the CEO of the German investment funds association BVI