Money market instruments for liquidity and investment
Up to now, the purchase of money market instruments to invest in money market funds (Geldmarktsfonds) was reserved. In practice, this was not a problem, as each investment fund was permitted to invest up to 49% of its liquid assets in bank deposits, but also in money market instruments. Incidentally, the last time more than 10% of Spezialfonds’ assets were invested in liquidity instruments was in 1990. Under the IMA, money market instruments are now equivalent to securities as full-value assets. The same applies to bank deposits, and only 20% of the Sondervermögen may now be invested in bank deposits at one and the same credit institution.
In this regard an additional 20% limit will constitute a certain restriction. In line with the provisions of the UCITS directive, the IMA no longer considers bank deposits in Germany to be fully protected, but restricts the total of all securities, money market instruments, bank deposits and OTC derivatives that the Sondervermögen has invested with a single institution, or has purchased from that institution, to 20% of the Sondervermögen. In this case, problems may arise if, for example, the KAG not only deposits the liquid assets of the Sondervermögen at the depository bank, but also purchases from the latter issued equities, bonds or derivatives.
Interestingly, the 20% limit only applies to individual institutions, but not to all investments by the enterprises of one group. Group aggregation only needs to be done in the case of securities and money market instruments.
Both single hedge funds and umbrella hedge funds (Dach-Hedgefonds) can be set up as Spezialfonds. The same investment regulations apply as for Publikumsfonds, ie, there are few restrictions on single hedge funds in using derivatives and in the choice of strategies for generating income; and Dach-Hedgefonds are no longer allowed to invest more than 20% in one and the same single hedge fund, and in a maximum of two single hedge funds for which the same issuer or fund manager is responsible. As in the case of ‘Gemischte Sondervermögen’, the purchased single hedge fund may not invest its resources in other target funds. It remains to be seen what level of interest there is in hedge funds among institutional investors, especially as certain hedge fund strategies can also be used by conventional funds under the new derivatives regulations.
Capital adequacy requirements
The new capital adequacy requirements are of interest to the KAGs, but less so for investors. Whereas according to previous management practice, KAGs had to have an equity capital - which the IMA calls nominal capital (‘Nennkapital’) - of €2.5m, according to the new regulation €730,000 are sufficient. This minimum figure increases by 0.02% of the excess amount if the managed fund volume exceeds €3bn. So, with a fund volume of up to €11.85bn, the new regulations are therefore simpler than the previous rule, and the greater the fund volume the greater the capital requirements. Most Spezialfonds KAGs therefore need less equity than before, but there are still 12 KAGs that are affected by the higher capital adequacy requirements solely because of the Spezialfonds volume managed by them.
KAGs now often have parent companies that may well require an additional dividend; if this equity is no longer required, it seems a logical notion to make it available by means of a dividend, or by means of a capital redemption. However, such a step should be carefully considered with regard to the KAG’s reputation with the BaFin and possibly also in the market.
Investment stock corporations
The IMA imposes virtually no equity capital requirements on the newly-regulated investment stock corporations (‘Investmentaktiengesellschaften’). These simply require an ‘initial capital’ of at least €300,000. This initial capital is already represented by the fund assets; there are in any case no plans for a capital stock like the equity capital of a KAG, which is available to investors in the event of compensation claims.
Depending on how the BaFin applies the other establishment conditions in practice, the barriers for new fund providers to enter the market are very much reduced by the creation of the Investmentaktiengesellschaft. However, it remains to be seen whether this vehicle will be correspondingly successful, mainly because of the wide-ranging operation of the German Companies Act (Aktiengesetz).
Also questionable is whether ‘Spezialfonds-Investmentaktiengesellschaften’ are permissible at all. According to the argumentation for the government bill on S 91 Para. 2 of the IMA, all provisions of this Act should apply to Spezialfonds, unless otherwise stipulated in the clause on special Sondervermögen.
However, the wording of the provision makes no express reference to the chapter on the Investmentaktiengesellschaft. In addition, the Investmentaktiengesellschaft must offer 90% of its shares for sale to the public within six months of being granted a licence. This could lead to the conclusion that the Investmentaktiengesellschaft may not be set up as a Spezialfonds. But neither does the Act include an express ban on selling all of an Investmentaktiengesellschaft’s shares to a single institutional investor.
New disclosure requirement
The disclosure requirements newly introduced under the IMA are another potential source of substantial additional expense for KAGs. In future, KAGs will not only have to send asset schedules to the BaFin as part of their financial statement and half-year report, but on a ‘regular basis’ and by remote data transfer. Using the transmitted data the BaFin should be able to verify that the investment limits are being observed. In addition, the KAG is responsible for reporting each transaction to the BaFin, and the IMA specifies in detail which data have to be included.
The transaction report is to serve as the ‘qualitative control’, and enable the BaFin, for example, to monitor grievances relating to price structures. The legislature, at least, has
given no plausible reasoning as to the extent to which it is already possible to achieve this aim through the existing supervisory and control facilities, rather than through the additional disclosure requirements, which would be costly to implement.
The BaFin wishes the data to be delivered daily, although the supervisory authorities would probably be prepared to put up with a couple of days’ delay.
The decisive factor for the KAGs in this regard is that
longer reporting cycles, for example once a month, or only
the reporting of excesses, could possibly suffice when it comes to Spezialfonds.
Outsourcing of fund management permissible
For the first time, the IMA includes a specific statutory regulation on the outsourcing of its business by a KAG. As well as a reference to the prerequisites of S25a of the German Banking Act (KWG), created especially for deposit-taking credit institutions, the IMA establishes the additional requirement that the KAG should not be prevented from acting in the interests of its investors because of the outsourcing. In addition, only such enterprises that are licensed asset managers and are subject
to official supervision can be considered as external fund managers.
The KAG cannot, however, transfer liability for errors to the external manager; the KAG is liable for the latter’s errors just as for its own. Compared to the earlier regulation and practice, whereby the KAG took all decisions itself and only took advice from the external asset manager, the new regulation provides no relief from liability for the KAGs. In view of this, it is expected that the advisory model practised up to now will continue to be used in the future.
Investment consultancy as a permissible secondary activity for KAGs
The IMA has now made it clear that KAGs may also provide investment consultancy services as a secondary activity, if their business licence also covers free portfolio management. This has previously been a contentious issue, as the BaFin considered consultancy services as an activity to be distinguished from management, whereas the investment sector regarded consultancy services as a ‘drawback’ to management, ie, something that was already covered by a corresponding licence.
Regulation regarding the investment limitations for insurance companies
The expansion of the investment possibilities for an investment fund has necessitated a revision of the regulation regarding the investment limitations for insurance companies. The amended regulation was due to come into effect in August 2004. It now states that the eligibility of investment funds to serve as collateral will no longer depend on certain wordings in the contract terms. This means that in principle every investment fund may be purchased for the benefit of the cover assets (Deckungsstock – now ‘Sicherungsvermögen’).
But the insurance company then has to distinguish between transparent funds and funds that
have a non-transparent asset structure.
In the case of transparent investment funds the insurer must
be informed about the current leverage, and also set off the risk amount in excess of 100% on certain Sondervermögen of existing assets against the 35% rate. In addition, other assets held by the investment fund, such as ABS
and CLN, bonds, equities and profit sharing rights from non-EEA states and hedge funds, must be
set off against the corresponding limits.
For the KAGs, this new regulation will mean that they will have
to make the corresponding
data available to the insurance companies.
Although receipts by the Spezialfonds have fallen for five consecutive years, and this instrument is sometimes viewed critically with regard to preparation of the accounts under IFRS, in the future there will still be substantial receipts contributing to the growth of the Spezialfonds.
These can possibly be substantially increased if the KAGs are prepared to accept the critical aspects as a challenge, and also provide investors with services such as the key figures required
for preparation of the accounts,
in addition to the expected performance.
Till Entzian is a lawyer and consultant on Spezialfonds based in Frankfurt