A Q&A guide to investment funds law in Germany.
This Q&A is part of the PLC multi-jurisdictional guide to investment funds. It provides a high level overview of investment funds in Germany, looking at both retail funds and hedge funds. Areas covered include a market overview, legislation and regulation, marketing, managers and operators, restrictions and requirements, tax and upcoming reform.
To compare answers across multiple jurisdictions, visit the Investment Funds Country Q&A tool. For a full list of jurisdictional Q&As visit www.practicallaw.com/investmentfunds-mjg.
In 2011, the German investment funds industry has had to implement new rules, arising from:
The ongoing harmonisation of the investment sector in the EU, through Directive 2009/65/EC on undertakings for collective investment in transferable securities (UCITS) (UCITS IV Directive).
Changes to German national law under the Investor Protection and the Functionality Improvement Act 2011 (Anlegerschutz- und Funktionsverbesserungsgesetz).
As at 31 October 2011, the total assets under management of German investment funds were about EUR1.741 trillion, about EUR643 billion of which was invested in retail funds (as at 1 November 2011, US$1 was about EUR0.7) (source: The Federal Association of Investment and Asset Management (Bundesverband Investment und Asset Management eV) (BVI)). These figures have recently decreased significantly due to the market turmoil following the financial crisis.
In recent years, the number of investors in investment funds has grown considerably. In 2007 only 30% of all households owned investment funds; this rose to 60% by the end of 2010. Net inflows from private investors reached an all-time high in 2010.
According to the BVI, the most pronounced growth of net assets in 2010 took place in equity funds, which had both:
A good performance (15% for equity funds investing globally).
Satisfying net sales (not as high as for 2009, but well above the figures during the financial crisis).
2011 has, however, seen a significant decline in assets under management.
There is a very wide range of suppliers of closed-ended retail funds who are active in different asset classes (for example, real estate and shipping). German closed-ended retail funds currently hold about EUR16.6 billion, made up of (source: Association for closed-ended funds (Verband für geschlossene Fonds) (VGF)):
EUR10.8 billion assets under management.
EUR5.8 billion equity capital.
In the last few years, stronger market regulation and the significant abolition of certain tax benefits have made the marketing of closed-ended funds more difficult. The following laws will also have a huge impact on the future of the closed-ended fund market:
The German Capital Investment Act (Vermögensanlagengesetz), which is part of the German Act to Amend the Law Governing Investment Intermediaries and Capital Investments (Gesetz zur Novellierung des Finanzanlagenvermittler-und Vermögensanlagengesetzes) (FinAnlVG).
Directive 2011/61/EU on alternative investment fund managers (AIFM Directive).
See also, Question 14.
Regulatory framework. German open-ended retail funds are structured as either:
Investment funds managed by a capital investment company (Kapitalanlagegesellschaft) (KAG).
Investment stock corporations with variable capital (Investmentaktiengesellschaft) (InvAG).
Both the KAG and the InvAG need a licence from the Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht) (BaFin) (seeQuestion 3).
The key legal provisions are set out in the:
Investment Act (Investmentgesetz) (InvG).
Investment Tax Act (Investmentsteuergesetz) (InvStG).
Banking Act (Kreditwesengesetz) (KWG).
Stock Corporation Act (Aktiengesetz) (AktG).
Securities Trading Act (WertpapierhandelsgesetzI) (WpHG).
The AktG applies to InvAGs, and the InvG provides for more fund-specific rules, which prevail over the general provisions of the AktG. Amendments to the InvG and the InvStG, which implement UCITS IV, entered into force on 1 July 2011.
Regulatory bodies. The Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht) (BaFin) is the regulatory authority responsible for supervision of KAGs, InvAGs and investment funds.
Regulatory framework. The key provisions are set out in the:
Securities Prospectus Act (Wertpapierprospektgesetz) (WpPG).
Sales Prospectus Act (Wertpapier-Verkaufsprospektgesetz (Verkaufsprospektgesetz)).
Ordinance on prospectuses for non-securities instruments (Verordnung über Vermögensanlagen-Verkaufsprospekte) (VermVerkProspV).
German Civil Code (Bürgerliches Gesetzbuch) (BGB).
German Commercial Code (Handelsgesetzbuch) (HGB).
Limited Liabilities Companies Act (Gesetz betreffend die Gesellschaften mit beschränkter Haftung) (GmbHG).
The regulatory environment will change significantly after the introduction of the FinAnlVG, which will replace the current Sales Prospectus Act, and after the implementation of AIFM Directive (see Question 14, Regulation).
Regulatory bodies. BaFin is the relevant regulatory body, although there are currently no licensing requirements for closed-ended retail funds (see Question 3, Closed-ended retail funds). This will change with the implementation of the AIFM Directive (see Question 14).
Local retail funds. German retail funds are structured as either a:
Fund managed by a KAG. A fund under German law has no legal identity of its own and, therefore, must be managed by a KAG (see Question 2, Open-ended retail funds: Regulatory framework). The corporate form of a KAG can be either a:
limited liability company (Gesellschaft mit beschränkter Haftung) (GmbH); or
stock corporation (Aktiengesellschaft) (AG).
The registered office and head office of the KAG must be situated in Germany and it must establish an orderly business organisation that ensures compliance with the applicable legal provisions.
A KAG requires a licence granted by BaFin for establishing funds and managing funds' assets. The application to BaFin for permission must contain:
suitable evidence of the funds necessary for operation;
the names of the managers (see Question 6, Open-ended retail funds);
information to assess the:
reliability of the managers;
professional qualification of the managers and whether they have sufficient experience in relation to the type of funds to be managed (see Question 6);
the names of the holders of significant interests in the KAG and information to assess their reliability and the amount of their interests;
a statement of any facts that indicate a close relationship between the KAG and other natural or legal persons;
a sustainable operational plan which shows the:
type of planned transactions; and
organisational structure and planned internal control mechanisms of the KAG.
In addition, a KAG must comply with specific share capital requirements, depending on the type of fund and its assets under management (from EUR300,000 up to EUR10 million).
InvAGs. InvAGs must be licensed by BaFin. Permission is granted only if:
it has start-up capital of at least EUR300,000;
its registered office and its management are located in Germany;
the managers of the InvAG are reliable and have the necessary professional qualifications;
the articles of association meet the requirements of the InvG (for example, that the InvAG's business is only that of investing its own assets on the basis of risk diversification);
it has appointed a custodian bank (Depotbank) for the safekeeping of its assets;
where the InvAG is to be managed by a third party manager it must have appointed a KAG for managing its activities and assets.
Foreign retail funds. Different rules apply for EU and non-EU funds:
EU funds. A UCITS fund, which can make use of the EU-passport, can be easily distributed on a cross-border basis once registered in its home member state. Before distributing shares of its funds in Germany, the EU investment firm must submit a notification letter to its home authority, which will submit the documents to BaFin. The notification letter must include the following information:
an indication of all distribution channels in Germany;
an indication of the paying and information agent in Germany;
information concerning UCITS (for example, publication of sale, repurchase and redemption prices).
In addition the following documents must be attached:
UCITS attestation;
articles of association (or fund rules);
sales prospectus;
latest annual report and any subsequent semi-annual report;
key investor information (KII) or simplified prospectus (this must be submitted in German; all other documents can be submitted in German or any language common in international finance (usually English), unless otherwise agreed between BaFin and the competent authority).
The investment company can publicly distribute shares of the relevant fund in Germany once it is informed by its domestic authority that these documents have been submitted to BaFin.
Non-EU funds. The public marketing of foreign investment units which cannot make use of the EU passport (EU funds which do not qualify as UCITS and non-EU funds) is permissible if:
the foreign investment company and the management company are subject to effective public supervision for the protection of investors in the state in which they have their state;
the competent supervisory bodies of that state which are, according to BaFin's experience, prepared to co-operate satisfactorily with BaFin;
the foreign investment company nominates a domestic credit institution or a reliable, suitably qualified person as its representative domiciled in Germany to BaFin;
the items comprising the pool of assets are held in custody by a custodian bank or, where real property is involved, monitored by a custodian bank that safeguards the investors in a manner comparable to that set out in the relevant provisions in the InvG;
one or more domestic credit institutions or domestic branches of credit institutions domiciled in another country are nominated as paying agents through which payments made by or directed to investors can be channelled; and
the contractual terms and conditions or the articles of association of the investment company provide for several other provisions set out in the InvG.
Local retail funds. No licensing requirements currently apply to closed-ended retail funds. However, BaFin must officially approve the publication of the prospectus if local closed-ended funds are marketed publicly. The prospectus must comply with the Sales Prospectus Act.
Foreign retail funds. No licensing requirements currently apply to foreign closed-ended retail funds. BaFin must officially approve the prospectus if the fund is marketed publicly. This prospectus must comply with the Sales Prospectus Act.
Local retail funds. A licence is required for marketing funds that provide principal broking services (Finanzkommissionsgeschäft) or services to receive and transmit orders (Anlage-und Absschlussvermittlung). Therefore, licensed banks and financial services providers are authorised marketing agents.
However, an agent must only obtain a trade licence if the agent:
Provides investment advice and receives and transmits orders only in relation to investment funds managed by a KAG, InvAG or foreign investment fund that can be publicly distributed in Germany.
Does not acquire ownership or possession of customers' monies or fund units.
KAGs and InvAGs are authorised to market fund units without obtaining any (additional) licence.
Foreign retail funds. Foreign open-ended retail funds can be distributed by German banks and financial institutions, which must comply with additional requirements for the public marketing of foreign funds in Germany (see Question 3, Open-ended retail funds).
A licence is required if a party that cannot make use of the EU passport wishes to either:
Conduct banking business in Germany commercially (or on a scale that requires a commercially organised business).
Provide financial services in Germany commercially (or on a scale that requires a commercially organised business).
BaFin considers that banking business or financial services are provided in Germany not only where the provider has its registered office in Germany, but also where it targets the German market to offer banking products or financial services repeatedly and on a commercial basis to companies and/or persons with their registered office or ordinary residence in Germany.
Local retail funds. Participations in closed-ended funds are mainly marketed by banks and independent financial advisers, who must obtain a trade licence (see above, Open-ended retail funds). A financial service provider licence is not required.
Foreign retail funds. Foreign closed-ended retail funds can also be marketed by domestic banks and independent financial advisers, who must obtain a trade licence. Foreign service providers also generally need a trade licence to market closed-ended funds in Germany.
In principle, both open-ended retail funds and closed-ended retail funds can be distributed to all German investors. This applies to both foreign and local retail funds.
See above, Open-ended retail funds.
Managing directors of a KAG. KAGs must appoint at least two managing directors (four-eye principle) to the board of directors (Geschäftsführung in the case of a GmbH or Vorstand in the case of an AG) who are trustworthy and have the appropriate professional qualifications and sufficient experience (that is, appropriate and sufficient theoretical and practical knowledge in the relevant management area). In addition, there must be no facts which suggest that the manager of the company is not personally trustworthy.
Supervisory board of a KAG. A KAG must have (in addition to the board of directors) a supervisory board (Aufsichtsrat) composed of at least three members. At least one member of the supervisory board must be independent from:
The KAG's shareholders.
Affiliated companies of the KAG's shareholders and business partners, if the KAG manages open-ended retail funds.
A KAG must operate autonomously and its managing directors (who can carry out a KAG's full business operations) cannot be employed by the Depotbank (and vice versa).
The purpose of the supervisory board is to safeguard the unitholders' interests because the KAG must always act in the investors' interests.
InvAGs. The requirements and standards are the same as for a KAG (see above).
The management of a domestic fund by an EU investment company is permitted by the management company passport. However, the management of a domestic fund is not permitted for investment companies that are not domiciled in the EU. This will change in 2015 after the implementation of the AIFM Directive (see Question 14).
Currently closed-ended retail funds must only comply with the applicable civil, corporate and commercial law provisions; no regulatory constraints apply to their managers. There are also currently no requirements concerning the management of a domestic retail fund by a foreign manager.
This will change with the implementation of the AIFM Directive (see Question 14, Regulation).
A KAG/InvAG must appoint a credit institution to hold the portfolio of assets (Depotbank). BaFin must approve this appointment.
The Depotbank must have its seat or branch in Germany and be authorised to carry out deposit and custody activities. It must, among other things, perform the custody of investment asset pools, including to:
Keep the fund assets separate from the KAG's own assets.
Protect the fund's assets by keeping the securities and cash belonging to the investment fund safe in blocked accounts and cash collateral, in the case of securities loans.
Ensure that the necessary collateral for securities loans is validly granted and available at all times.
Ensure that the issue and redemption of units as well as the calculation of the value of units are always carried out in accordance with the InvG and the fund rules.
Supervise the investment fund's transactions.
Approve specific transfers.
Act solely in the best interests of the investors.
It also has a number of other functions (to act as a paying agency, transfer agency, functions to control, represent investors' interests, and other obligations).
The duties of the Depotbank are set out in the German Investment Act, which are specified in a BaFin circular dated 2 July 2010 (Tasks and obligations of a depositary bank according to Section 20 et seq. InvG, Rundschreiben 6/2010 (WA) zu den Aufgaben und Pflichten der Depotbank nach den §§ 20 ff. InvG).
Closed-ended retail funds are mainly set up as partnerships (for example, limited commercial partnerships) and civil, corporate and commercial law regulations apply. If possible, given the nature of a fund's asset, the company normally keeps the assets in custody by the company and deposits them with a bank. In the case of securities, the company's accounts are established for the investors. This system of investors' accounts, known as capital share accounts, is established by the articles of incorporation or the partnership agreement.
Legal vehicles. The two vehicles used to set up open-ended funds in Germany are the investment funds managed by a KAG, and InvAGs:
Funds managed by a KAG. KAGs are set up under the InvG. The relationship between the KAG and investors are governed by contract under the Fund Rules, made up of the:
general fund rules (Allgemeine Vertragsbedingungen);
special fund rules (Besondere Vertragsbedingungen).
The Fund Rules must be set out in writing and approved by BaFin. Models of Fund Rules (for the different types of investment funds) have been established by the BVI and agreed with BaFin. If model Fund Rules are used for UCITS Funds, BaFin's approval is assumed. Otherwise, under the InvG, BaFin must respond to an approval request within four weeks. Investors participate by obtaining a fund's units. As this procedure is a standard process for domestic funds, it is easy and fast to implement. A UCITS fund can be passported into other European jurisdictions.
InvAGs. An InvAG does not require a KAG or separate investment manager, although it can delegate certain functions. Where it has a third party manager, the InvAG must appoint a KAG for this role.
Investors in an InvAG acquire the company's shares (corporate shares (Unternehmensaktien) in investment stock and investment shares (Anlageaktien) in its funds). Owners of shares do not have voting rights, unless the company's articles provide otherwise.
InvAGs were introduced in 2004 by the Investment Act in 2004, which was amended in 2008 to meet market requirements. Only 19 InvAGs have been established so far, mostly by institutional investors seeking tax benefits. As the InvAG has no advantages for retail investors, it is not expected that a large number of them will be established. An InvAG, similar to a Luxembourg SICAV, can be established as a UCITS fund and passported into other European jurisdictions.
Advantages. The legal vehicles have the following advantages, among others:
Funds managed by a KAG. These legal vehicles:
are highly regulated.
follow the principle of risk diversification and risk spreading;
have high liquidity (generally there is redemption of fund units on a daily basis);
have a high level of investor protection (for example, clients' assets and money are ring fenced);
are tax transparent;
there is listing of the funds in specific fund segments.
InvAG. These legal vehicles:
are strongly regulated;
follow the principles of risk diversification and risk spreading;
are companies under which investors become shareholders of the company with all advantages (such as voting rights);
possess a model that is similar to the SICAV (a model well-known in other countries);
are considered to be white-label platforms (that is, platforms that can be used by other investment businesses that can be customised for their purposes);
can be easily distributed in other countries as shares;
can be listed as a stock corporation on a stock exchange;
may fall within the scope of a double tax treaty as a corporation.
Disadvantages. The legal vehicles have the following disadvantages, among others:
Funds managed by a KAG. These legal vehicles:
do not have direct voting rights;
do not have specific information rights; and
have a model that is not familiar in other countries.
InvAG. InvAGs are less frequently established in Germany and must be explained to the client.
Legal vehicles. For tax reasons, closed-ended retail funds are mainly founded in the corporate form of either:
A limited partnership (Kommanditgesellschaft) (KG).
A limited partnership with a limited liability company as general partner (Gesellschaft mit beschränkter Haftung und Co KAG) (GmbH & Co KG).
Alternatively, civil law companies (Gesellschaft bürgerlichen Rechts) (GbR) or general partnerships (offene Handelsgesellschaft) (OHG) can be established.
A KG comprises both:
One or more limited partners (Kommanditist), who are only liable to the amount of their capital contribution.
One or more general partners (Komplementär), who are liable for the company's debts without limitation.
The general partner in a GmbH & Co KG is a limited liability company, the GmbH. As a result, only the GmbH is liable for the company's debt. A GmbH's minimum share capital is EUR25,000.
Standard forms of partnership agreements are available. Therefore, KGs and GmbH & Co KGs are easy to set up and they follow the standard corporate law provisions in relation to management. Depending on the type of fund (for example, real estate funds, private equity funds and shipping investment funds), the fund's structure can be set up in a tax efficient way.
Investors' interests in closed-ended funds are called partnership interests (for the KG and OHG) or shares (for the GmbH).
Advantages. The advantages of KGs and GmbH & Co KGs are that the investor:
Holds either partnership interests or shares in the fund, and has the associated advantages of those interests.
Can participate in tax saving or tax deferral models (see Question 13, Closed-ended retail funds).
Disadvantages. The disadvantages of KGs and GmbH & Co KGs are that:
They are currently only lightly regulated.
The investor holds either partnership interests or shares in the fund, and has the associated risks.
There is a low level of investor protection.
There is a risk of a total loss of the investment.
Detailed investment and borrowing restrictions are set out in the InvG. For UCITS compliant retail funds, the general limitations are set out in the UCITS IV Directive. Additional specific requirements and restrictions apply to non-UCITS funds in the form of:
Real property funds.
Balanced funds.
Old age provision funds.
Infrastructure funds.
Employee involvement funds.
Other funds.
No regulatory restrictions apply for investments or borrowings by closed-ended retail funds. The prospectus must reflect all factual and legal details the investor requires to make an informed investment. However, fund-specific restrictions might be included in the prospectus.
Retail fund units can be redeemed by the investors at any time under the rules set out in the fund's contractual terms and conditions. However, a KAG may be allowed, in accordance with the terms, to suspend the redemption of units if unusual circumstances exist which make a suspension necessary to protect investors' interests.
In addition, the set-up of the pricing structure, in relation to minimum investment limits, redemption charges, and so on, may lead to practical issues or redemption restrictions.
Finally, special provisions for the redemption of fund units of real property funds have recently been introduced. The contractual terms and conditions of real property funds can provide that units can be redeemed only on a specific date (which occurs at least once a year). In all cases, shares worth EUR30,000 or more can only be redeemed after a holding period of two years and after a notice period of 12 months.
Generally, it is not anticipated that the investors will redeem closed-ended retail fund units. However, the partnership agreement may provide redemption options.
Units can be transferred to third parties without restriction.
Depending on the partnership agreement or articles, the interests in closed-ended funds may or may not be transferred. A secondary market (which is not very liquid) for closed-ended funds was established a few years ago.
Investors. When selling units in Germany, potential investors must be offered all of the following free of charge:
The fund's current KII, which replaced the former simplified prospectus on 1 July 2011. (Non-German UCITSs can continue to use the simplified prospectus if allowed to do so in their home state.)
The fund's current full prospectus (accompanied by the articles of association unless the sales prospectus contains a reference to the place where they can be obtained free of charge in Germany).
The latest semi-annual and annual report.
The fund's latest articles.
Funds must also provide detailed information, when requested, on the investment limits that apply to risk management as well as further details in view of the investment fund's risks.
All documents, including any marketing material which is made available or offered to (potential) investors, must be in a language which is common in the sphere of the financial market (usually English). The KII must be available in German.
In addition, a fund must comply with specific tax reporting requirements under the InvStG to ensure treatment as a tax transparent fund (see Question 13, Open-ended retail funds).
Regulators. Publication in Germany can take place in a newspaper, by written notice to German investors or in the German Electronic Federal Gazette (Elektronischer Bundesanzeiger).
In relation to the publication requirements for a UCITS, a foreign investment company must publish in German:
The annual report as at the end of each financial year (within four months).
The semi-annual report (within two months).
The sales prospectuses.
The articles of association (or the fund rules) if they are not part of the sales prospectus (see above).
The issue and redemption prices of the units.
Other documents and information to be published in the state in which the investment company has its seat.
Apart from the issue and redemption prices, these documents must be submitted to BaFin without undue delay after their first use. (This also applies to dissolution reports.)
In relation to publication requirements for a non-UCITS, a foreign investment company must comply with additional reporting requirements under the InvG. InvAGs must notify BaFin of the company shareholders and any respective changes.
Investors. A sales prospectus must be provided to investors in closed-ended funds. Investors in a KG can request annual financial statements and check them against business records. The court can order disclosure of balance sheets or other documents if good cause is given.
The upcoming Capital Investment Act will require the prospectus to include more detailed information, particularly in relation to conflicts of interest. Capital investment providers will also need to prepare a capital investment information sheet that describes the material features and risks of the capital investment (see Question 14).
Regulators. Closed-ended retail funds are not subject to any regulatory reporting requirements.
Funds. The profits of an open-ended retail fund are subject to taxation in accordance with the InvStG. As the fund is generally treated as tax transparent, revenues are taxed at the level of the investor. The fund itself is exempt from German Corporate Income Tax (Körperschaftssteuer) and Trade Tax (Gewerbesteuer) (this applies both to funds managed by a KAG and InvAGs). However, profit distributions and retained interest income are subject to withholding tax (Kapitalertragsteuer) at the fund level. A 25% flat tax (Abgeltungssteuer) applies and profits are generally subject to taxation.
Only certain profits are exempt from annual taxation if these are retained by the fund, but capital gains are taxed on the sale of the fund units and withholding tax will still apply.
Tax transparency only applies to legal entities and non-private investors. The fund must disclose tax relevant facts to the public concerning the sources and amounts of its profits, otherwise the fund is regarded as semi- or non-transparent and the investor is subject to punitive taxation (see below, Resident investors).
Resident investors. Generally, the investor is taxed (up to a maximum of 45%) on profits received from an open-ended fund. Certain exemptions apply and profits may not be subject to annual taxation or can be wholly tax exempt. This depends on the kind of profits and whether they were retained or distributed by the fund (see above, Funds).
Non-resident investors. The same applies to non-resident investors as for resident investors (see above, Resident investors). However, these investors can be exempt from general taxation or from withholding tax due to a double tax treaty.
Funds. Closed-ended funds structured as partnerships are generally tax transparent. However, the fund itself can be subject to trade tax, if it carries out a commercial business.
Resident investors. Since the fund is regarded as tax transparent, revenues are taxed at investor level.
Generally, tax effective starting losses are subject to certain restrictions regarding:
Offsetting the losses against other taxable income of the investor.
Loss carry-forwards to offset against positive future income arising out of the investment.
Depending on the fund structure, investors can receive either:
Leasing income (without trade tax on the fund level).
Commercial business income (with trade tax on the fund level, which can be partially offset against the individual tax payable by a natural person).
Profits arising from the sale of the partnership interest can be exempt from taxation. The income of the investor as a natural person can be taxed up to about 45%. Legal entities as investors are subject to corporate income tax. However, certain exemptions can apply.
Non-resident investors. Income of non-resident investors is taxable in Germany. However, the income can be exempt from taxation in Germany due to a double tax treaty.
The UCITS IV Directive was implemented by the German UCITS IV Implementation Act (OGAW-IV-Umsetzungsgesetz), which came into force on 1 July 2011.
In the federal government's view, difficulties have repeatedly arisen in respect of distribution and investor protection in investment funds, especially with closed-ended funds. These difficulties are considered to be primarily attributable to the insufficient provision of information and poor advice offered by the distributing companies to potential investors. On 6 April 2011 the federal government presented the draft FinAnlVG. Its provisions are designed to extend regulation to the "grey capital market" (that is, that part of the capital market that is only lightly regulated by the state), particularly by establishing a level of investor protection for independent distributors that is comparable with the current protection of securities intermediaries and advisers. The FinAnlVG will enter into force on 1 January 2013.
Several provisions of the FinAnlVG have the same scope as the draft AIFM Directive provisions, which must be implemented by 22 July 2013.
Since the financial crisis, there have been several legal actions against investment companies, which usually involve the suspension of the redemption of shares in real property funds. There are also several pending actions against closed-ended funds. However, there are no reliable statistics on pending legal actions.
The InvG introduced funds with additional risks (hedge funds) into Germany in 2004. The InvG differentiates between:
Single hedge funds (Sondervermögen mit zusätzlichen Risiken).
Funds of hedge funds with additional risks (Dachsondervermögen mit zusätzlichen Risiken).
To qualify as a single hedge fund, the fund must at least be permitted to use unlimited leverage or to conduct outright short sales.
However, the German market, for both single hedge funds and funds of hedge funds, is still underdeveloped. BaFin has only approved 19 single hedge funds, and seven funds of hedge funds.
The implementation of the UCITS IV Directive brought no changes to the German hedge fund market. However, the forthcoming AIFM Directive will change the European market for alternative investment to a great extent. The AIFM Directive regulates all of those entities that manage arrangements or entities, which fall within the definition of alternative investment funds (alternative investment fund managers (AIFMs). The AIFM Directive aims to provide a European internal market for AIFMs, and a harmonised and stringent regulatory and supervisory framework for the activities within the EU of all AIFMs, whether EU or non-EU.
Hedge funds are governed by the InvG for regulatory purposes and the InvStG for tax purposes (see Question 2, Open-ended retail funds: Regulatory framework).
BaFin is the competent supervisory authority in Germany (see Question 2, Open-ended retail funds: Regulatory bodies).
There are no specific risk regulations for hedge funds. However, investors must be informed in the detailed sales prospectus of the fund's risk profile and the prospectus must include a warning referring to a potential total investment loss. Where a prime broker has custody of the fund, a warning that the assets are not held in custody by a Depotbank must be included (see Question 21).
There are no specific regulations concerning the valuation and pricing of fund units. However, the determination of fund unit prices and the redemption of fund units can be limited to at least once per calendar quarter. The value of a fund unit is determined by the custodian bank in co-operation with the KAG. Publication of the issue and redemption prices is not necessary for single hedge funds.
A hedge fund must establish:
Risk measurement systems, in accordance with up-to-date market standards, which record, quantify, and control the risks related to the fund or otherwise estimate the risk on a qualified basis.
A limit system, which controls the investment limits of the fund.
The general provisions of the Securities Trading Act (Wertpapierhandelsgesetz) (WpHG) regarding insider dealing and market abuse apply. In addition, BaFin can limit leverage and short sales by hedge funds.
Hedge funds must publish tax relevant facts to ensure that an investor is not subject to detrimental taxation (see Question 13, Open-ended retail funds). Further information must be provided for potential investors in a detailed sales prospectus, annual reports and additional selling documents.
InvAGs and KAGs, which manage investment funds, are subject to the Anti-Money Laundering Act (Geldwäschegesetz) (GwG). As a result, funds of hedge funds must not be invested in foreign target funds from states which do not co-operate in relation to combating money laundering as provided by international agreements.
Short sales are generally permitted for hedge funds in Germany. For leverage or short sales to be used, the contractual terms and conditions of a hedge fund must actually provide for them.
The Act on the Prevention of Improper Securities and Derivatives Transactions (Gesetz zur Vorbeugung gegen missbräuchliche Wertpapier- und Deri-vategeschäfte) entered into force on 27 July 2010. It prohibits uncovered short-selling transactions in shares and certain debt securities as well as certain uncovered credit derivatives. Exemptions apply to investment services enterprises engaging in certain transactions, including:
Market makers.
Lead brokers.
Designated sponsors.
Enterprises that perform other similar functions.
However, those investment services firms must report these activities to BaFin and provide details of all relevant financial instruments.
On 31 January 2011 BaFin extended the scope of the General Decree of 4 March 2010 under which market participants must:
Notify BaFin of net short-selling positions in selected financial stocks of a threshold of 0.2% or more.
Publish net short-selling positions of a threshold of 0.5% or more.
The notification and publication requirements now relate to all transactions which, in terms of the holder's aggregate economic interest, result in a net-short position in shares in ten companies in the financial sector. The provisions of the General Decree will apply until 25 March 2012.
The same requirements apply as for open-ended retail funds (see Question 4, Open-ended retail funds). However, financial services providers are not allowed to market single hedge funds.
Funds of hedge funds can be marketed to private and institutional investors (see Question 20). Single hedge funds must not be publicly distributed (that is, they can only be marketed through private placement).
The requirements for the marketing of foreign funds hedge funds are the same as for the marketing of foreign retail funds (see Question 3). However, the notification must include additional information about the investment company. The public distribution of foreign single hedge funds is not permitted (see Question 20).
Single hedge funds must not be publicly distributed (that is, they can only be marketed through private placement). The potential investors do not need to meet any specific criteria (for example, their professional experience).
The fund's assets can be held by a credit institution, such as a Depotbank, or a branch of a credit institution. The institution must have its seat in Germany.
Alternatively, a prime broker can also have custody of the assets if it has its seat in one of the following:
An EU member state.
A European Economic Area (EEA) member state.
A full member state in the Organisation for Economic Co-operation and Development, if the prime broker is subject to effective public supervision and has an appropriate creditworthiness.
Generally, the same publication and filing requirements apply to hedge funds as to other investment funds (see Question 12, Open-ended retail funds). However, hedge funds are only able to use a detailed sales prospectus (rather than a KII or simplified prospectus). The prospectus must be delivered to a potential investor as a natural person together with all selling documents before the acquisition of the relevant fund units. The prospectus must include risk warnings (see Question 17, Risk). In addition, the potential investor must expressly be advised of these risks before the acquisition of the fund units. However, single hedge funds do not have to publish their annual and semi-annual accounts or their issue and redemption prices.
Hedge funds must meet the same licence and notification requirements as other investment funds (see Questions 3 and 6). In addition, persons who are responsible for investment decisions must have sufficient experience and practical knowledge regarding investments in hedge funds.
Investment companies that are not domiciled in the EU are not permitted to manage a domestic hedge fund.
Hedge funds use the same legal structures as open-ended retail funds (see Question 8, Open-ended retail funds).
If a hedge fund qualifies as a hedge fund under the meaning of the InvG it is also considered as a fund for tax purposes and the general provisions of the InvStG concerning the taxation of funds apply (see Question 13, Open-ended retail funds: Funds).
See Question 13, Open-ended retail funds: Resident investors.
See Question 13, Open-ended retail funds: Non-resident investors.
The redemption of fund units can be limited, but must be at least once in each calendar quarter. The redemption of the fund units must be notified to the KAG/InvAG up to:
40 days before the relevant redemption date, in the case of single hedge funds.
100 days before the relevant redemption date, in the case of funds of hedge funds.
Units can be transferred to third parties without restriction. However, a resale of the shares of a single hedge fund by way of a public offer in Germany is not permitted.
The AIFM Directive and, to some extent, the FinAnlVG will change the German hedge fund market (see Question 14, Regulation). The FinAnlVG will come into effect on 1 January 2013. Certain of its rules will enter into force the day after the Act is promulgated; others will enter into force six months after the Act is promulgated.
The AIFM Directive entered into force on 21 July 2011. Member states will be expected to have transposed the AIFM Directive into national law by 22 July 2013. Certain provisions of the AIFM Directive will take effect on this date, such as the EU passport for EU AIFMs. Other provisions (such as the EU passport for non-EU AIFMs) will enter into force in 2015 or later.
After the financial crisis, there have been several actions against investment companies, but no official statistics are available.
