New Distribution Rules for Alternative Funds in Germany

On 22 July 2013, a new legal framework for the distribution of Alternative Investment Funds will enter into force in Germany. After a grandfathering period lasting until 21 July 2014, any form of marketing of Alternative Investment Funds, including private placements, is only permissible upon successful conclusion of a regulatory notification procedure.

By 22 July 2013, all EU Member States must implement the Alternative Investment Fund Managers Directive ("AIFMD" or the "Directive"). The German legislator will implement the Directive by creating an entirely new statute, the Capital Investment Act (Kapitalanlagegesetzbuch – "KAGB"). The KAGB will replace the former Investment Act which transposed the UCITS IV-Directive1 into German law. The German Federal Parliament (Bundestag) approved the KAGB on 16 May 2013. Germany’s second parliamentary chamber, the German Federal Council (Bundesrat), approved the KAGB on 7 June 2013. The KAGB will become effective on 22 July 2013.

The KAGB will have a significant impact on the distribution of alternative investment funds ("AIF") in Germany. This note focuses on the future legal framework for the distribution of non-European AIF’s on German territory.

Unlike European AIF managed by alternative investment fund managers ("AIFM") domiciled in the European Union, non-European AIF will at least until 2015 not benefit from a European passport. Until the introduction of a European passport for non-European AIFM, non-European AIF can only be distributed in accordance with the national distribution regimes implemented by each individual EU member state.

New marketing rules: the end of the private placement regime

Marketing is the direct or indirect offering or placement of fund units. Indirect offering or placement of fund units captures the distribution of AIF by intermediaries other than the AIFM itself. Unlike other EU Member States, Germany has not opted to establish a private placement system; the KAGB therefore no longer distinguishes between public distribution and private placement but regulates all forms of marketing of AIF to investors domiciled in Germany. Only the sale of fund units exclusively upon the initiative of the investor is not governed by the KAGB.

Which rules apply after 22 July 2013?

As there is no more private placement regime, every active marketing and distribution of non-European AIF in Germany will require prior completion of a notification procedure with the German Federal Financial Services Supervisory Authority ("BaFin"), subject to certain grandfathering provisions. 

Non-European AIF’s can only successfully complete the notification procedure if they meet certain requirements. The scope of these requirements depends on the targeted investor group:

Professional Investors: Professional investors are all investors who are professional investors within the meaning of Annex II of the European Markets in Financial Instruments Directive (MiFID) or who have opted for the status of professional investor. This includes, in particular, banks, investment firms, insurance companies, national and regional governments but also corporates exceeding certain thresholds;

Semi-Professional Investors: The category of semi-professional investors is a German particularity and is not defined in AIFMD. Semi-professional investors include, among others, (i) investors with a committed investment amount of at least EUR 200,000 and in respect of which the AIFM or the distributor has confirmed the suitability of the investment and (ii) investors with a committed investment amount of at least EUR 10,000,000 in the AIF;

Retail Investors: All investors not qualifying as professional or semi-professional investors are considered retail investors.

The lightest notification regime applies to the marketing to professional investors while the strictest regime governs the marketing to retail investors. The notification requirements for marketing to retail investors are comparable to the current regime for the notification of non-harmonised investment funds (i.e. non-UCITS) for public distribution in Germany which does not distinguish between different types of investors. As a consequence, the KAGB will actually make it easier to notify foreign non-UCITS funds for distribution to professional investors in Germany. However, while marketing to professional investors is customarily done as a private placement not subject to any BaFin notification, in the future any form of marketing even to professional investors will be subject to an – albeit light – notification regime.

The three notification regimes for the distribution of non-EU AIF

(a) Distribution to professional investors
Non-European AIF can be notified for distribution to professional investors if the following requirements are met:

  • The non-EU AIFM must appoint an independent entity performing the functions of a depositary2 as set out in Art. 21 (7) – (9) AIFMD for the AIF; 
  • The non-EU AIFM must comply with the special notification, disclosure and prohibition of asset stripping rules for Private Equity Funds3;
  • The non-EU AIFM must comply with certain pre-investment information requirements4;
  • The non-EU AIFM must comply with reporting obligations towards BaFin5;
  • There must be a cooperation agreement between the competent authorities of the non-EU AIFM (and non-EU AIF, if different from the domicile of the manager) and BaFin;
  • The home country of the non-EU AIFM must not be classified as a non-cooperative country and territory by the Financial Action Task Force (FATF).

(b) Distribution to semi-professional investors
If non-EU AIF are to be marketed to semi-professional investors, the non-EU manager and the non-EU AIF must not only fulfill the requirements set out under I.1.a above but must be fully AIFMD-compliant. This includes, in addition to the aforementioned requirements for marketing to professional investors, compliance with the requirements regarding remuneration, the delegation rules and valuation and organizational requirements.

(c) Distribution to retail investors
These requirements are significantly more restrictive than for the other two regimes. The non-European AIF must not only be fully AIFMD-compliant but must also comply with product related restrictions imposed by the KAGB for the various types of public mutual funds:

  • The AIF and its AIFM must be domiciled in the same jurisdiction. It is thus not possible to notify a Cayman Island AIF managed by a US AIFM for distribution to German retail clients;
  • Open-ended AIF must comply with the investment restrictions of their German open-ended counterpart6;
  • Closed-ended non-European AIF must satisfy the principle of risk diversification7 if distributed to retail investors unless investors must commit to invest at least EUR 20,000 and fulfil the criteria of semi-professional investors (except for the minimum commitment of EUR 200,000); 
  • A German representative must be appointed. 

The Notification Procedure

The intention to distribute a non-European AIF must be notified to BaFin in writing. The notification must include comprehensive information and documents on the AIF and its AIFM. The exact scope of the information and documents to accompany the notification depends on the respective notification regime.

BaFin will review the submitted documents and may request missing documents within 20 business days. If the notification relates to the distribution to professional investors, BaFin will inform the AIFM within two months after the submission of the complete notification8. In the case of distribution to semi-professional investors, the review period is four months9, in case of distribution to retail investors the review period is six months.

As the current private placement regime will be grandfathered for only one year, it is advisable to start preparing notifications early in order to meet the 21 July 2014 deadline as it customarily takes considerable time to collate all required notification documents.

Ongoing Regulatory Requirements

Non-EU AIF distributed in Germany are subject to certain ongoing regulatory requirements. In case of distribution to professional and semi-professional investors, the following requirements apply:

  • Prospective professional and semi-professional investors must be provided with an offering memorandum whose minimum content is based on Art. 23 AIFMD. They must furthermore be provided with the latest annual report to be prepared in accordance with Art. 22 AIFMD;
  • The non-EU AIFM must provide professional and semi-professional investors upon request with an annual report prepared in accordance with Art. 22 AIFMD at the latest six months after the end of the business year;
  • The non-EU AIFM must inform investors without undue delay of any changes relating to the liability of the custodian;
  • The non-EU AIFM must disclose on a regular basis to investors (a) the percentage of the AIF’s assets which are subject to special arrangements arising from their illiquid nature; (b) any new arrangements for managing the liquidity of the AIF; (c) the current risk profile of the AIF and the risk management systems employed by the AIFM to manage those risks. The frequency of disclosures is governed by the AIFM Level II Regulation;
  • The non-EU AIFM is subject to ongoing reporting requirements vis-à-vis BaFin whose scope is based on Art. 24 AIFMD.

Which requirements apply to distribution after 2015?

In 2015, European Securities and Markets Authority (ESMA) is charged to submit an opinion on the extension of the concept of the European passport to non-EU AIFM. The outcome of this opinion is still open. If ESMA issues a positive opinion, non-EU AIFM may apply for authorization in a European member state of reference (“MSR”) to market non-EU AIF under the passport system and the national German distribution regime described under I. above will cease to exist10. At present, the German legislator does not intend to make use of the option under AIFMD to let its national distribution regime and the EU passport for non-EU managers co-exist until 2018. In order to continue distribution of non-European AIF in Germany after 2015, non-European AIFM will therefore have to apply for authorization in a European MSR in case ESMA issues a positive opinion.

In order to distribute non-EU AIF under the European passport, the following requirements must be met:The non-EU AIFM must apply for authorization in the relevant European MSR. The relevant MSR is determined by the criteria provided for in AIFMD, i.e. the manager is thus generally not free to select a European MSR;

  • The non-EU AIFM must comply with all requirements of AIFMD. This means that in comparison to the national distribution regime entering into force under the KAGB on 22 July 2013, the requirements for distribution to professional investors will actually become more restrictive once the European passport is introduced although non-EU AIFM will then benefit from the pan-European passport rather than having to comply with a multitude of different national distribution regimes;
  • The non-EU AIFM must have a legal representative in its European MSR;
  • There must be a cooperation agreement between the competent authorities of the non-EU AIFM (and non-EU AIF, if different from the domicile of the manager) and BaFin;
  • The home country of the non-EU AIFM must not be classified as a non-cooperative country and territory by the Financial Action Task Force (FATF);
  • The home country of the non-EU AIFM must have signed a tax information sharing agreement with the MSR in accordance with the OECD Model Tax Convention;
  • The home state of the non-EU AIF (if different from the domicile of the manager) must have signed a tax information sharing agreement with the MSR in accordance with the OECD Model Tax Convention.

Grandfathering Provisions for Private Placements

The private placement of non-European AIF can continue on the basis of the currently existing private placement rules until 21 July 2014. However, in a circular on the KAGB grandfathering provisions published on 18 June 2013, BaFin has clarified that only funds for which “distribution activities” have already been performed prior to 22 July 2013 can rely on this grandfathering provisions. Where possible, it is therefore advisable to commence and document private placements of AIF before 22 July 2013 in order to take advantage of the grandfathering provisions.

There are currently three different private placement regimes in Germany11. The private placement for non-European AIF during the grandfathering period will be governed by the relevant private placement regime in existence before 22 July 2013.

After 21 July 2014, public and private placements of non-European AIF will require successful completion of a notification procedure to BaFin.

Certain aspects of the grandfathering provisions and the new distribution rules are still subject to debate. In its circular on the KAGB grandfathering provisions published on 18 June 2013, BaFin has indicated that it will provide further regulatory guidance on distribution matters in an additional FAQ/circular which is expected to be released before 22 July 2013.

Footnote

1.
Directive 2009/65/EC of the European Parliament and of the Council of 13 July 2009 on the coordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities (UCITS)

2.
The functions to be performed by such entity according to Art. 21 (7) – (9) AIFMD must include the following:

    • monitoring of the AIF cash flows;
    • custody of financial instruments that can be held in custody;
    • verification of the ownership of the AIF or the AIFM acting on behalf of the AIF for other assets;
    • ensuring that the sale, issue, re-purchase, redemption and cancellation of shares of the AIF are carried out in accordance with the applicable national law and the AIF rules of instruments of incorporation;
    • ensuring that the value of the shares of the AIF is calculated in accordance with the applicable law, the AIF rules or instruments of incorporation and the procedures laid down in Art. 19 AIFMD;
    • ensuring that in transactions involving the AIF’s assets any consideration is remitted to the AIF within the usual time limits;
    • ensuring that the AIF’s income is applied in accordance with the applicable national law and the AIF rules or instruments of incorporation.

3.
See our Newsletter "What Managers of Private Equity Funds must know about the new German Investment Law".

4.
The AIFM must in particular provide prospective investors with certain information on the proposed investment with a minimum mandatory content prescribed by the KAGB. Typical private placement memoranda or offering documents will usually cover at least most of the information required by the KAGB. 

5.
The reporting requirements relate, among others, to  the portfolio composition of the AIF and, in case of AIFM employing leverage on a substantial basis, to the level and the sources of leverage. Cf. Art. 24 AIFMD for further details of the items to be reported.

6.
Such as German real estate funds, German Balanced Funds (Gemischte Investmentvermögen), German Other Funds (Sonstige Sondervermögen)

7.
The principle of risk diversification requires an investment in at least three different assets with a substantially similar relative weight or an investment achieving an economic risk diversification.

8.
The review period is longer (3-4 months) for non-European AIF which are feeder funds.

9. 
The review period is longer (5-6 months) for non-European AIF which are feeder funds.

10.
Under the KAGB, the distribution rules described in section II. above would remain in place if the European passport is not extended to non-EU AIFM.

11.
The private placement regime for securities under the German Securities Prospectus Act (Wertpapierprospektgesetz) implementing the European Prospectus Directive, the private placement regime for uncertificated capital investments covering, among others, many partnership interests and the private placement regime for collective investment schemes qualifying as foreign investment funds within the technical sense of the current German Investment Act.