June 11, 2014 The „New“ German Investment Regulation (Anlageverordnung) Draft/Consultation Reform of Capital Investments of Insurance Companies Executive Summary > The asset classes are regrouped > Regulated private equity AIF constitute a separate asset class in their own right > Any acquisition of unregulated private equity funds is excluded > Open-ended and closed-ended specialized real estate AIF and closed-ended mutual AIF are consolidated for real estate quota > UCITS funds/UCITS-compliant funds constitute a separate asset class in their own right > Residual/catch-all quota for other AIF > Replacement by Solvency II 1. Introduction and background information Insurance companies are only permitted to invest the guaranteed assets and the other restricted assets (restricted assets) in compliance with the requirements provided in Section 54 Versicherungsaufsichtsgesetz [VAG, German Act on the Supervision of Insurance Undertakings] in conjunction with the regulation which was enacted pursuant to Section 54 Subsection 3 VAG, namely, the German Regulation on the Investment of Restricted Assets of Insurance Undertakings (German Investment Regulation (Anlageverordnung AnlV) – in certain investments (asset classes) (what is called eligibility to serve as guarantee assets). In particular, investments made by a German insurance company have, as a matter of principle, to comply with the principles of security, profitability, diversification and spread pursuant to Section 54 Subsection 1 VAG. The AnlV substantiates and clarifies these principles with respect to those insurance companies which are authorized for direct insurance business. The provision set forth in Section 54 VAG and in the AnlV are explained in detail by the Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin) [German Federal Financial Supervisory Authority], in particular in their circular memorandum 4/2011 (VA) of April 21, 2011 (Capital Investment Circular Memorandum). In practice, the Investment Regulation (AnlV) and the Capital Investment Circular Memorandum are of significant importance with respect to the structuring of capital investments by insurance companies and pension funds: for it is only when a capital investment product is designed in such a way that it complies with the requirements of the AnlV and the Capital Investment Circular Memorandum that the product can be distributed to such financially strong investors. In particular with respect to the fact that the Kapitalanlagegesetzbuch (KAGB) [German Capital Investment Act] came into force in July 2013, which involved a restructuring of the law relating to open-ended and, in particular, previously unregulated closed-ended funds, an adjustment of the AnlV to the current legal situation had become necessary. On May 27, 2014, the Bundesministerium der Finanzen [German Federal Ministry of Finance] presented a first draft bill of the revised Investment Regulation (AnlV). Beyond the formal adjustment to the KAGB’s new terminology, the draft also provides – with respect to capital investments in funds – a reform of the classification of the previously existing asset classes. Below, we have provided a brief outline of the planned amendments. 1 The New Investment Regulation (Anlageverordnung) 2. Reform of the „Funds“ Asset Class, According to Investment Focus With respect to the permissible assets (Section 2 AnlV), the draft provides, in particular, various changes in the area of investments in investment asset pools: a. New Asset Class: „Private Equity Funds“ The AnlV draft divides the previous so-called equity quota (previously to be found in Section 2 Subsection 1 Sentence 1 No. 13 AnlV) into investments in shares in operational companies and in regulated private equity funds. The currently existing so-called equity quota will continue to apply, unchanged, under the prerequisites set forth in No. 13 (a), a provision which was merely provided with a new number. A newly introduced provision is Section 2 Subsection 1 Sentence 1 Number 13 (b) AnlV, which provides the option to invest in shares and units in domestic closed-ended AIF within the meaning of Section 1 Subsection 5 KAGB, if (i) they invest, directly or indirectly, in assets according to Section 261 Subsection 1 No. 4 KAGB (participations in undertakings that are not admitted to trading on a stock exchange or included in another organized market) as well as in other instruments which are similar to equity capital instruments, and GSK Update / June 11, 2014 It remains unclear whether the foreign structures which are well-established in the private equity segment and which are not subject to any investment supervision, like the Delaware LP or the Cayman Island or Jersey Partnership, will continue to be capital investments which can be acquired by means of the equity quota pursuant to Section 2 Subsection 1 Sentence 1 No. 13a AnlV. The same question applies to closed-ended private equity funds, which, although they qualify as AIF, are merely subject to the registration requirement, but which do not have a BaFin permit pursuant to Section 20 Subsection 1 No. 13 due to their compliance with the applicable threshold values set forth in the AIFM Directive for assets under management (AuM) in the amount of 100 million (with leverage) or, respectively, 500 million (without leverage). An argument in favor of a classification under No. 13 (a) is presented by the government’s statement of reasons concerning the AnlV’s draft bill, according to which vehicles which are not subject to any supervision under investment law may be assigned to No. 13 (a) if the prerequisites are met. (ii) their investment fund manager has a permit according to Section 20 Subsection 1 KAGB. Investments in shares and units in comparable foreign investment asset pools have equal standing, provided that they were issued by a fund manager domiciled in another state of the European Economic Area or a full member state of the OECD that is subject to public supervision for the purpose of protecting the investors, and that has been granted a permit comparable to the permit of Section 20 Subsection 1 KAGB. Likewise, the acquisition of private equity funds of funds is permissible, provided that the target funds likewise meet the prerequisites of No. 13 (b). According to the previous administrative practice of the insurance supervision, shares or units of the closed-ended AIF have to be freely transferable. In particular, a transfer may not be tied to the agreement of the management or the other shareholders. However, a problem which might occur in this connection is that the typical private equity fund, at any rate when taking the KAGB’s requirements as a basis – as opposed to the administrative practice of the investment supervision when applying the InvG [Investmentgesetz, German Investment Act] in its old version – is typically not at all qualified to constitute an operative business, and, therefore, cannot be classified under No. 13 (a) AnlV. For otherwise, even the domestic PE funds were to lose the status as investment asset pools in accordance with the KAGB and, thus, their regulatory obligations. Thus, a synchronism as to the interpretation is to be expected. A corresponding clarification in the 2 The New Investment Regulation (Anlageverordnung) GSK Update / June 11, 2014 b. Open-ended and Closed-ended Real Estate Funds shares or units in investment asset pools which are – or whose fund manager is – merely subject to a registration requirement and thus not subject to supervision by BaFin [German Federal Financial Supervisory Authority]. With respect to real estate investments, the Draft provides in Section 2 Subsection 1 Sentence 1 No. 14 (c) AnlV that, beyond real estate, participations in real estate companies, shares in REIT stock corporation companies and/or comparable foreign shares, shares or units in domestic (open-ended / closed ended) specialized AIF or in closedended mutual AIF, As it is the case regarding the private equity segment, it has to be ensured in the event of an investment by means of a real estate fund of funds that the target funds likewise comply with the statutory requirements of the AnlV, i.e., that they are domiciled in an EEA state and that they are managed by a manager domiciled in an EEA state and provided with a comparable permit. (i) which, directly or indirectly, invest in real estate or rights pursuant to Section 231 Subsection 1 No. 1 through No. 6 KAGB as well as Section 235 Subsection 1 KAGB (land, heritable building rights, usufructuary rights in land, and real estate companies); and It is to be expected that the prerequisites for acquiring real estate funds will be put into more concrete terms in the Capital Investment Circular Memorandum. (ii) whose investment fund manager has a permit according to Section 20 Subsection 1 KAGB, The investment in shares in domestic and foreign UCITS is now provided for in Section 2 Subsection 1 Sentence 1 No. 15 AnlV. Capital Investment Circular Memorandum, which is yet to be adjusted, would be welcome. may likewise be acquired. Investments in shares and units in comparable European Union investment asset pools have equal standing, provided that they were issued by a fund manager domiciled in another state of the European Economic Area that is subject to public supervision for the purpose of protecting the investors, and that has been granted a permit comparable to the permit of Section 20 Subsection 1 KAGB. c. UCITS Funds/UCITS-compliant Funds Whether shares and units in domestic open-ended specialized AIF within the meaning of Section 1 Subsection 6 KAGB (i) which are comparable to the requirements for UCITS with regard to both eligible assets as well as redemption rights, and (i) whose investment fund manager has received a permit according to Section 20 Subsection 1 KAGB, Beyond the typical specialized real estate fund (Immobilien-Spezial-Sondervermögen, now: openended domestic specialized AIF with the investment focus on real estate), this provision encompasses also closed-ended specialized real estate funds as well as closed-ended mutual real estate funds. are eligible for acquisition is provided for in Section 2 Subsection 1 Sentence 1 No. 16 AnlV. Not listed as allowable real estate investments are open-ended mutual real estate funds (offene Publikums-Immobilien-Sondervermögen) within the meaning of Sections 230 et seqq. KAGB. This is consistent with the current legal practice by the insurance supervision, which regards shares in (open-ended) real estate mutual funds (offene Publikums-Immobilien-Sondervermögen) as unsuitable for the restricted assets, because of the notice and minimum holding periods which have to be complied with in such cases. Just as unsuitable are Comparable EU investment assets are likewise eligible in accordance with the corresponding prerequisites. This provision encompasses specialized securities funds which are comparable to UCITS in terms of their investment, but which, due to their specialized fund characteristics, do not constitute UCITS themselves, but rather, AIF. d. „Other“ Funds According to Section 2 Subsection 1 Sentence 1 No. 17 AnlV, shares, units, and interests in a limited partnership (Kommanditgesellschaft) in domestic investment asset pools 3 The New Investment Regulation (Anlageverordnung) (i) which are not mutual real estate funds (not Publikums-Immobilien-Sondervermögen), (ii) which are not already included by Section 2 Subsection 1 Sentence 1 No. 13 (b), 14 (c), No. 15 and No. 16, and (iii) whose investment fund manager has received a permit according to Section 20 Subsection 1 KAGB, may be acquired for the restricted assets („other funds“). Investments in shares and units in comparable European Union investment asset pools have equal standing, provided that they were issued by a fund manager domiciled in another state of the EEA that is subject to public supervision for the purpose of protecting the investors, and that has been granted a permit comparable to the permit of Section 20 Subsection 1 KAGB. Thus, Section 2 Subsection 1 Sentence 1 No. 17 AnlV constitutes a residual/catch-all provision for any and all other investment asset pools for which no specific regulations exist. At the same time, it is made clear that mutual real estate funds (Immobilien-Publikums-Sondervermögen) may not be acquired, not even in the context of this residual/catch-all clause, and are thus generally excluded from serving as a suitable type of investment. Investment asset pools which are – or whose fund manager is – merely subject to the registration requirement are likewise not subject to the scope of the residual/catch-all clause for other funds. 3. Changes Regarding the Quantitative Restrictions (Mix) Beyond the changes regarding the admissible capital investments, the draft also provides for a reform concerning the quantitative restrictions (Section 3 AnlV). a) Both indirect and direct investments according to Section 2 Subsection 1 Sentence 1 No. 17 AnlV (other funds) as well as other direct and indirect investments according to Section 2 Subsection 1 AnlV, whose income or repayment is linked to hedge fund or commodity risks now may not exceed 7.5 per cent (as opposed to previously 5 per cent) of the guarantee assets and of the other restricted assets, respectively (please confer Section 3 Subsection 2 No. 2 AnlV). GSK Update / June 11, 2014 b) The other changes in Section 3 AnlV are mainly of an editorial nature. 4. Debtor-related Restrictions (Diversification) Beyond the structural realignment with respect to the asset classes, the draft of the AnlV also contains alterations concerning the debtor-related restrictions (Section 4 AnlV). a) According to the draft bill, Section 4 Subsection 4 AnlV will be amended to the effect that investments pursuant to Section 2 Subsection 1 No. 9, No. 12, and No. 13 AnlV in one and the same undertaking, as well as shares and units in closed-ended investment asset pools according to Section 2 Subsection 1 No. 17 AnlV may not, in the aggregate, exceed 1% of the restricted assets. b) With respect to what is called the real estate quota, Section 4 Subsection 5 AnlV clarifies that indirect real estate investments in shares or units in an investment asset pool according to Section 2 Subsection 1 Sentence 1 No. 14(c) AnlV do fall under the scope of the real estate quota. 5. Transitional Provision The draft bill provides a grandfathering arrangement, in particular with respect to such capital investments which hitherto used to fall under the scope of the equity quota, but which now do no longer qualify for this due to a lack of existing regulation. These funds may remain in the portfolio and may be permanently allotted to the equity quota pursuant to No. 13 (b). It is only until December 31, 2019, that shares or units in open-ended specialized AIF which were acquired before the amended AnlV comes into force, but which do not comply with the new requirements, may be allotted to the „domestic openended specialized AIF“ asset class. 6. Conclusion The changes of the Investment Regulation (AnlV) take the alterations of the KAGB into account. In particular, the provisions concerning the eligibility of the acquisition of participations in closed-ended funds are now further clarified. In many respects, the requirements regarding the eligibility of the 4 The New Investment Regulation (Anlageverordnung) acquisition of investment asset pools still remain very vague. It is therefore to be expected that the specific requirements for both open-ended as well as closedended funds will be determined – as has happened before – in the context of the review of the Capital Investment Circular Memorandum, by the BaFin [German Federal Financial Supervisory Authority]. At any rate, with respect to insurance companies, the amendments constitute merely a transitional provision. For when Solvency II enters into force – probably as of January 2016 – the whole system of capital investments will be regulated in a completely new way, and it will be split off from the rather GSK Update / June 11, 2014 formal approach which the Investment Regulation (AnlV) takes. 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