International Investment takes a look at how German fund regulation has been updated over the last year
1. 4th Law on Promotion of Financial Markets Amending the German Investment Companies Act
Hopes are high among German fund managers that the current debate in parliament of the fourth law on promotion of financial markets will lead to a timely adoption of the government's proposals for the reform of the German Investment Companies Act (Gesetz Ã¼ber Kapitalanlagegesellschaften (KAGG)) by mid-2002.
Overall the changes aim at broadening the range of available products and to allow for more investor choice. Unlike the last major amendment of the KAGG in 1998, the law will not include new fund types such as AS funds. This time it will provide only for a few important amendments which make it easier for all funds to adapt to the changing German fund market. Specific to real estate funds, the law will provide for better investment possibilities which allow such funds to go global.
As Germany is moving more to an environment of third-party distribution, one of the more important amendments is the possibility of offering funds with separate unit classes in the future. Instead of charging only the customary front-end sales load, funds will be able to use different fee structures for the different asset classes. This enables providers to use the same asset pool according to the requirements of the different investors and distributors in a fund. Further improvement is the possibility of an easier merger of different funds, thereby allowing the cleaning up of the product range in view of the introduction of the euro and changing investor needs.
Open-ended real estate funds will benefit from unrestricted investment possibilities outside the EU and the EEA, instead of the current 20% limit. In the future we may see funds investing only in US or worldwide properties. Further improvements for fund managers are provided by the possibilities of investing up to 25% of assets in properties that do not confer full ownership rights, as well as the possibility of engaging in joint ventures as a minority shareholder.
2. Riester Pensions and Funds
Following the adoption of the AltersvermÃ¶gensgesetz (AVmG) on 11 May 2001, important progress has been made to allow for full participation of German and foreign Ucits investment funds in the field of private pensions, the so-called Riester pension.
The law outlines 11 criteria, which need to be met by all products to be eligible for tax benefits, the most important being a guarantee of capital contributions at the beginning of retirement and the requirement to pay pensions either in the form of an annuity or a withdrawal plan. All products offered as Riester pensions need to be certified for tax purposes by the insurance regulator BAV. Individual fund products together with life insurance and bank products will receive BAV certification during the month of December to allow for product distribution after 1 January 2002.
In this context BVI has achieved important clarifications by the regulators on the reach of the withdrawal plan and the capital requirements for fund providers. These regulations will enable investment funds to have a competitive edge over traditional pension products in the future.
First, under an investment fund-based withdrawal plan, up to 20% of the initial capital available at the beginning of the pension can be paid as a lump sum. An additional 20% can be paid as variable rates during the term of the plan, similar to a US style variable annuity. In contrast, Riester annuities need to pay out 100% of capital in the form of regular fixed amounts or steadily increasing payments. The flexibility to structure cash flows makes investment fund-based products much more interesting for investors.
Second, and probably more importantly, the capital requirements applicable to the capital contribution promise for investment fund based products as foreseen in the BAKred circular 12/2001 favour Riester funds over traditional pension products in the long term.
German-based fund management companies (Kapitalanlagegesellschaft ' KAG) need to maintain an 8% capital requirement of contributions only in such cases where the value of the fund units drops below the value of the discounted contributions taking into account the volatility of the investment fund(s) used in the individual retirement account.
The formula recognises the fact that at least in theory the fund manager can meet the capital contribution promise at any time if enough capital remains to be invested in a risk-free bond at a discounted interest rate with a maturity equal to the maturity of the individual retirement account contract. Based on this formula (developed in close co-operation between the JWG University of Frankfurt, the Ministry of Finance, and the fund regulator BAKred) KAGs may offer Riester pensions without effective capital requirements depending on the fund(s) used in the account and the remaining maturity of the in the individual retirement account.
This rule, which is currently applicable only to private pensions, will without any doubt also influence the future direction of occupational pensions. Why should employers resort to Pensionskassen and Pensionsfonds which carry a 4% requirement if properly structured pure fund-based systems do not carry expensive capital charges?
Furthermore, it should be mentioned that the fund regulator BAKred has issued on 6 December the long-awaited circular 11/2001 on outsourcing to third parties by banks, investment services firms and investment fund managers. In the future, outsourcing by KAGs is in principle possible if it does not impair:
• The orderly conduct of fund management functions.
• Management and control functions of senior management.
• The examination and control powers of the BAKred.
As a result, KAGs may outsource fund management and fund administration functions to German and foreign outsourcing partners in the future. To this end the BAKred will rescind the circular dated 29 September 1997, which forbids the outsourcing of fund management and fund accounting functions by a KAG. The BAKred, however, reserves the power to issue specific regulations on these matters if it deems it necessary.
It is expected that the new approach to outsourcing will significantly change the current structure of the industry over the medium term. The BVI will monitor the development and closely liaise with the BAKred in this matter to insure that the interests of the fund industry are maintained.
Furthermore the supervisory authority is expected to issue a circular which will clarify the responsibilities of fund management with respect to the selection and supervision of distribution channels. The fund regulator wants to ensure the product providers take the necessary steps to make certain their distributors adhere to the standards developed by the courts with respect to proper advice.
4. Implementing the Ucits Directive
Finally, the Ucits directive is expected to be implemented in German law by mid-2003. The major issue is how to allow in German law for the new investment options made available to traditional Ucits by the directive. According to the directive, a Ucits may now invest not only in exchange-traded securities, for example equities and bonds, but also in units and shares of other funds, derivative and money market instruments, and cash.
This wide scope of investment possibilities allows for a 'Super-Ucits' that does not easily fit within the traditional structures of the German fund law. German fund law currently separates between securities, money market and cash funds. Furthermore, the marketing of funds, especially on the internet, would benefit from the envisaged simplified prospectus, which can be used throughout Europe without the need for further documentation. The simplified prospectus can only reach its full potential if the different member states allow for a harmonised model prospectus as proposed by the European Fund association FEFSI.
The German investment fund and asset management industry will continue to engage itself in a constructive dialogue with parliament, government, and other interested parties on these subjects.
As Germany is moving more to an environment of third-party distribution, one of the more important amendments is the possibility of offering funds with separate unit classes in the future.
Open-ended real estate funds will benefit from unrestricted investment possibilities outside the EU and the EEA, instead of the current 20% limit.
Paul Bruns and Elaine Parkes
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From 3 to 10 October