Hedge Funds in Germany under the German Investment Modernisation Act

www.absolut-report.de | No.15 | 08/2003 | ISSN 1616-5373 ® Absolut report Alternative Investments Information Issue No. 15 | 08/2003 Absolut Research GmbH Hedge Funds in Germany Hafentor 2 under the German D-20459 Hamburg Phone: +49 (0) 40 33 39 68 34 Investment Modernisation Act Fax: +49 (0) 40 33 39 68 35 Achim Pütz, Dr. Albrecht von Sonntag, Dr. Till Fock E-mail: info@absolut-report.de Internet: www.absolut-report.de +++ Updated version December 2003 +++ 26 hedge fund law Hedge Funds in Germany under the German Investment Modernisation Act Achim Pütz, Dr. Albrecht von Sonntag, Dr. Till Fock Nothing has quite so preoccupied the investment industry, investors and the press over the last few months as the proposals from the German Ministry of Finance to regulate the promotion of hedge funds and funds of hedge funds in Germany. These proposals have indeed been praised, but have also attracted critical comment on account of residual uncertainty over how the Ministry of Finance's proposals will work in practice. Achim Pütz, Dr. Albrecht von Sonntag, and Dr. Till Fock of SJ Berwin Knopf Tulloch Steininger offer Absolut|report readers an overview of the forthcoming legislation and explain what can (and what probably cannot) be expected as a result in the hedge fund sector in due course. Abs olut report Nr.15 08/2003 27 hedge fund law I. Introduction hedge funds. Section IV comments capital in return for a management To date, hedge funds have basically on the tax treatment for such funds fee. Since 1998, German law has also not been available for distribution which will apply under the Investment permitted the formation of an invest- within the regulated markets in Ger- Tax Act . ment company, which is a vehicle for many. They can be established neit- collective investments commonly her as an investment fund (Sonder- II. Regulation of Domestic used or recognised in many other vermögen) by an investment mana- Hedge Funds jurisdictions. Here the investor beco- gement company (Kapitalanlagege- A key feature of the proposed legis- mes a shareholder in the fund. sellschaft) nor as an investment lation is that for the first time a do- The establishment of an investment company (Investmentaktiengesell- mestic hedge fund will be capable of management company purely for the schaft). Nor can shares in foreign establishment as an investment fund sole purpose of running a hedge fund hedge funds be publicly sold in Ger- managed by an investment manage- may not always appeal in practice to many due to the restrictive regulati- ment company or as an investment hedge fund managers. An investment ons of the German Foreign Invest- company. The legislation will treat management company is required to ment Funds Act (Auslandinvestment- single hedge funds and funds of hedge be regulated in Germany and, as such, gesetz, AuslInvestmG).1 This will funds on a different basis; it is propo- is subject to stringent supervisory change in the near future. On No- sed these should be governed by dif- requirements. For example, it requires vember 28, 2003, the Upper House ferent sets of investment regulations at least two managing directors with of the German Parliament (Bundes- to be promulgated under the Act. managerial experience (usually at rat) finally adopted the bill for an However, both types of hedge fund least three years) as defined in the Investment Modernisation Act. This vehicle are basically subject to the German Banking Act (Kreditwesen- Act has several purposes. First, it same general provisions which apply gesetz, KWG). And it is subject to will generally overhaul and consoli- to other investment funds and must maintenance of regulatory capital date the investment legislation and meet certain requirements regarding equal of 25 % of its previous year's corresponding fiscal regulations cur- sales prospectuses, contractual terms expenditure (subject to a minimum rently codified in the German Capital and conditions (articles of associati- of ¡730,000) plus a further 0.02 % Investment Companies Act (Gesetz on), and accounting, and are obliged of funds in excess of ¡3,000m under über Kapitalanlagegesellschaften, to appoint a custodian bank for the management. KAGG) and the German Foreign safekeeping of their investment assets. Given these onerous requirements, Investment Funds Act. Secondly, it the investment industry has been par- will integrate hedge funds2 into the 1. New hedge fund models ticularly interested to determine the range of regulated investment funds Under the new legislation, a hedge policy of the new legislation towards capable of being marketed in Ger- fund may be set up as an investment improving the framework for the esta- many. These provisions will in due fund managed by an investment ma- blishment of investment companies, course be incorporated into an "In- nagement company (Sondervermögen which is currently impracticable and vestment Act" (InvestmG) and a cor- mit zusätzlichen Risiken, Sections has no market following. For example, responding "Investment Tax Act". 112 et seq. InvestmG) or as an invest- there is no tax incentive for using this The new legislation will come into ment company (Investmentaktienge- legal form since the investment com- force on January 1, 2004. sellschaft, Sections 96 et seq. Invest- pany and its shareholders are both This article will review the conse- mG). Historically, the only legal form taxed under the general provisions of quences of the bill for hedge funds. permitted for regulated investment the German Corporation Tax Act First, Section II below describes the funds was that of an investment fund (Körperschaftsteuergesetz, KStG) and proposed supervisory requirements not having legal capacity, where an the German Income Tax Act (Einkom- for regulated domestic hedge funds investment management company mensteuergesetz, EStG). Moreover, set out in the legislation. Section III undertakes a contractually based com- the investment company cannot rede- reviews the preconditions for the sale mitment to its investors to manage em issued shares and is thus not sui- to the public of shares in foreign the fund generated from the raised table as a basis for constitution of an 1 In this context cf. also Achim Pütz in: Absolut|report No. 1, 12/2001, P. 23. 2 In the following the term hedge fund is used to mean both single hedge funds and funds of hedge funds. Nr.15 08/2003 Abs olut report 28 hedge fund law open-ended fund structure (c.f. the dent service provider. However, the are not permitted by the new legisla- Luxembourg SICAV). As a supposed service provider must be a licensed tion. In order to prevent the new in- alternative mechanism for supporting asset manager and the fundamental vestment company model from being the liquidity of the shares in an invest- decisions on the fund's investment used for private equity funds, partici- ment company, the existing legislation strategy must remain with the invest- pations in companies not listed on an requires that it must publicly offer ment management company and the exchange or not admitted to trading 90 % of its shares within a period of investment company respectively. Ac- are only admissible up to a 30% share six months of formation.