HVB Alternatives has launched a service to help third party hedge fund managers meet the requirements of the new German investment law. Stefan Henrich outlines the legislative changes and the opportunities in the German market for managers.
HW: What are the legislative changes that have driven the launch of the new service from HVB Alternatives?
SH: Under the upcoming liberalisation of the German foreign fund regime, the hedge fund industry is moving forward towards the direct marketing of fund of hedge funds products to German institutional as well as private investors.
Even single hedge funds may be offered to German investors. However, as far as private investors are concerned, direct single hedge fund investments may occur only in the form of private placements. Institutional investors may invest in single hedge funds in the form of a special fund (Specialfond).
Structured hedge fund products like Index Certificates, participating certificates (Genussscheine) or other bearer instruments, however, will retain their importance due to the beneficial tax treatment of those kinds of products. Despite the upcoming easements, not only German-based but also foreign fund managers will have to overcome various hurdles prior to the marketing and distribution of their funds or fund-linked products in Germany. For the time being, however, the proposed new regulatory and tax reporting requirements, based on the draft of the Act Modernising the Investment Regime (Investmentmodernisierungsgesetz), containing as a regulatory part the draft of the Investment Act (Investmentgesetz-Entwurf), and as a tax part the draft of the Investment Tax Act (Investmentsteuergesetz-Entwurf), provides for certain regulatory reporting requirements which need to be fulfilled if a fund of hedge funds is publicly distributed in Germany.
The tax reporting obligations, on the other hand, apply to both public distribution and private placement distribution channels in equal measure. It is essential - and vital - that the tax reporting obligations are carefully dealt with to avoid investors becoming subject to an extremely adverse tax penalty regime, such as the regime under the existing Foreign Investment Act (Auslandsinvestmentgesetz). In terms of identifying the optimal fund vehicle, the tax reporting requirements are neutral. They apply to foreign funds as well as to domestic funds. When answering the question of whether a fund of hedge funds or a single hedge fund is able to fulfil the various reporting requirements set forth under the proposed law, three basic criteria need to be considered:
(i) Type of reporting
(ii) Frequency of reporting
(iii) Level of reporting.
HVB Alternatives' new service for third party hedge fund managers will help find the appropriate fund structure (including selection and co-ordination of service providers: lawyers, auditors, prime brokers, administrators, custodian banks, leverage & guarantee providers, rating agencies), and help them meet the requirements of the new German investment law or to set up an ideal and tax optimised structured hedge fund product.
In our view, fund managers who regard Germany as an important market place should have no major problem in revealing the requested information to the fund of fund or the German tax bodies - particularly once they have realised that they do not face the uncovering of their investment strategies. However, the processing and the examination of the requested information will be problematic not only for the single hedge fund and the fund of hedge funds, but also for the German supervisory authorities and the tax bodies.
The current time schedule for the legislative procedure is as follows: Approval by the Federal Parliament (Bundestag) on 7 November 2003. The approval by the Council of States (Bundesrat) is not yet scheduled. Based on this, the new regime is expected to come into force beginning of 2004.
HW: What is the potential size of the German market?
SH: At the present stage there are few reliable estimates. However, HVB Alternatives shares the analysis from the German Association of Alternative Investments (BAI) that the German market could see a potential capital inflow into hedge fund products (this includes direct investments as well as structured hedge fund products) of up to EUR 50 billion within the next three years
We assume that around 60% of the estimated volume will be placed with institutional investors, whereas 40% should go into the private and the retail sector.
HW: What are the opportunities for single hedge fund managers in the German market?
SH: A conventional hedge fund domiciled in Cayman (with or without being listed in Dublin) may be sold in the future "directly" to German institutional and private Investors. However, the manager of such a fund would have to make sure that he complies with the regulatory and tax reporting requirements set out under the new German investment law.
Furthermore, if the fund aims for public distribution of its shares in Germany he needs to apply to the German supervisory authorities (BAFin) for the respective authorisation (Vertriebsanzeige). The proposed new law states that such authorisation will be granted only to those funds which are set up in the European Union or which are located in a jurisdiction with an acknowledged regulatory supervision comparable to those within the EU member states.
Furthermore, the fiscal authorities in such a "Non-EU Jurisdiction" must show their willingness to work together with the German authorities, if necessary. In any case a mere listing on a European Stock Exchange (like Dublin) is of no great help - the hedge fund industry speculates that e.g. Switzerland, as a non-EU member state, may fulfil such requirements. It is however quite unlikely that e.g. Cayman or Bermudas may qualify as a domicile for hedge funds publicly distributed in Germany.
On the other hand it needs to be pointed out that a fund of hedge fund, set up in Germany or an EU member state and applying for a "Vertriebsanzeige" in Germany may of course invest, without limits, in those single hedge funds which are located in jurisdictions which are not meeting the stated requirements (e.g. Cayman, Bermudas etc.) for obtaining a "Vertriebsanzeige".
HW: What about funds of hedge funds?
SH: The same regime as stated above will apply.
It will be important that the respective fund of hedge funds is located within the European Union. If this is the case, the German governmental bodies clearly state that German and foreign funds of hedge funds which apply for public distribution of their shares will be treated equally.
However, it seems to be that funds of hedge funds established abroad (e.g. Luxembourg) could face some "assuaged" reporting requirements (compared to German fund of hedge funds) as far as the regulatory reporting is concerned. This derives from the fact that e.g. a Luxembourg fund primarily has to fulfil the reporting requirements of the Luxembourg regulators even though there are diversification rules under the new German fund regime which apply also for foreign funds. However, at least when it comes to tax reporting, a Luxembourg fund would be treated like any domestic fund of hedge funds.
It terms of the opportunities for funds of hedge funds, it can be assumed that private investors will primarily focus on funds of hedge funds since only they will be subject to public distribution next year. This will also apply to most institutional investors. However, some experienced institutional investors may also focus, apart from single style funds of hedge funds, on single hedge fund investments.
HW: Where is your new structuring and due diligence service for third party hedge funds based?
SH: Our "Products & Structures" unit based in Vienna and Munich will provide the new service.
HW: Can the service be used by managers targeting other European markets?
SH: Yes, we are already dealing with mandates where German and foreign fund managers are looking for appropriate and valid structures in other European markets. The emphasis here - up to now - is on the German speaking markets like Austria, Switzerland and Liechtenstein, but this will change rapidly. As far as hedge fund wrappers are concerned they are already currently structured and designed for various European jurisdictions.
HW: What other products are currently being planned by HVB Alternatives?
SH: HVB Alternatives will launch a new fund of hedge funds family which will fulfil the requirements of the new German investment law and which will be marketed to institutional and private investors next year immediately after having been authorised by the BAFin.
Stefan Henrich is the Head of Products & Structures, Munich Branch, HVB Alternatives
copyright hedgeweek 2003