New regulations affecting German open-ended funds

13/05/2011

In the aftermath of the recent disarray of the real estate markets and notably some resounding fund closures, Germany passed, on February 11th, 2011 the Act on Strengthening Investor Protection and Improving the Functionality of the Capital Market.

The main aims behind this Act are to provide retail investors with greater protection, to set out clearer rules on the timing and structure of redemption freezes as well as contemplating other steps necessary to protect investors in times of financial markets turmoil. 

The core provisions of the Act can be split into four key areas:

-     Improving investor protection by means of qualification and registration of investment advisers;
-     Improving investor information in standardizing information-leaflets summing up the material characteristics of the respective financial instrument prior to completion of any investment advice;
-     Expanding the notification obligations under the German Securities Trading Act to include financial instruments not covered until now, in order to improve participation transparency;
-     Regulation of German open end real estate funds (GOEF’s).

As regards (GOEF’s) specifically, the Act provides for measures in relation to:

  • Liquidity management: the suggested measures aim at addressing the liquidity problems of the funds by imposing a minimum holding period of two years, and a subsequent 10% and 5% charge on withdrawals of units in the third and fourth year. In doing so, the Act provides for the renunciation to the principle of daily redemptions which has been highly controversial for a long time. Instead, the fund will have set dates on which redemptions are permitted, with a minimum of one and a maximum of twelve dates each year.
  •  Protection of retail investors: Smaller investors are exempt from the above restrictions for the redemption of sums of less than €30,000 within half of a calendar year. In addition, for the wider benefit of unit holders, fund managers will have to pay at least 50% of the net profit to investors as a dividend.
  • Valuations: At least one valuation per year will need to be carried out. The number of valuations per year will need to match the number of redemption dates.
  • Crisis Management: the Act sets forth an action plan in three steps (spanning over a time period of 2,5 years) in case of occurrence of a suspension of redemption
  1. The first step consists of two six months terms during which the fund should aim at improving liquidity. Lack in improving liquidity will force the fund manager to sell assets in line with their current book value in the second six month period;
  2. The second step covers a twelve month period during which the fund should continue with property disposals (with a maximum allowed sale discount of 10%);
  3. The third step covers another twelve month period during which 20% discounts on the latest valuations are permitted. During this period, the fund manager loses his investment mandate and the management of the fund automatically goes over to the respective depository bank.

The Act sets forth transitional regulations for open end real estate funds which already exist at the time when the Act came into effect and provides for the new regulations to be applied as from January 1, 2013 on.