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Germany is about to enact a law that will create a new asset class for investors in the federal republic that should also attract foreign investors. The star attraction of the next set of financial reform bills set to go before the Bundestag this autumn is an easing of the rules covering hedge funds.
Part of a fifth wave in a makeover of Germany’s financial regulations, designed to bring Germany’s banking rules into line with EU regulations, the financial modernization bill is scheduled to be read during this autumn’s session and must be passed by January.
In theory, German investors can already invest in hedge funds, but the existing rules mean few have bothered to do so. As with its famous holidaymakers, the German money that goes into hedge funds goes abroad.
Grappling with gobbledegook The new rules have to be passed by a January deadline if Germany is to meet the requirements of the EU’s Ucits directive on investment funds first issued in 1995, but recently updated. EU gobbledegook, Ucits stands for “undertaking for collective investment into transferable securities”.
By that, says Steffen Kern, an economist with Deutsche Bank, “they mean rules for investment funds. All the member countries have to comply by the start of next year with the latest Ucits rules and the German law will be one of the most progressive in Europe and is certainly more progressive than the national regime [on investment funds] currently in place.”
The proposed laws are creating quite a buzz in the German investment community. The German Federation of Fund Managers (BVI) estimates that $1 billion could be under management as soon as next summer and Goldman Sachs says that this could rise to $100 billion within five to 10 years.
Bankers say there is significant pent-up demand. Goldman Sachs itself has five “low octane” funds waiting in the wings that it will roll out on January 1 2004 after the new rules come into effect.
Frank Bock, an expert on hedge funds with the BVI, says: “There are a few technical points that need ironing out, but broadly speaking we are very happy with the proposals and welcome the reform.”
Other fund managers are more cautious, but Cominvest Asset Management, the fund management arm of Commerzbank, says that it is watching the developments closely and it may bring its Jupiter management to Frankfurt from the UK if the new laws are as good as they seem.
The main beneficiaries of the changes will be institutional investors, which traditionally make the most use of hedge funds and will have unfettered access. However, some bankers are complaining that the restrictions on other kinds of investor are too severe and are lobbying the government to loosen the regulations further.
The draft version says that retail investors can only buy into hedge funds through fund of funds structures, and pension and insurance companies also do not have complete freedom to invest their money as they might like.
Opinion is divided about how much of a problem these restrictions are. The government’s desire to protect pensioners’ money and forestall the possibility of a cataclysmic insurance company failure should a hedge fund go belly up are politically justifiable.
More contentious are the restrictions on retail investors.
Funds catering to high-net-worth individuals would like to see reporting conditions kept to a minimum as these clients typically don’t like saying where their money is. Those funds that hope to tap into high street investors are happy to see complete transparency as a necessary part of building up a retail business.
“Hedge funds can’t be a black box,” says Bock. “These funds shouldn’t only be available to high-net-worth individuals. If they are going to be offered to retail customers then they must be as open and transparent as possible.”
Also at issue is how the funds will be taxed. Although funds set up in Germany will be taxed in the same way as other investment instruments, the draft law demands that the managers disclose a breakdown of where the money has been invested, something fund managers say is a burden on hedge funds, which have to make fast-moving decisions on markets worldwide.
Nevertheless, German bankers are excited, as the new rules will create the most liberal hedge fund regime in Europe, which they hope will attract significant inflows of investment funds from other countries.
“If the market picks up on the new freedoms and there is enough demand and liquidity, Germany will become a very attractive ‘onshore’ market for hedge funds,” says Kern “The planned regulatory framework equates to increased security for investors. However, it remains to be seen if German hedge funds will be able to compete with the ‘real’ hedge funds down there in the Caribbean as the market here may not enjoy the same freedoms as offshore funds. We will wait to see what happens, but prospects are very good.”
