German Law Restructures Open-ended
Funds
Hans-Dieter Schulz-Gebeltzig, Rechtsanwalt,
Linklaters Opperenhoff & Rädler
Christoph Wörner, Wissenschaftlicher Mitarbeiter, Linklaters
Opperenhoff & Rädler
In an effort to promote Germany as a financial
hub and strengthen its ability to
compete in international capital markets, a new German law,
the Fourth Financial Market Promotion Act, was recently
passed and became effective July 1, 2002. This new legislation
will allow more flexibility for German investment and trading
activities, as well as creating new opportunities for open-ended
real estate funds interested in acquiring commercial real
estate in the United States.
Open-ended Versus
Closed-ended Real Estate Funds
German open-ended funds are investment funds which are administered
by investment companies (Kapitalanlagegesellschaften). These
companies issue unit certificates. One specific feature
of an open-ended fund is the aim to increase the fund’s
assets; this is the reason why new capital assets are continually
taken up and the unit certificates will normally be taken
back at any time, at net asset value. In exceptional cases,
the investment company can temporarily refuse to take back
unit certificates in order to protect the investors in their
entirety. The acquired capital does not become part of the
investment company’s assets; a fund (Sondervermögen)
will be created instead.
As opposed to open-ended funds, closed
real estate funds are funds where no further interests will
be issued after placement of a certain number of unit certificates.
Unit certificates which have been issued, will normally
not be taken back, and if necessary, the investor himself
has to take care of the alienation of his share and the
fixing of a purchase price. There are no specific statutory
provisions for closed real estate funds. They take the form
of a limited partnership, a civil law association or a community
of part owners. Closed real estate funds have the character
of a share in a company. The real estateinterest in closed
real estate funds is a limited right from the outset, often
to one single property. Closed real estate funds are not
investment companies in the literal sense for lack of diversification
of risks; in the past, they
were mainly tax driven.
New Business
Opportunities
Investment companies are credit institutions which may,
as their sole principal banking activity, conduct the management
of investment funds. In the future, investment companies
will be allowed to distribute third party investment fund
units and to provide related investment advice. The marketing
of other companies’ shares will enable investors to
acquire the shares of different issuers from a single source
and is thus geared to consumer needs. This extension of
business activity will also enhance the ability of small
and medium-sized companies to compete with large investment
companies, as it will enable the former to round off the
range of products they offer. The rights related to the
unit certificates can be structured in a different way within
one fund. This not only applies to open-ended real estate
funds, but to all kinds of investment funds.
When managing an investment fund,the investment
company must always act in its own name, but for the joint
account of all unit holders within the scope of a management
agreement. When doing so, the investment company must always
act in the interest of the unit holders. The investment
company cannot legally bind the investment fund or its unit
holders. Therefore, the investment company opens a separate
depositary bank account in its own name on behalf of each
specific investment fund. When in the course of management,
transactions are entered into on behalf of the investment
fund in the name of the investment company, the investment
company is entitled, in accordance with the terms of its
management agreement, to reimbursement of its expenses by
the unit-holders out of the assets of the investment fund.
Open-ended real estate funds will be able
to invest their money in real estate
and rights equivalent to real estate outside the European
Economic Area (EEA), thus outside the 15 EU countries and
Norway, Iceland and Liechtenstein, without any limits, if
the currency exposure does not exceed 30 percent. Up to
now such real estate in foreign currency areas had been
financed by taking up loans in the currency of the state
in which real estate is located in order to reduce the currency
exposure. The cancellation of the former limitation of 20
percent investments outside the EEA now allows the establishment
of real estate investment funds which are completely invested
in foreign countries outside Europe (e.g., pure US funds).
The expansion of the investment opportunities on one hand
is supplemented by the admission of the acquisition of hereditary
building rights, but also by the admission of the acquisition
of residential property, part ownership rights, hereditary
building rights to housing and partial hereditary building
rights to housing (real estate). This is of particular significance
for the performance of open-ended funds, as in many countries
(e.g., USA, Southeast Asia) real estate is not offered as
property as such but in the form of rights equivalent to
hereditary building rights.
In the future, profitable minority participations
in a real estate company, which contribute to a further
risk diversification will be possible. Additionally, the
limitation of the participations of an investment company
in real estate companies for the account of real estate
funds has been increased from 20 percent to 49 percent of
the value of the assets of the fund.
New Investment
Restrictions
To offset these expanded investment opportunities additional
regulations with regard to transparency and regulations
for the limitation of risks will be introduced in the interest
of investor protection. Investments outside the EEA are
only permitted, as provided by the fund rules, if an appropriate
regional diversification of the assets is guaranteed and
if the states and the exact respective maximum percentage
of the investment fund which may be invested in that investment
fund are given in the fund rules.
An efficient investor protection could
not be ensured by the previous diversification requirements
that a real estate investment fund must contain at least
ten properties. Accordingly, this provision has been cancelled.
Up till now, no single property was allowed to exceed 15
percent of the value of the assets of the fund. This limitation
is now supplemented by the regulation that the total value
of all properties, the single value of which exceeds 10
percent of the investment fund, may not exceed 50 percent
of the value of the investment fund.
Role of a Depositary
Bank
It is a mandatory requirement that the assets belonging
to the investment funds are held in safekeeping by another
credit institution, the depositary bank (Depotbank), which
must be authorized to engage in at least deposit taking
and custody business. In particular, the depositary bank
performs the following tasks: continous control of the real
property interest, the interest of other assets not eligible
for deposit, as well as safekeeping of bank deposits, money
market notes and securities forming part of the investment
fund. The depositary bank also issues and redeems the unit
certificates.
In addition to the safekeeping of the
assets belonging to the investment funds, the depositary
bank’s function also includes the control of the investment
company. In order to protect the interest of the investors,
the consent of the depositary bank has to be obtained in
case of an alienation of, or the creation of an encumbrance
on property. In order to ensure the compliance with these
protective provisions, a blocking note for each real property
has to be entered in the land register. If in the case of
foreign real estate, the entry of the restraint on disposition
in a land register or a comparable register is not possible,
the effectiveness of the restraint on disposition must be
assured by other suitable means.
The depositary bank must review each transaction
of the investment company for the joint account of the unit
holders as to comply with the provisions of the Investment
Companies Act and the relevant fund rules, but not as to
the investment policy of the investment fund. If the depositary
bank determines that there is a violation of the Investment
Companies Act, this situation must be remedied by the investment
company as quickly as possible, while giving due consideration
to the unit holders’ interest.
Both German credit institutions and German
branches of foreign credit institutions may become depositary
banks as long as they are authorized to engage in deposit
taking and custody business in Germany. Only one depositary
bank may be appointed for each investment fund. Non-German
assets may, however, also be held in safekeeping on securities
accounts with non-German banks acting as sub-custodians.
The accounts of the investment fund are administered by
the depositary bank, but it is nevertheless permitted to
keep blocked accounts with other credit institutions.
Special Funds
The Investment Companies Act distinguishes between public
(mutual) funds (Publikumsfonds), the units of which may
be acquired by an indefinite number of natural persons and
legal entities, and special funds (Spezialfonds), the units
of which must be held by not more than ten unit holders,
all of which are not natural persons but institutional investors.
Special funds have numerous advantages over public funds
with respect to their establishment, as well as their reporting
and publication requirements. Unlike a public fund, a special
fund does not need to publish a prospectus, its fund rules
do not need approval by the Federal Financial Supervisory
Agency and its net asset value need not be calculated and
published on each stock exchange day.
All types of open-ended investment funds,
with the exception of old age provision investment funds,
can be established as special funds, including real estate
investment funds. Special fund investors are mostly insurance
companies, pension funds, support funds, credit institutions,
corporates and other institutional investors.
To establish a special fund, the investor,
the investment company and the depositary bank must enter
into a tripartite agreement which contains the
material terms of the cooperation and makes reference to
general and special
fund rules. In addition, the investment company and the
depositary bank often
enter into a depositary agreement. The fund rules, rather
than being approved
before the launch of the investment fund, are included in
the audit of the
financial report of the investment fund. Accordingly, a
special fund may be
established very quickly and without cumbersome procedures,
provided that
the infrastructure is already in place.
Law Change is
Timely
Many possible variations regarding real estate investments
are created for the 20 open-ended real estate funds registered
in Germany which had a high inflow of capital during the
first half of the year. On July 31, 2002, the German open-ended
real estate investment funds had assets in the value C =
66.67 billion. (July 31, 2001: 50.81 billion). The new investment
opportunities in real estate
and rights equivalent to real estate outside the European
Economic Area
are an important contribution to the developing globalization
of the real diversification of real estate funds has always
been impeded by the limitation
of the investment opportunities outside the EEA. In that
way the old legal
situation has avoided to absorb the domestic performance
by higher
profitable foreign investments during the last real estate
downturn phase,
which was a result of the parallel economic situation on
the real estate
market in the EEA. It can already be recognized that the
investment
companies use their new freedom regarding investment across
the
European borders by establishing new open-ended real estate
funds or
changing their portfolios. The chances for open-ended real
estate funds,
however, have been improved materially by the introduction
of the Fourth
Financial Markets Promotion Act.
Act Opens the
US Markets for German Mortgage Banks
Because of the Fourth Financial Markets Promotion Act there
are new business
opportunities for German Mortgage Banks (Hypothekenbanken).
German
Mortgage Banks are private credit institutions, whose business
purpose is to
lend against domestic real estate and issue bonds and notes
(mortgage
certificates) on the basis of the acquired mortgages and
to grant loans to domestic entities and public institutions
or against assumption of the full warranty by such entity
or institution (public-sector loans) and issuing bonds and
notes (public-sector bonds and notes) on the basis of the
acquired claims.
Mortgage banks may only be operated in
the legal form of a German limited
liability company (Aktiengesellschaft) and a German limited
partnership with share capital (Kommanditgesellschaft auf
Aktien). As opposed to mortgage banks, German regional banks
(Landesbanken) are public institutions. A public institution
is an asset portfolio held by a public administrative body
intended to continously serve a special purpose. Thus, regional
banks are organizationally and legally independent administrative
entities of the governments. They operate bank-related transactions
of any kind and other businesses serving their tasks in
the common interest. Due to the amendment of the German
Act on Mortgage Banks (Hypothekenbankgesetz) by the Fourth
Financial Markets Promotion Act German Mortgage Banks are
entitled to grant loans also outside the EEA in Switzerland,
the United States of America, Canada or Japan. Furthermore,
it is now also possible under specific conditions to grant
loans to properties, which are located outside the EEA in
the United States of America, Canada or Japan.
A special thanks to Christoph Wörner
for assistance with this article. Mr. Wörner holds
a degree in tax and is qualified in law in 2002. He works
as a research solicitor in the German Real Estate Department
of Linklaters Oppenhoff & Rädler in Frankfurt am
Main.
