Spezialfonds have been a key driver of growth for the German fund industry. Yet the scope of the current Aifmd definition, which includes Spezialfonds, represents a far-reaching problem, argues Thomas Richter, CEO of the German Investment Funds Association BVI.
There is no doubt, the German fund industry has recovered extremely well from the effects of the global economic crisis: In the first half of 2015, the industry attracted a record €109 bn in inflows and is set to double 2014 levels.
Key driver were again inflows in Spezialfonds, an investment structure which is unique to the German market.
Between January and June 2015, Spezialfonds attracted €69.9bn in inflows, as significant majority of all investments, in other words they constitute a cornerstone of the German fund industry.
Yet due to their uniqueness in the European context, Spezialfonds now face a regulatory challenge, as BVI CEO Thomas Richter explains.
Spezialfonds are funds limited exclusively to institutional investors, allowing for a more lenient regulatory framework compared to mutual funds which are also open to retail investors. Their assets tend to exceed €10bn and often just based on one investor. According to Richter, they can best be described as “a mandate in a fund wrapper.”
They are predominantly German funds and popular among German investors for a variety of reasons as Richter explains: “Firstly, investors in Spezialfonds are very often either insurances or pension funds, they tend to be conservative in their fund selection and will have to justify their decision internally. In the German context, Spezialfonds have a relatively clear-cut regulatory framework and are an investment which is generally easily justified.
Secondly, investments in Spezialfonds facilitate the accounting process as the investor just has to list the fund, instead of each individual holding.
Thirdly, there is also a fiscal incentive, capital gains from direct bond holdings are taxed timely while those realized in a fund are taxed when the fund distributes the gains or after redemption.”
Yet with the growing harmonisation of EU regulation on investment funds, Spezialfonds face a common problem. With the introduction of Aifmd, European legislators struggled to formulate a definition for alternative asset classes and facing a very complex landscape of asset classes, they choose a negative definition, encompassing “all funds which are not regulated as Ucits.”
With this broad definition investment vehicles as diverse as hedge funds, open ended real estate funds, and indeed Spezialfonds were suddenly covered by the same regulatory framework.
The problem with this broad definition is, according to Richter, that Spezialfonds might well become the pawn sacrifice of regulation, which is actually aimed at hedge funds. “After Lehman Brothers went bust, politicians pledged that no market space or vehicle could remain unregulated.
On top of that, hedge funds were widely regarded as key cause of the financial crisis. When the EU regulator proposed the current definition of alternative investments, the German government was at the time simply under too much political pressure to fight for a more balanced approach, which is why they had to grit their teeth and go for it” he explains.
“Now we are in the ironic situation that the German fund industry is suddenly the biggest provider of alternatives, because the Spezialfonds which account for €1.3trillion are counted as alternative investment funds.”
The impact of this definition has not been felt immediately. After all, Aifmd entered into force in 2011 and inflows into Spezialfonds continued to grow. But there are a number of regulatory measures which could potentially have a significant effect on Spezialfonds, including Solvency II, Mifid and the banking structure reform, which is currently discussed by FSB (Financial Stability Board), IOSCO (International Organization of Securities Commissions) and EBA (European Banking Authority).
“The banking structure reform for example aims to prevent systemically relevant banks from proprietary trading through investing in hedge funds. Because the term ‘hedge fund’ is not legally defined at the EU level , the regulator writes AIFs instead, which would create a massive problem for German banks invested in Spezialfonds” he argues.
No collateral damage has occurred yet, but it is frustrating that we have to intervene every time” says Richter.
Has the regulatory threat caused a fatigue of Spezialfonds? The latest BVI fund flow data from July show an interesting trend, for the first time in 13 months, investments in mutual funds have overtaken investments in Spezialfonds. Whether this remains a on-off or part of a long-term trend remains to be seen.