Dr Ines Hantschel, BaFin
Alternative Investment Fund Managers (AIFMs): Authorised versus registered – what should consumers know about the differences?
The German Investment Code (Kapitalanlagegesetzbuch – KAGB) implementing the EU’s Alternative Investment Fund Managers Directive (AIFMD) entered into force on 22 July 2013. Since then, two sorts of Alternative Investment Fund Managers, or AIFMs have been in operation – those authorised by BaFin and those only registered with BaFin.
Registered AIFMs must meet far fewer requirements in some areas than authorised ones. Therefore, the sales prospectus and key investor information documents for retail investment funds managed by registered AIFMs in accordance with section 2 (5) of the KAGB must clearly indicate in a visible form that these AIFMs are not authorised and therefore do not need to comply with certain requirements of the KAGB. In addition, funds that are managed by registered AIFMs may not be marketed by all sales agents, but only by investment firms that have been specially authorised by BaFin and that are subject to special supervision.
This article explains the different requirements set out in the KAGB for authorised and registered AIFMs. Consumers should be aware of these differences when deciding whether to acquire fund units.
Marketing to retail investors
Not all AIFMs are permitted to market units or shares in investment funds they manage to retail investors. This restriction applies firstly to AIFMs that exclusively manage special AIFs in accordance with section 2 (4) of the KAGB and that, apart from the requirement to register with BaFin, merely need to comply with certain reporting requirements. Secondly, it applies to AIFMs that are domiciled in other member states of the European Union, that are registered with the local supervisory authority there, and that are permitted to market their special AIFs in Germany.
Other registered AIFMs may also manage retail AIFs. Units in these funds can be acquired not only by professional and semi-professional investors, but also by retail investors.
One of the key differences between authorised and registered AIFMs from a consumer’s perspective is that the capital requirements set out in the KAGB only apply to authorised AIFMs. Only these must have initial capital of €300,000 if they are internally managed or €125,000 if they are externally managed. Depending on the volume of assets under management, BaFin can require both forms of authorised AIFM to maintain additional capital up to a maximum of €10 million. Independent of this, authorised AIFMs’ own funds must correspond to at least one quarter of their fixed annual costs at all times. Finally, they must cover professional liability risks, either by maintaining additional funds in the amount of 0.01% of the assets managed or by taking out insurance. In addition, authorised AIFMs cannot invest these own funds freely, but instead must comply with specific rules.
None of these capital requirements apply to AIFMs that are merely registered. These are only required to hold the minimum capital specified for their legal form. Investors should therefore be aware that those AIFMs may have significantly fewer recoverable assets available to satisfy liability claims.
Organisational rules and rules of conduct
Authorised AIFMs must not only maintain their own funds, but also have to meet extensive organisational requirements. For example, the rules of conduct require that they conduct their activities honestly and fairly and in the interests of investors and market integrity.
In addition, the KAGB requires authorised AIFMs to have a suitable risk management system in place, including in particular a long-term risk control function which is hierarchically and functionally separate from the operating units. The risk management system must ensure that all risks can be properly identified, measured, managed and monitored on an ongoing basis. Stress tests must also be performed regularly for this purpose. The same applies to the liquidity management system, which authorised AIFMs must establish for each open-ended investment fund they manage and for each closed-ended investment fund for which they employ leverage. This is designed to ensure that the liquidity profile of the investment fund’s investments is in line with the requirements for the redemption of units and other payment commitments.
An additional precautionary measure for authorised AIFMs is that they must appoint a depositary for each investment fund managed. The depositary holds certain assets for the investment fund in custody and reviews certain transactions made by the AIFM.
These organisational rules and rules of conduct do not apply to registered AIFMs that only manage special AIFs. However, AIFMs registered in accordance with section 2 (5) of the KAGB that manage closed-ended retail AIFs must observe them to a large extent. The only exception to this is liquidity management; in addition, the risk management requirements are lower.
The KAGB specifies that compliance by authorised AIFMs with the organisational rules and rules of conduct must be monitored on an ongoing basis. Their annual financial statements are examined by an official auditor, which submits its annual report to BaFin. If companies breach the organisational rules or the rules of conduct, BaFin may take action against them.
AIFMs that were registered in accordance with section 2 (5) of the KAGB and that manage closed-ended retail AIFs are not subject to such an annual audit. Only the annual financial statements and management reports of the funds they manage are subject to an audit in which the official auditor must also examine whether the underlying agreements – i.e. the articles of association or the partnership agreement, the fund rules and any trust agreement – have been complied with. However, they are not required to submit the corresponding audit report to BaFin.
It is true that the AIFM must publish the audited annual financial statements and the management report, submit them to the Federal Gazette and provide a copy in paper form to investors upon request. However, in contrast to authorised AIFMs and the funds they manage, continuous supervision of their business activities by BaFin is not required.
Product and marketing supervision
For reasons of investor protection, additional rules apply to funds in which retail investors may also invest. For example, only certain assets may be acquired for both open-ended and closed-ended retail investment funds. Further restrictions may arise from the fact that the law prescribes investment limits and restrictions in certain assets, on their encumbrance and on the use of leverage. Prior to marketing, BaFin conducts a separate approval procedure to assess whether the retail fund’s fund rules are designed to comply with these provisions.
Retail funds that are not undertakings for collective investment in transferable securities (UCITS), must also successfully complete a notification procedure indicating intention to commence marketing before they can be marketed in Germany. To this end, the AIFM must submit the sales prospectus and the key investor information document for the fund, among other things, to BaFin. Both of these documents must also be made available to the public and must be updated if material facts change.
As a matter of principle, these product and marketing rules only apply to retail investment funds managed by authorised AIFMs. However, in order to better protect investors, the KAGB has also extended these rules to closed-ended retail investment funds managed by registered AIFMs in accordance with section 2 (5).
Note to consumers
BaFin’s product and marketing supervision of retail funds managed by registered AIFMs in accordance with section 2 (5) of the KAGB is therefore largely the same as for the products of authorised AIFMs.
Nevertheless, consumers for whom the most comprehensive supervision of products and AIFMs possible is important should instead opt for products from authorised AIFMs. Potential investors who are not bothered by the reduced requirements for capital adequacy, the organisational rules and rules of conduct and the monitoring of registered AIFMs should thoroughly weigh up whether the potential return associated with the relevant fund product is enough to offset the lower level of supervision.
- Alternative Investment Fund Managers (AIFMs): Undertakings whose business operations focus on managing German or EU investment funds or foreign AIFs (section 17 of the KAGB).
- UCITS: Undertakings for collective investment in transferable securities. Investment funds that comply with the requirements of the European UCITS V Directive and that mainly invest in specific securities stipulated in the directive.
- AIFs: Alternative investment funds. Any investment funds that are not undertakings for collective investment in transferable securities (UCITS).
- Special AIFs: AIFs in which only professional or semi-professional investors may acquire units, but not retail investors.
- Retail AIFs: AIFs open to all investors.
- Internal/external management: The KAGB and the AIFM Directive distinguish between the investment funds themselves (AIF) and their managers. Internal management is where the manager and the fund are one and the same legal entity. External management is where the manager and the fund are legally separate entities and do not comprise the same people. Only external AIFMs are permitted to manage multiple funds.
- Open-ended/closed-ended funds: In contrast to closed-ended funds, investors in open-ended funds may redeem their units prior to the fund’s liquidation. Investors in open-ended retail investment funds must be able to redeem their units at least twice a month.
- Leverage: Any method by which an AIFM increases the exposure of an AIF by borrowing cash or securities, by leverage embedded in derivative positions, or by any other means. For example, the KAGB sets specific limits on the amount of cash that can be borrowed for the account of retail investment funds. AIFMs must regularly report to investors and to BaFin on the extent of their leverage.