New liquidity management instruments in Germany

In an effort to strengthen Germany as a fund location, the German Capital Investment Code (Kapitalanlagegesetzbuch – KAGB) has been amended as part of the German legislative package of the "Act on the Introduction of Special Provisions for the Recovery and Resolution of Central Counterparties and on the Amendment of the Securities Trading Act to the Information and Evidence Requirements pursuant to Articles 4a and 10 of Regulation (EU) No. 648/2012" (Gesetz zur Einführung von Sondervorschriften für die Sanierung und Abwicklung von zentralen Gegenparteien und zur Anpassung des Wertpapierhandelsgesetzes an die Unterrichtungs- und Nachweispflichten nach den Artikeln 4a und 10 der Verordnung (EU) Nr. 648/2012). The new rules relating to, inter alia, liquidity management instruments, such as redemption restrictions and swing pricing, entered into force on 28 March 2020. In light of Covid-19, the German Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht – BaFin) expects capital management companies (KVGs) to shortly adopt its use in their respective liquidity management systems.

Swing pricing allows for a cause-oriented burden on individual investors when subscribing or redeeming investment units. Swing pricing can either be applied as a permanent measure so that a modified NAV is used for each purchase and sale of investment units in the event of a net surplus of redemptions or issues (referred to as full swing pricing (vollständiges Swing Pricing)), or it can be activated only when a previously defined threshold of the net surplus is exceeded (referred to as partial swing pricing (teilweises Swing Pricing)). Both options are permissible, with it being at the discretion of the KVG which option (if either) it chooses.

The legislative package permits a KVG to specify redemption periods for the redemption of units of a fund in the investment rules (Anlagebedingungen). This introduces an internationally customary means of managing the liquidity of investment funds. Should the KVG make use of this liquidity management option, the redemption period

• will apply to each redemption request by the investor;
• must be integrated into the KVG's liquidity management system as a
  permanent measure; and
• must be specified in the investment rules so that investors are aware
  of it.

The determination of the redemption period is at the discretion of the KVG, which must take into account the interests and investment strategy of investors and the liquidity of the Fund's assets when exercising it in particular. However, to exclude unreasonably long redemption periods, a statutory maximum redemption period of one month is introduced, this being based on the normal liquidity of the assets permitted for the investment funds concerned and the redemption options. The assets in which UCITS and mixed investment funds are permitted to invest are generally very liquid, while real estate funds, for example, to which a one-year period applies, invest in highly illiquid assets. The maximum redemption period, though, does not apply to special-AIFs (Spezial-AIFs), as professional and semi-professional investors are deemed able to decide for themselves whether they wish to accept longer redemption periods.

The legislative package also permits KVGs to restrict redemption. Redemption restrictions (so-called redemption gates) are a common international tool for managing the liquidity of an investment fund in situations where the fund receives many redemption requests from investors in a short period of time. Gates are a temporary restriction on the redemption of investment units once a pre-determined threshold relating to redemptions for a fund has been exceeded. Once such threshold has been exceeded and the liquidity situation of the KVG does not allow for a redemption in the interest for the whole of the investors, redemption will be suspended. The maximum period for such suspension of redemption is restricted to 15 working days (Arbeitstage). The KVG must promptly inform BaFin when a redemption gate has been either activated or lifted and must promptly make available such information on its website.

A further measure in the KAGB amendment package concerns the possibility for the structuring of closed-end umbrella funds: Investment companies with fixed capital and closed investment companies will, in future, be permitted to form sub-funds. Each sub-fund requires the drawing up of fund rules and its respective approval by BaFin. The market has shown a desire for such structuring options not only for open-end funds but also for closed-end funds. This will reasonably expand the structuring options for German real asset funds and aims to eliminate disadvantages compared to other fund locations. Finally, the legislative package authorises BaFin to specify further details in an ordinance on how the audit report for KVGs is to be submitted to BaFin. This should, for example, enable submission in electronic form via BaFin’s reporting platform.