BaFin consults on regulatory developments concerning insurers and impacts on the fund business

Publication of consultation papers

In December 2016 and in January 2017 BaFin, the German Federal Financial Supervisory Authority, published two consultation papers. Consultation 16/2016 deals with BaFin’s advice on investing the restricted assets (Sicherungsvermögen) of direct insurance companies which have to comply with the provisions applicable to minor insurance companies, of German domestic pension funds and of pension pools (KARS-new). Consultation 17/2016 deals with BaFin’s advice on using derivative financial instruments and on investing in structured products. The new consultation papers consider, for the first time, new regulatory requirements such as Solvency II and AIFMD and are intended to replace, in their respective final versions, the latest version of BaFin’s circular 4/2011 (insurance control), offering advice on investing the restricted assets of insurance companies (KARS), and affiliated circulars.

Content and scope

KARS-new outlines BaFin’s administrative practice concerning the principles of the German Insurance Company Act as well as the provisions of the German Investment Ordinance (AnlV) applicable to minor insurance companies, pension funds and pension pools. KARS has had a larger scope and has applied to all German regulated insurance companies. As already done in KARS, BaFin specifies requirements for investment management, internal investment guidelines and procedures, risk management and control procedures, asset liability management, internal audit, general investment principles, as well as the investment catalogue of the AnlV. In many respects, KARS-new is more concrete and more detailed than KARS. In particular, the requirements placed on the management board are outlined in more detail.

Principle of investment security and rating requirements

In the principle of investment security, KARS-new includes the new rating requirements. An insurance company is obliged to always conduct its own credit risk assessments, but BaFin considers it to be sufficient if such insurance company undertakes a plausibility check of the rating assessment provided by a recognized external rating agency.

Like KARS, KARS-new requires that the principle of investment security shall also apply with respect to indirect investment, which will have an impact, eg, on investing in funds. As a result, management companies will be indirectly obliged to adhere to the rating requirements of KARS-new. This means that, eg, funds may only invest in bonds which have at least an investment grade rating. No insurer may invest in funds whose investment guidelines or terms and conditions allow investing in assets with a rating below speculative grade. High-yield bonds, having at least speculative grade, are generally eligible but must be reviewed quarterly and may not exceed 5% of the restricted assets.

Investing in funds

Investment process

Inter alia, the requirements on the investment process of insurers investing in funds are new. These new requirements set forth in detail the obligations of insurers falling under the scope of KARS-new to independently carry out audits and to keep records. An insurer must request comprehensive information on the target investment. Next to the investment guidelines, eg, also supplemental agreements must be disclosed. This will apply to both non-EU and EU investment funds. In the course of its due diligence process, an insurer must also obtain company information, eg on the management board as well as on external service providers.

Investment catalogue

As far as the investment catalogue is concerned, KARS-new changes in particular the provisions on the acquisition of funds. KARS-new clarifies now that insurers may not acquire open-ended mutual real estate funds. KARS-new reflects in general the terminology of the German Capital Investment Code and differentiates in particular between UCITS and AIF. With respect to the differentiation between closed-ended and open-ended funds, KARS-new applies a different definition than the German Capital Investment Code: open-ended funds are such funds where investors have at least an annual redemption right. Compared to the German Capital Investment Code the KARS-new extends the scope of open-ended funds.

AnIV and KARS-new also set forth provisions on investing in credit funds. An investment in German special AIF, ie alternative investment funds, with fixed investment conditions which may acquire unsecuritised loan receivables is possible provided that such funds continue to meet certain requirements. These requirements are, for example, that the fund may only invest in derivatives in accordance with section 197 para 1 and 2 of the German Capital Investment Code, a distribution in kinds of assets must be excluded and the fund may only invest in precious metals up to 30% of its net asset value.

Also such funds may only invest 30% of their net asset value in unsecuritised loan receivables. An investment in credit funds which invests predominantly in loans (either by purchasing of unsecuritised loan receivakes or the direct granting of loans) is possible in accordance with section 2(1)(17) AnlV. KARS-new interprets section 2(1)(17) AnlV in such a way that it extends the opportunities to invest in funds. Provided that a fund is not covered by another provision under AnIV, section 2(1)(17) AnlV will apply. However, any investment in such funds is restricted to 7.5% of the restricted assets.

In addition, it is possible in our view that a special AIF with fixed conditions invest in a pure credit fund provided that such credit fund is eligible for the restricted assets.

In general, funds must be transparent, which will continue to be the case if the insurer is sufficiently informed on the composition of the fund within one month (special AIF), respectively three months (mutual fund) after the end of the quarter and if the blending ratio is complied with.

The consultations will end on 31 January 2017. A subsequent hearing is not intended to take place.