The typical legal forms of investment funds used in Germany are limited partnerships, investment stock corporations and contractual funds with no legal personality of their own (Sondervermögen). The most frequently used legal form for private funds is the limited partnership, whereas retail funds, undertakings for the collective investment in transferable securities (UCITS) funds and real estate funds are more often structured as contractual funds. A key difference is that a limited partnership is transparent for German tax purposes, whereas the rules of the German Investment Tax Act apply in respect of corporate fund structures and contractual funds treating such funds as opaque entities.

The process for setting up an investment fund in Germany differs for registered sub-threshold managers and fully licensed managers of alternative investment funds. The regulation of investment funds in Germany is primarily exercised through the regulation of the respective manager, who is required to apply for a full licence or to be registered with the German supervisory authority for financial services (BaFin) under the German Investment Code (KAGB). The KAGB implements the European Alternative Investment Fund Managers Directive (AIFMD) rules into German law.

Registered Managers – Registration Process

Availability

This registration process is available to certain small or medium-sized managers only. The most important category of these small to medium-sized managers is known as a “sub-threshold manager” under the AIFMD and KAGB. In practice, most German alternative investment fund managers outside the real estate area still fall within this category.

Sub-threshold managers under the KAGB are managers with assets under management of not more than EUR500 million with no leverage at fund level, or not more than EUR100 million if there is leverage at fund level, and who manage so-called special alternative investment funds (“Special AIFs”) only. Special AIFs are AIFs whose interests or shares may only be acquired by professional investors or semi-professional investors (ie, non-retail funds).

Registration procedure

The registration process is relatively simple. It requires the submission of a registration request together with certain documents on the manager and the investment fund(s) the manager intends to manage (such as the fund’s limited partnership agreement and the manager’s articles of association). In addition, a Special AIF may not require the investors to pay in capital in excess of their respective original capital commitment.

Ongoing compliance issues

An advantage of the registration is that only a few provisions of the KAGB apply to “registered-only” managers – mainly the provisions on the registration requirements, some ongoing reporting requirements and the general supervisory powers of BaFin. However, fund-specific requirements do not apply to “registered-only” managers and their funds. In particular, the depository requirements and marketing requirements do not apply, and nor do the additional requirements of the KAGB for fully licensed managers, except that certain additional internal governance and reporting obligations apply to the extent that any debt funds are managed.

In exchange for such light regulation, “registered-only” managers do not benefit from the European marketing passport under the AIFMD. A registered manager can, however, opt to become a fully licensed manager (or upgrade to an EU European venture capital fund (EuVECA) manager). Since 2021, “registered-only” managers have been required to audit their annual financial statements. Such audit must include a review of compliance with the KAGB and German anti-money laundering law.

Fully Licensed Manager – Licensing Process

Availability

Fund managers who do not qualify for a registration or who opt to upgrade must apply for a full fund management licence with BaFin under the KAGB. A full fund management licence opens a door for managers to market funds to retail investors, and also gives access to the marketing passport under the AIFMD. Retail investors are neither professional nor semi-professional investors.

Licensing procedure

The licensing procedure is a fully fledged authorisation process with requirements equivalent to the requirements for granting permission under Article 8 of the AIFMD or Article 6 of the UCITS Directive. The licensing procedure checks requirements such as sufficient initial capital or owned funds, adequate experience of the directors, sufficiently good repute of the directors and shareholders, and organisational structure of the manager.

Ongoing issues

The licensing of the manager results in the manager being subject to the entirety of the KAGB, which entails the following in particular:

• the appointment of a depositary for the funds;
• access to setting up contractual funds;
• adherence to the corporate governance rules for funds set up as investment corporations or investment limited partnerships (so-called Investment KGs);
• adherence to the fund-related requirements of the KAGB;
• adherence to the pre-marketing and marketing rules of the KAGB;
• access to the marketing passport under the AIFMD or UCITS Directive;
• access to the managing passport under the AIFMD or UCITS Directive; and
• adherence to the reporting requirements of the KAGB.

Investors admitted to investment funds in Germany typically benefit from limited liability. As limited partners of a limited partnership, which is the most frequently used structure for alternative investment funds in Germany, their liability in relation to third parties for obligations of the fund is limited to their respective liability amount registered with the commercial register of the respective fund partnership. The liability amount is typically a small portion (ie, 0.1%) of their capital commitment or a small fixed amount. Once this portion of their capital commitment has been contributed to the alternative investment fund, their liability in relation to third parties ceases to exist.

Regarding the relationship of the investors to the alternative investment fund itself, the liability is restricted to the unpaid portion of the investor’s capital commitment. For fund structures other than limited partnerships, an even stricter limitation of liability applies. Legal opinions are commonly issued to confirm such limitation of liability.

For the usual AIFs that are marketed to non-retail investors, there is no legal requirement to issue a private placement memorandum (PPM); however, all fund managers are subject to the SFDR disclosure obligations and disclosures under Article 23 of the AIFMD must be provided if the fund is marketed under the AIFMD. In any case, a PPM is commonly produced for all AIFs to ensure that the investors are informed – completely and correctly, and in a non-misleading manner – about the respective AIF, its management, its investment strategy, the risks associated with an investment and the expected tax consequences of the investment. These disclosures are recommended in order to avoid the liability of the sponsor or managers under general prospectus liability rules.

If the fund is marketed to semi-professional investors, a key information document must be produced.

There are annual reporting requirements for managers of retail funds and managers of non-retail funds. There are also semi-annual reporting requirements for contractual funds and investment stock corporations (AG) with variable capital. The reports need to be published.

Furthermore, new notification requirements implementing Council Directive (EU) 2018/822 for cross-border tax arrangements have applied for intermediaries of funds (usually the fund manager) since 1 July 2020.

During the last two decades, alternative funds have experienced a considerable and increasing capital inflow from German institutional investors. A significant portion of the institutional investors are professional pension schemes (berufsständische Versorgungswerke), insurance companies, tax-exempt or taxable pension funds (Pensionskassen, Pensionsfonds) and, increasingly, banks. Furthermore, industrial companies can be found as investors in alternative investment funds, especially in specialised private equity or venture capital funds, which promise strategically interesting investment opportunities. Finally, public investors (öffentlich-rechtliche Geldgeber) invest in alternative funds, often motivated by reasons of broader structural economic policy. Rather than investing directly, institutional investors often invest through managed accounts set up as single or group investor funds.

Legal structures depend on investors’ specific requirements and preferences. The legal structures for private funds in which most types of investors are usually prepared to invest are limited partnerships and, particularly regarding real estate, contractual funds. However, specific structural requirements apply for certain types of investors.

For example, certain non-taxable or tax-exempt investors, including pension funds (Pensionskassen), can only invest in business-type partnerships if certain conditions and thresholds are met. Investments by investment funds intending to be treated as tax-transparent (Spezial-Investmentfonds) have to check the eligibility of investments in closed-end funds on a case-by-case basis. Generally, feasible ways exist for Spezial-Investmentfonds to invest in partnerships as well as corporate or contractual fund structures, subject to certain restrictions and thresholds.

Based on applicable product requirements, investments by Spezial-Investmentfonds via corporate funds or holding vehicles might be challenged, depending on the respective Spezial-Investmentfond’s share in such fund or holding vehicle. Statements by the Federal Ministry of Finance confirm that interests in alternative funds in general can be treated as eligible investments for Spezial-Investmentfonds if they qualify as transferable securities under the UCITS Directive.

German pension funds that are subject to German domestic insurance regulation (Solvency I investors) usually prefer investment funds that are managed by a regulated manager. Requirements regarding the provenance and regulatory status of the fund depend on the classification of the fund. For private equity funds, fund vehicles and managers that have their seats within an EU/EEA country or Organisation for Economic Co-operation and Development (OECD) member state and that have a manager regulation that is at least comparable to the regulation of a sub-threshold alternative investment fund manager (AIFM) are sufficient. For a fund to qualify as a private equity fund, it needs to be closed-ended and may only invest in certain types of corporate finance instruments. Funds with investment policies covering instruments beyond equity and equity-like instruments require special scrutiny in this respect. For all other types of funds, only EU/EEA vehicles with full-scope AIFMs with an EU/EEA seat are eligible as AIF investments.

Interests in closed-end funds held by Solvency I investors or Solvency II investors need to be transferable without the prior consent of the general partner, manager or any other investor, as long as the interests are transferred to another institutional (or other creditworthy) investor. At the same time, the fund documents might need to contain specific language clarifying that an interest can only be transferred upon the prior written consent of a trustee appointed by the investor to safeguard the investor’s assets, dedicated to covering a client’s claims against the insurer.

There are no general restrictions for investors investing in investment funds. However, certain restrictions apply to specific types of investors – eg, Solvency I investors may not invest in investment funds that directly invest in working capital or consumer credits.

German insurance companies (Solvency II investors) have certain transparency requirements due to the prudent person principle under Solvency II. Investors usually require look-through information on the basis of a standardised tripartite reporting template. Moreover, Solvency II investors are subject to capital requirements, which are determined by risks in connection with investments, among other factors. Unleveraged closed-end funds are privileged in that respect.

Due to rules implementing further Basel III rules in 2021, fund managers must also accommodate the increasing transparency requirements of the growing group of banks reaching out for investments in AIFs – eg, in order to avoid investing banks having to fully back their investments with regulatory own funds.

Last but not least, ESG concerns are on the agenda of an increasing number of investors. Some institutional investors are already subject to statutory ESG obligations – eg, pension funds have to consider ESG aspects in connection with their business organisation and risk management, and are obliged to be transparent with regard to their handling of ESG factors. Solvency II investors have to consider sustainability aspects as part of the prudent person principle.

BaFin is responsible for regulating funds and fund managers.

In Germany, the management of investment funds is regulated by the KAGB, which implements the AIFMD and the UCITS Directive. The law requires that the manager is fully licensed or registered with BaFin under the KAGB. If a fund is internally managed, then the fund itself needs a licence or registration.

For details on investment limitations and other rules applicable to alternative funds, see 2.4 Operational Requirements.

There is, in general, no registration or regulation requirement for non-local service providers such as administrators, custodians and director services providers. However, when a German manager outsources portfolio or risk management, the delegate must be authorised or registered in their home country. In addition, any delegate domiciled outside of the EU must appoint a domestic authorised agent to whom notifications and service of process can be effected by the respective German authority.

An outsourcing delegate who provides services falling under the Markets in Financial Instruments Directive (MiFID) will be subject to a licence requirement under the German Banking Act (KWG) or the recently introduced German Securities Institutions Act (WpIG) if they actively solicited the relationship with the manager (as opposed to reverse solicitation).

If German regulatory law requires a depositary for a German AIF, the depositary – or at least a branch of the depositary – must be domiciled in Germany.

EU Fund Managers

EU fund managers are allowed to perform fund management services under the AIFMD passport regime with regard to German Special AIFs. They may also use the AIFMD passport to provide other services and ancillary services (such as MiFID investment advice or discretionary individual portfolio management).

Non-EU Managers

Non-EU managers are currently not allowed to perform fund management services in Germany. This might change in the future with regard to AIFMs in those countries for which the passporting regime under the AIFMD for third-country managers will eventually become effective.

Outside of providing fund management services (eg, managed account solutions), non-EU managers may provide certain regulated services in Germany, such as investment advice or discretionary individual portfolio management. This requires either that the services are in the scope of an existing relationship with the German manager or that the relationship is established at the initiative of the German client (reverse solicitation). As an alternative, such service providers may apply to BaFin for an exemption from the German licence requirements (which is a lengthy process).

The registration procedure for a sub-threshold manager is comparatively simple and takes about one month. A full licensing procedure varies between six and 12 months, or even more. For the details on registered and fully licensed managers, see 2.1.2 Common Process for Setting Up Investment Funds.

A stricter regulation of pre-marketing activities and of the content of marketing materials has applied since the harmonised European regime for pre-marketing of alternative investment funds came into force in August 2021 (Directive (EU) 2019/1160 and the related Regulation (EU) 2019/1156)). The European marketing regime provided by the EU Directive only applies to marketing activities by, or on behalf of, EU managers.

The German Implementation Act, however, extends the EU pre-marketing rules to non-EU managers. The commencement of pre-marketing of an AIF in Germany by a German or non-German manager (except for “registered-only” managers) needs to be notified to BaFin directly or through the respective regulator of an EU manager, and any subscription by German investors within 18 months following the commencement of pre-marketing will require adherence to the formal marketing notification and, thus, precludes reverse solicitation.

Germany understands marketing activities to be any direct or indirect offering or placement of units or shares in an investment fund. Reverse solicitation is currently not regarded as marketing, but its scope is further limited due to the pre-marketing regime.

Marketing materials must be in line with the European Securities and Markets Authority (ESMA) guidelines on the fair and not misleading standard of the content of marketing materials. These guidelines mirror the rather strict rules under the MiFID regime.

For placement activities in Germany by EU “registered-only” or non-EU managers, the BaFin FAQs maintain the position that placement by a manager, in particular, takes place with regard to a fund if:

• the fund has been established (ie, first closing with investors); or
• the terms of the fund are ready to be sent for acceptance to investors.

Such FAQs also stipulate that reverse solicitation – ie, the approach of a manager by a German investor on its own initiative – will be permissible even on the basis of general advertisement activities of such manager if unrelated to particular funds.

AIFs can basically be marketed to retail and non-retail investors. However, alternative funds that are closed-end Special AIFs can only be marketed to professional and semi-professional investors. The EU EuVECA regime and the European long-term investment funds (ELTIF) regime apply to the marketing of EuVECA funds and ELTIF funds in the EU and in the EEA.

The marketing of alternative funds requires an authorisation by BaFin or at least a European marketing passport under the AIFMD, except for marketing by German sub-threshold managers.

Depending on the type of investment fund and whether retail investors are targeted, the notification process and the materials to be presented to BaFin vary.

To the extent an EU-AIFM has notified the marketing of an AIF in Germany to its local regulator, BaFin generally only reviews whether the notification and materials provided by such local regulator are complete, and marketing may already commence when such local regulator has informed the EU-AIFM of the submission to BaFin.

As explained in 2.1.4 Disclosure Requirements, there are annual reporting requirements for managers of retail funds and managers of non-retail funds. There are also semi-annual reporting requirements for contractual funds and AG with variable capital. The reports need to be published.

As explained in 2.3.1 Regulatory Regime, Germany recognises the concept of Special AIFs, which are AIFs whose interests or shares may only be acquired according to the fund documents by professional investors within the meaning of the AIFMD or by semi-professional investors. Special AIFs themselves are either subject to a lighter regulatory regime than retail funds (in the case of fully licensed managers) or are not subject to a regulatory regime at all (in the case of a German sub-threshold manager, except for debt funds).

In the authors’ experience, BaFin is generally co-operative and open to discussions. Expected timeframes can sometimes be an issue, particularly where BaFin is requested to answer questions on new issues.

BaFin regularly takes enforcement actions, with enforcement usually being a proportionate, step-by-step approach. Often, BaFin just issues a request for explanations as a warning and takes further actions only if the answers are not satisfactory.

As a starting point, retail investors are neither professional nor semi-professional investors (see 2.3.1 Regulatory Regime).

Retail funds are typically set up as UCITS funds or as so-called Public AIFs (as opposed to Special AIFs). Legal vehicles are mostly contractual-type funds (Sondervermögen) for open-end structures, and investment limited partnerships for closed-end retail funds. Corporate structures are less common in the retail sector as they are more complicated.

The choice of the vehicle is, in principle, dependent on whether an open-end fund or a closed-end fund is desired.

Arrangements and Vehicles for Open-End Funds

For open-end funds, the contractual fund and the investment corporation with variable capital structures are available. They can have different classes of units or shares, and can also establish sub-funds (umbrella structure). For open-end funds, most fund managers prefer a contractual fund to a corporation as the setting up and operation are easier.

Vehicles for Closed-End Funds

For closed-end funds, the only available vehicles for retail funds are the investment corporation with fixed capital and the closed-end investment limited partnership. Managers can only set up a closed-end fund in the form of a contractual fund for non-retail investors.

Both vehicles can issue different classes of shares or interests and establish sub-funds (umbrella structure).

The contractual fund is established by the fund manager on a contractual basis with the investor. The contractual fund is a pool of assets separated by statute and contract from the (other) assets of the fund manager. The investment guidelines for contractual funds set out the details of the contractual relationship between the fund manager and the investors, particularly the applicable investment restrictions.

Investment corporations and investment limited partnerships are basically corporations and limited partnerships, with some modifications required by investment law. They are established in accordance with the applicable procedures for establishing corporations and partnerships (with some modifications because of investment law). In addition to the articles of incorporation or the limited partnership agreement (LPA), separate investment guidelines are necessary.

The investment guidelines and marketing of retail funds need BaFin approval. BaFin also has to approve the selection of the depositary for the respective retail fund. The approvals are usually obtained in parallel with each other.

Depending on the type of fund, the process can be rather short in the case of a standardised fund product, or it can be rather lengthy and expensive in the case of a bespoke alternative asset retail fund (in particular, a closed-end fund).

As further described in 2.1.3 Limited Liability, investors admitted to investment funds in Germany benefit from limited liability.

An extensive disclosure document (prospectus) is required if an AIF is marketed to retail investors. The prospectus must contain the following minimum information, where applicable:

• general information on the investment fund;
• the investment policy of the investment fund;
• risks and investor profile;
• the manager, depositary and auditor;
• outsourcing;
• the issue, redemption and conversion of units; and
• past performance.

There are also specific minimum information requirements for the prospectus of closed-end Public AIFs.

In addition to the prospectus, so-called key investor information must also be provided. The key investor information was supplemented by the key information document (KID) in accordance with the European PRIIP (packaged retail and insurance-based investment products) Regulation.

For UCITS, Germany follows the disclosure rules of the UCITS Directive, and since 2 August 2021 has required that the UCITS prospectus informs the investors about the “facilities” established for local investors under the EU Directive on cross-border distribution of investment funds (Directive (EU) 2019/1160).

As described in 2.1.4 Disclosure Requirements, there are annual reporting requirements for managers of retail funds and managers of non-retail funds. There are also semi-annual reporting requirements for contractual funds and AG with variable capital. The reports need to be published.

Retail funds can be subscribed by retail investors as well as by professional and semi-professional investors.

For open-end funds, the contractual fund and the investment corporation with variable capital structures are available.

For closed-end funds, the only available vehicles for retail funds are the investment corporation with fixed capital and the closed-end investment limited partnership.

For details concerning operational requirements regarding retail funds, please see 3.1.1 Fund Structures and 3.1.2 Common Process for Setting Up Investment Funds.

There are only a few restrictions for investors investing in retail funds – eg, German Solvency I investors may not invest in retail open-ended real estate investment funds.

The main law governing retail funds is the KAGB, which is based on the AIFMD and the UCITS Directive and which is supplemented by German-specific rules for retail funds. In addition, several lower-level ordinances apply (the Derivative Ordinance, the Organisational and Rules of Conduct Ordinance and the Mediation Ordinance).

This set of laws is supplemented by self-regulatory standards, mainly the Rules of Good Conduct issued by the German Investment Funds Association and the Association’s sample investment guidelines.

As described in 2.3.1 Regulatory Regime, a full fund management licence opens the door for a manager to market funds to retail investors.

Please see 2.3.2 Requirements for Non-local Service Providers.

The management of a retail AIF is not permitted for non-local managers.

For UCITS, management by non-local UCITS managers is possible via the cross-border passport under the UCITS Directive.

The licensing procedure can take from six to 12 months, or sometimes longer.

The rules concerning pre-marketing only apply to AIFs, as noted in 2.3.5 Rules Concerning Pre-marketing of Alternative Funds.

Retail funds can be marketed only by the following three categories of “marketers”.

• The fund manager itself can always market its “own” funds and, if fully licensed (ie, not only registered as a sub-threshold manager), may also market investment funds of other managers.
• MiFID firms are entitled to market investment funds (provided they have a MiFID licence or passport for investment advice and the transmission or receipt of orders).
• Firms or individuals with a financial intermediary licence under the German Commerce Act (GewO) may also market retail funds. The financial intermediary licence is a non-MiFID licence and is based on the optional exemption from MiFID II stipulated in Article 3 of MiFID II. However, since 2 August 2021, these firms or individuals may no longer engage in pre-marketing on behalf of a manager.

If the retail fund is marketed by the fund manager itself, the fund manager must make the fund documents and the latest semi-annual and annual fund reports available to the prospective investor. In addition, certain ongoing publication requirements apply (such as the publication of fund documents and fund reports on the manager’s website).

For MiFID firms, Germany considers the prospective investor as the regulatory client of the MiFID firm. Accordingly, MiFID firms have to adhere to the MiFID II rules of good conduct towards the prospective investor (requiring items such as suitability or appropriateness checks). This applies in a broadly similar fashion to the above-mentioned GewO firms. The MiFID application further means that marketing materials provided by the fund manager must comply with the MiFID II requirements on marketing materials (eg, with regard to past or simulated performance). As mentioned in 2.3.6 Rules Concerning Marketing of Alternative Funds, since 2 August 2021, managers have been subject to similar requirements on the content of their marketing materials as MiFID firms.

Retail funds can be marketed to any investor in Germany (regardless of whether the investor is professional, semi-professional or retail).

The marketing of alternative funds or UCITS to retail investors requires either an authorisation by BaFin or, with respect to UCITS, a European marketing passport under the UCITS Directive.

There are annual and semi-annual reporting requirements for managers of retail funds. The reports need to be published. Furthermore, the redemption price must be published as well as any disclosures made in the home country of such manager.

In addition to as previously discussed in 2.3.10 Investor Protection Rules, civil law prospectus liability rules offer effective protection for retail investors. Basically, civil law prospectus rules impose a liability on the manager and initiator of the fund. The measuring stick is whether the prospectus is incomplete or misleading in aspects that are material for the investment decision of a typical investor.

As noted in 2.3.11 Approach of the Regulator, BaFin is generally co-operative and open to discussions.