In the context of Alternative Investments

MA-Thesis / Master von Marco M. Sperlich

Introduction:

In light of the financial crisis, international interest in the supervision and regulation of the financial industry has increased rapidly. On 2 April 2009 the Group of Twenty (G20) leaders met in London and agreed to extend regulation and oversight to all systemically important financial institutions, instruments and markets, and included, for the first time, systemically important hedge funds.

The International Organization of Securities Commissions (IOSCO), respectively the Commission of the European Communities (CEC) already launched a wide ranging public consultation on hedge funds during the period 18 December 2008 to 31 January 2009. The consultation resulted in a final report, Hedge Funds Oversight on 22 June 2009. The final report recommend high level principles on the regulation of hedge funds, taking into account the outcome of the public consultation and the hearings hold in Madrid on 20 April 2009.

Text Sample:

Chapter 3.1, German legislation:

The InvG which reformed the investment fund industry in Germany has now been in place for more than 5 years, having been enacted on 1 January 2004.

The principal objectives of the InvG were to implement amendment Directives 2001/107/EC and 2001/108/EC of the European Parliament and of the Council of 21 January 2002 amending Council Directive 85/611/EEC of 20 December 1985 on the co-ordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities (UCITS Directive).

In relation to hedge funds the InvG should promote Germany as an investment fund market, put a stop to the exodus of investment funds to other European countries, and establish a strong and attractive regulatory regime for onshore hedge funds, regulated in the Sections 112-120 InvG.

At the beginning of 2005 there were 15 hedge funds with EUR 0.5 million total AuM. The number of hedge funds domiciled in Germany at the end of 2008 amounts to 39 with a total AuM of EUR 1.5 million (see image 4). Compared to the 2008 market wallet of EUR 1.2 billion in German public and special funds, the market share of hedge fund is less than 0.1% in Germany, which is still behind the expected EUR 50 billion market wallet of the hedge fund industry.

Hedge fund structures and rules:

Hedge funds launched and marketed in Germany are subject to supervision under the InvG and may be approved as retail or institutional funds by the Federal Financial Supervisory Authority (BaFin).

The Section 112 InvG defines funds with additional risks (single hedge funds) and Section 113 InvG funds-of-funds with additional risks (funds of hedge funds).

Single hedge funds (SHFs) adhere to the principle of risk diversification and, in all other aspects; they are not subject to any restrictions in the selection of the assets pursuant to Section 2 (4) Nos. 1 to 4 and Nos. 7 to 9 InvG. Further the contractual terms must provide at least one of the following conditions for the joint account of the investors:

- Short selling of assets and leveraging by using unrestricted borrowings or derivatives; - Investments in participations of companies which have not been admitted to a stock exchange or are not included in an organized market, will be limited to 30% of the value of the fund; - The right of investors to redeem fund units may be restricted.

It has to be noted that with respect to Section 112 (2) SHFs may not be marketed publicly but only by way of private placements (professional investors).

According to Section 113 (1) Nos. 1-2 InvG, Funds of hedge funds (FoHFs) may in principle acquire units in domestic regulated SHFs and foreign investment funds with comparable investment policies as their target funds.

With respect to SHFs, in addition to the principle of risk-spreading, the following other diversification rules apply as per Section 113 (1-5) InvG:

- Borrowing only up to the limit of 10% of the fund value (to be provided in the contractual terms of the FoHFs).

- No executions of short selling and leverage.

- Only the hedging of foreign currencies associated with the funds assets is permitted.

- No more than 20% of a FoHFs may be invested in a single target fund.

- Only up to 49% of FoHFs value can be invested in cash deposits and money market instruments.

In addition, pre-compliance checks apply to the fund managers to obtain minimum information about the target funds prior investing. For example, the purchase of foreign target funds is only permitted if the assets have been entrusted to a custodian bank for safekeeping or another comparable organization fulfils the functions of the custodian bank.

In this context I would like to add the public marketing and distribution of foreign hedge funds (FHF) based on Section 139 (1) InvG as this is as a matter of fact is subject to a notification requirement. One of the main conditions of Section 139 (2) indent 8 InvG is providing proof that the foreign investment company and the investment company are subject to effective public supervision in their domiciled country in order to protect the investors. Furthermore foreign FoHFs have to provide extensive documentation about the company and the products, too.

Similar to German SHFs the public marketing and distribution of FHFs is not permitted, which highlights the restrictive availability of hedge funds to retail investors in Germany.