New rules could stifle German insurance firms’ allocations

According to 2013 statistics from the German Private Equity and Venture Capital Association (BVK), insurance companies account for 13% of German private equity's overall investor base – not far behind the 15% contributed by funds-of-funds.

While the German Federal Ministry of Finance (BMF) continues to deliberate how insurance companies will be caught by Solvency II rules – which do not come into force until 2016 – the authorities are now discussing new proposals to protect insurance companies in the interim. But these new rules could have a dramatic impact on insurers' allocations to private equity.

Labelled by King & Wood Mallesons SJ Berwin (KWM) as a "short-term threat to funds", the new rules could demand that insurance companies only invest in funds managed by an OECD- or EEA-resident manager; that funds have a licence, preferably AIFMD-compliant; and that vehicles are subject to the jurisdiction of an OECD full member state and only make equity and equity-like investments.

"An environment such as this requires flexibility; if you go ‘belt and braces' then you're not going to be able to manoeuvre" - Christian Shatz, KWM

As a result, the proposal could take US funds out of the game, limiting LPs' diversification opportunities. Steve Judge, president of the Private Equity Growth Capital Council, has hit back with an open letter to the BMF in which he argues that the proposal could be doubly damaging, limiting US managers' LP base and stifling German LPs' diversification strategy.

On a local level, fund managers unable to comply could see their fund downgraded to an "ineligible asset". GPs that do not fit the proscribed rules would only be eligible to receive 5% from an insurance fund's total assets. Says Schatz: "[If the proposal goes through] this will have a dramatic impact on the market because the number of eligible funds will decrease substantially."

The national industry is regulated by the German Ordinance on the Investment of Restricted Assets of Insurance Undertakings (the Investment Ordinance or Anlageverordnung), which governs how insurance companies and retirement schemes allocate their assets. The ordinance is, in its own words, supposed to provide a "smooth transition" to the upcoming Solvency II legislation.

Straitjacket
As the proposals demand insurance companies limit their allocation to funds that only invest in equity and equity-like assets, the ruling could have a major impact on other components of the local industry. "It will become fairly difficult to find a sufficient number of funds to invest in. Typically funds also provide shareholder-like options which may not always qualify as equity-like instruments," says Christian Schatz, partner at KWM's Munich office.

Despite BMF's intentions to provide investors with appropriate protection and deliver stability to Germany's financial system following the AIFMD rulings, industry professionals have questioned the need for tougher legislation: "An environment such as this requires flexibility; if you go ‘belt and braces' then you're not going to be able to manoeuvre. These guidelines are narrowing the scope too much; all that should actually matter is returns, returns, returns," says Schatz.

But has the BMF really thought these proposals through from all angles? Schatz is unconvinced: "To start a debate on investors doesn't make sense in my eyes. It's not being looked at from an economic point of view. We've been seeing efforts by the federal government to make Germany a more attractive country for private equity investment – this just doesn't fit with the political landscape at the moment."

The good old days
There is, thankfully, a silver lining: only new investments will be affected. A "Grandfather Clause" will permit all investments made under the old rules to be kept until maturity – minimising disruption.

Fortunately, the proposed ruling has sparked debate in Germany; politicians are lobbying against the proposals, while trade body BVK has submitted counter-arguments.

The impact could prove more than just financial, though. "What a regulator always underestimates is the psychological impact – a market psychology. A year can make a difference and for a lot of people it's not just a year," says Schatz.

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