German insurers face tougher road to PE investment

Draft German insurance rules proposed earlier this week could make it much less attractive for insurers to invest in private equity and venture capital funds.

Under current rules German insurers are able to invest in a private fund structured as a limited partnership or a similar vehicle, which pursues a business model, takes economic risks and provides its annual accounts in a certain format. These requirements are all relatively straightforward, according to a client alert from King & Wood Mallesons SJ Berwin (KWM).

However, new proposals will also require funds to have a manager located in Europe or an Organisation for Economic Co-operation and Development member state; and be either authorized under the Alternative Investment Fund Managers Directive (AIFMD) or “similarly supervised and licensed”.

Fund managers based outside of the EU may find it hard to fulfill that licensing requirement, KWM’s statement said. In addition, the fund must be closed-ended and invest only in equity shares and equity-like assets. This latter criterion may bar funds which use shareholder loans.

The rules do not create a blanket ban on funds unable to comply, but these products will be classified as “ineligible assets” which can be held under the so called “opening clause”. However, this carries significant drawbacks for the insurance company and it is possible that insurance companies will opt not to invest in this asset class at all in the future, or at least significantly reduce their exposure to it, added KWM.

A longer-term fundraising risk to private funds is Solvency II, an EU regulation that requires insurance companies to hold a greater amount of capital against investments deemed riskier than plain vanilla fixed-income or equities. Solvency II, which goes into force in 2016, also demands a boost in governance processes, reporting and transparency for insurance companies.

The German draft proposals are available for comment until June 27, 2014.