Tough times for the locusts

German regulators are currently considering several items that could impact the private equity community, both domestic and foreign.
The tax situation for private equity funds looks likely to improve, but two new regulatory proposals could have a negative impact. On the tax front, more clarity will benefit foreign funds, says Hans Stamm, a partner at Clifford Chance based in Munich. Until 2007, German investors in foreign private equity funds have in practice been subject to a high penalty tax. If these did not comply with German investment funds tax reporting. As of January 1, 2008 German law was changed such that funds which are closed ended, i.e. not granting investors any redemption rights and are not in their home jurisdiction regulated as an investment fund, are not subject to these stringent rules.
But some ambiguity remained in what was meant by “redemption rights.” In response, the German financial services regulator, BaFin, has issued a proposed circular defining redemption rights as the right to redeem shares or interest in a fund within any two year period. As this sort of redemption right is not market practice for most private equity funds and also to many private equity real estate funds, it is good news for the industry. Even better news for private equity is an explicit safe harbor for non-German funds which invest more than 20 percent of their assets in private equity.
On the regulatory front, however, there are eventually “dark clouds on the horizon,” Stamm says. As in the US and the UK, German regulatory authorities are considering increasing regulation of private equity funds. Regulators are mulling a proposal to change the German Banking Act to require that any private fund that raises money from non-institutional investors or invests in financial instruments carry a banking license. An official draft of the proposal will likely come out this fall.
“I think currently it’s very clear, were this new rule to apply to private equity funds, that it’s really a no-go, because they would need to register with the German banking authorities; they would need to establish a physical presence in the German market; they would face ongoing reporting obligations, and so on,” Stamm says.
At press time, another draft bill was circulating regarding amendments to the Foreign Trade and Payments Act that would give the Federal Ministry of Economics and Technology the right to review foreign acquisitions of stakes of 25 percent or more of the voting rights of German companies. The bill could have implications for foreign investors – particularly sovereign wealth funds – looking to buy companies in strategic sectors including energy, telecommunications, financial institutions, insurance and transportation.
But Michael Fischer, a partner at Reed Smith who specializes in German corporate law, says that the law might not have as much impact as foreign acquirers might fear. In order for the ministry to veto a deal it must demonstrate that the acquisition would present a threat to public policy or public security under a very narrow definition accepted by the European Court of Justice.
“At the end of the day there will be very, very few scenarios where investments would be prohibited,” Fischer says. “Even with this legislation Germany will still fall behind what you see in the US or France.”
He also notes that the ministry has just three months to review a transaction once it has been signed and another two months to prohibit or to limit the transaction or to issue instructions. If any parties request that the ministry review a deal it has just the two months to make a decision, after which the deal is automatically deemed valid. For transactions of sensitive nature, he recommends that the parties to the transactions initiate a potential review and notify the ministry of the transaction to bring about deal certainty.