New finance ministry proposals could exclude German insurers from domestic real estate market and abolish secondary trading, Shayla Walmsley warns.

The German finance ministry's draft proposals for the regulation of investment funds will effectively abolish real estate Spezialfonds as we know them.

The 500-page Capital Investment Code (KAGB), designed to replace the 2007 Investment Act in line with the AIFMD, will effectively prohibit open-ended real estate funds. The ministerial drafters have concluded that real estate is insufficiently liquid to be an eligible asset for any but closed-end funds - despite the fact 170 Spezialfonds with €34bn in assets under management have to date thrown up not a single liquidity issue.

Permit problems
Three things are likely to happen if the German finance ministry gets its way. German insurers will pull out of their domestic real estate market, the nascent secondary market will shut down and Luxembourg will celebrate.

The first two are intertwined. Under the new rules, investors will have to seek (and be granted) permission from the fund manager to transfer their interests. That would make it impossible for insurers to invest in Spezialfonds because, under existing rules, they need to be able to transfer their interests in the fund freely.

"It's inconsistent - it will not work," says Carsten Rothbart, head of tax and finance at the German Property Federation (ZIA).

Admittedly, there is very little activity in Spezialfonds secondaries in any case. Ashley Marks, director at Jones Lang LaSalle Corporate Finance, reckons the only significant activity is coming from high net worth investors with €10m-30m to commit.  The German valuation method does not lend itself to the secondary market, he says.

There is a second problem with permissions. Although the draft KAGB would allow a transition period for managers of existing funds, managers will be prohibited from launching new-look, closed-end Spezialfonds until they obtain a licence - a process that could take anywhere between a few weeks and several months. Some law firms are advising their clients to stock up just in case.

Germany's own goal
The net impact, were the proposals to pass unaltered, would be to reverse the competition Spezialfonds offered to Luxembourg structures. A ban would return German institutional investors to the status quo ante.

"Luxembourg would be in a good position to attract German institutional investors," says Rothbart. "Luxembourg would transpose the AIFMD into Luxembourg law. It wouldn't make the mistake that Germany would of changing it."

Although he points out that Warburg-Henderson offers real estate exposure via vehicles other than Spezialfonds, management board spokesman Henning Klöppelt is puzzled by the ministerial decision to kill the golden goose.

"It would be a shame for Germany as a financial centre to end the success story of institutional real estate funds abruptly and completely unnecessarily by a thoughtless act," he says.

Principles vs pragmatism
Still, the ministry is listening - maybe. Unsurprisingly, the ZIA is not the proposals' biggest fan. But Rothbart reckons protests by it and institutional investors will result in the removal of the offending changes.

"It's only a discussion document - not a draft as such," he says, adding that, by starting the protest now, Zia will give the finance ministry a chance to implement changes.

There is some optimism within the industry that the ministry might be persuaded to substitute mandatory charges in the case of early redemption - up to 18 months after the purchase of units, for example.

But, according to Henning Starke, financial markets group partner at SJ Berwin, the optimism is not necessarily justified. He puts the odds on the finance ministry "putting pragmatism before principles" at around 50%.

"The principle - the assessment that real estate is not suitable for daily liquidity - applies to institutional funds in the same way, and the practical side - that this has never been a problem as institutional funds usually only have a single investor or a small club of investors - could be neglected," he says.

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