Funds and Market Regulation (AIFMD/KAGB, MiFID II, ...) | Bundesverband Alternative Investments e.V.: Home

Key European legal sources in the area of fund and market regulation are the Undertakings for Collective Investments in Transferable Securities (UCITS Directive) and the Alternative Investment Fund Managers Directive 2.0 (AIFMD 2.0). Both directives have been implemented in German law in the German Capital Investment Code (Kapitalanlagegesetzbuch, KAGB). They are supplemented and concretized in each case on the basis of authorizations by executive legal acts of the European Commission. This applies, for example, to the further elaboration (Delegated Acts - DA) and the uniform application of the law in the member states (Implementing Acts - IA).

Publications by the European Securities and Markets Authority (ESMA) on the basis of a corresponding directive authorization or its own initiative provide application assistance, and the specifications of the German Federal Financial Supervisory Authority (BaFin) supplement the regulations or monitor implementation at national level.

The UCITS Directive concerns investment funds that invest in legally defined types of securities and other financial instruments (securities funds) and also includes product regulation, whereas the AIFMD deals with alternative investments (hedge funds, private equity, etc.) and primarily regulates the managers of these funds.

Together, these two sets of rules form the cornerstone of fund and market regulation.

In addition to the specific and direct regulation of the fund industry through AIFM Directive, UCITS Directive, ELTIF Regulation, EuVECA Regulation, and EuSEF Regulation, there are a multitude of other regulatory areas relevant to this industry, e.g. related to market infrastructure, trading and distribution activities or related services.

These include, in particular, the European financial markets directive MiFID II (together with the MiFIR Regulation), which also contains the relevant regulations on algorithmic or high frequency trading, the European market infrastructure regulation EMIR, which deals with requirements for the parties to derivative transactions, the regulation of securities financing transactions through the SFTR Regulation, the CSDR Regulation for the organisation and supervision of central securities depositories, or of course the European short selling regulation, which came back into focus in the Corona crisis and was subsequently adapted accordingly.

Lamfalussy procedure for legislation

EU legislation in the area of financial and securities market legislation, including investment law, is carried out in the so-called Lamfalussy procedure, named after Alexandre Lamfalussy, and is intended to facilitate and accelerate legislation. The procedure has 4 stages:

Stage 1: Basic directives and regulations are adopted by the Council and the European Parliament.
Stage 2: The technical details are defined in the form of implementing directives and regulations in so-called comitology committees (experts from the EU Commission and the member states).
Stage 3: The national supervisory authorities develop common standards and guidelines for uniform material implementation.
Stage 4: The Commission reviews the implementation of the directives on the basis of comprehensive reports, which the member states are obliged to submit.

The AIFMD regulates managers of alternative investment funds and serves as the EU framework directive, supplemented by the important AIFMD Level II Regulation (Commission Delegated Regulation (EU) No. 231/2013 regarding exemptions, operating conditions, depositaries, leverage, transparency, and supervision).

The directive regulates managers of alternative investment funds that are not covered by the UCITS Directive. It applies to managers based in the EU as well as third-country managers who wish to market their funds within the EU. In Germany, the directive has been transposed into national law through the KAGB.

AIFMD-Review:

The AIFMD underwent a comprehensive review as provided in Article 69 of the directive.

The result of this review process was the amending directive to the AIFMD, known as AIFMD 2.0. It represents a comprehensive revision of the original AIFMD directive and the updated EU legal framework, containing several clear changes compared to the first directive.

Liquidity Management:

AIFMs are now required to demonstrate an appropriate liquidity management system to national supervisory authorities. Open-ended AIFs must implement at least two suitable "LMTs" (liquidity management tools) as outlined in Annex V of the directive. These risk management procedures are designed to ensure an adequate response to liquidity risks and are therefore subject to regular scenario analysis and detailed reporting obligations regarding the results of these analyses to both supervisory authorities and investors. These adjustments aim to enhance the stability of EU financial systems and improve investor protection by enabling AIFMs to better respond to market conditions and redemptions.

Lending by AIFs:

AIFMD 2.0 aims to open up additional financing opportunities for EU-based companies, particularly benefiting those unable to access traditional forms of financing. A key part of this concept includes the changes and associated requirements for AIFs that engage in lending, along with an effort to achieve EU-wide harmonization of these regulations. The goal is to increase the availability of financial resources for EU companies while ensuring enhanced investor protection through limits, specific procedures, and the aforementioned LMTs. For example, AIFMD 2.0 restricts an AIF’s ability to leverage depending on its organizational form, prohibits an "originate-to-distribute" strategy, and bars lending in cases of conflicts of interest, such as prohibiting loans to entities where there is a conflict of interest. Member states have the option to impose stricter regulations ("gold-plating") or to restrict or prohibit lending to consumers.

Depositories and Reporting Requirements:

Following the implementation of AIFMD 2.0, AIFs will be allowed to use depositories located in a different EU member state than the AIF itself. This aims to mitigate the cost risks arising from inefficient processes in EU countries with smaller financial markets, thereby enhancing intra-European competitiveness. However, this privilege comes with extensive and challenging requirements. The affected AIF and all associated entities must provide comprehensive disclosures to both their investors and the national central banks of the individual member states where the AIF is registered.

Additionally, technical and organizational aspects have been adjusted. For example, at least two natural persons who manage an AIFM’s operations full-time must reside in the EU, or for AIFs distributed to retail investors, one member of the AIF’s management must be non-executive and independent. ESG requirements have also been incorporated, which integrate with and refer to the existing SFDR requirements. This means AIFMs must consider sustainability criteria and document them in the relevant guidelines.

AIFMD 2.0 came into effect on April 15, 2024. Transposition into national law in Germany is still pending but must be completed by the legislature within 24 months.

AIFMD 2.0 AIFMD Level II Regulation and list of other executive acts ESMA info page BaFin info page

With the ELTIF, EuVECA, and EuSEF regulations, specific legal acts for particular types of fund products (so-called product-regulated EU-AIFs) were created, which apply directly. These include the European Long-Term Investment Funds (ELTIF), the European Venture Capital Funds (EuVECA), and the European Social Entrepreneurship Funds (EuSEF).

For ELTIFs, ESMA maintains an up-to-date register: ELTIF register

ELTIF 2.0:

The European Commission launched the consultation for the ELTIF review in the fall of 2020.

On January 10, 2024, the changes finally came into effect in the form of the so-called ELTIF 2.0 regulation. Specifically, the need for amendments in areas such as previous participation barriers for retail investors, restrictive requirements on investable assets and their diversification, the lack of relief for funds with institutional investors, and the prohibition of master-feeder structures were addressed. These innovations aim to make the previously rarely issued ELTIF more attractive.

The key changes can be summarized as follows:

Expansion of the range of eligible assets for ELTIFs to include securitizations (debt securities, loans, mortgages), financial institutions, tangible assets without a minimum value, and clarification regarding the permissibility of investments in Green Bonds.
Introduction of the use of fund-of-funds strategies, including master-feeder structures, allowing ELTIF investments in other ELTIFs, EuVECA, EuSEF, UCITS, and EU-AIFs with permitted investment objectives under the ELTIF regulation; reduction of minimum requirements regarding shareholdings in subsidiaries.
Enhancement of the information accessible through the public central register on ELTIFs.
Increase in the market capitalization requirements for portfolio companies to €1.5 billion (previously €500 million).
Removal of restrictions on co-investments by ELTIF managers.
Lowering the minimum investment threshold in eligible assets to 55% of capital (previously 70%).
Reduction or complete removal of diversification requirements for ELTIFs marketed exclusively to professional investors.
Introduction of the possibility of using increased leverage: for retail investors up to 50% of net asset value, for ELTIFs marketed solely to professional investors up to 100% (previously 30% for both).
Facilitation of share redemptions from ELTIFs to promote a secondary market, with ESMA developing Regulatory Technical Standards (RTS) for this purpose.
Abolition of liquidation upon investor request in case of failure to establish redemption conditions.
Removal of suitability assessment for retail investors from the ELTIF regulation, with MiFID II suitability assessment required instead.
Elimination of investment volume requirements for retail investors (previously a minimum of €10,000 but a maximum of 10% of the investment assets).
Removal of the requirement for "suitable investment advice" and the operation of local facilities.

ELTIF 2.0 regulation EuVECA regulation EuSEF regulation ELTIF regulation: overview delegated acts ELTIF 2.0: Regulatory technical standards BaFin FAQs on ELTIF 2.0

The UCITS Directive (Council Directive 85/611/EEC of 20 December 1985 on the coordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities) defines specific requirements for funds and their management companies.

The UCITS Directive also concerns product regulation. One focus here is the regulation of the permissible assets in which investments may be made. Detailed regulations on this subject are contained in the EU Commission's implementing Directive 2007/16/EC (the so-called Eligible Assets Directive). Changes such as the simplification of the notification procedure for cross-border distribution, the enabling of cross-border fund mergers and the introduction of a new concept of investor information with the basic information sheets (BIB), which replaced the previous simplified sales prospectus, led to a recast of the UCITS Directive as UCITS V Directive 2009/65/EC.

The UCITS Directive and its developments have been supplemented and expanded over the past few years through several updates. Some of the changes introduced by AIFMD 2.0 were also implemented in the UCITS Directive to harmonize the regulatory framework and facilitate the management of funds that encompass both UCITS and AIFs. For example, UCITS management companies are now required to select and incorporate detailed Liquidity Management Tools (“LMTs”) into their constitutional documents. This is intended to ensure that the funds are adequately prepared for liquidity risks and can effectively manage their redemption requirements.

Most recently, in May 2024, ESMA launched a consultation aimed at improving the directive concerning eligible assets (“Eligible Assets Directive”) and its clarity and consistency with other EU legal frameworks.

UCITS Directive Implementing Directive 2010/43/EU Implementing Directive 2010/44/EU Eligible Assets Directive ESMA info page

The contents of European directives are only applied in accordance with national transposition laws. The German Capital Investment Code (KAGB) can make use of the national leeway by defining some regulations more strictly than prescribed by the directive (so-called gold plating).

The new reporting obligations and disclosure standards introduced by the Sustainable Finance Disclosure Regulation (SFDR) and the requirements of the EU Taxonomy Regulation, which the German legislator has incorporated into the KAGB, are of particular importance and also an example of gold plating. Under certain conditions, financial market participants must now provide detailed information and disclose the sustainability features of their products and Principal Adverse Impacts (“PAIs”) in an annual statement. A special feature of this in Germany is that the reports must also be prepared by an auditor.

The German legislator will also have to implement the AIFMD 2.0. To this end, it is planned to enact the Fund Market Strengthening Act: (Draft Fund Market Strengthening Act, as of August 2024).

As a codification of all German investment law, the KAGB not only regulates AIFMs, but also contains provisions for UCITS and also regulates numerous types of AIF funds. The KAGB is fleshed out by executive acts/ordinances issued by the Federal Ministry of Finance (BMF) and the Federal Financial Supervisory Authority (BaFin). As a rule, BaFin issues the ordinances instead of the BMF, which actually issues the ordinances, based on the Ordinance on the Delegation of Powers to Issue Ordinances to BaFin. BaFin also provides insights into its current administrative practice through publications.

The following chart provides an overview of the KAGB's system and fund categories:

KAGB Derivative Ordinance Capital Investment Audit Reports Ordinance Investment Accounting and Valuation Ordinance Investment Conduct and Organization Ordinance Ordinance on the electronic notification procedure

Guidances Notices Circulars Interpretation decisions FAQs

Short sales

The EU introduced the Short Selling Regulation in order to harmonize the various measures taken by member states with regard to the risk to the market from short selling.
The reporting threshold of 0.1% of the issued share capital set during the coronavirus crisis expired on March 19, 2021. With Delegated Regulation (EU) No. 2022/27, this reporting threshold was permanently introduced from 31.01.2022 on the recommendation of ESMA with the amendment of Art. 5 of the EU Short Selling Regulation.

EU Regulation on short selling Leerverkaufs-Anzeigeverordnung (LAnzV) ESMA page on short selling BaFin FAQ on short selling

Algorithmic trading and high frequency trading

Algorithmic trading and high-frequency trading refer to trading in financial instruments using automatic computer algorithms with no or limited human intervention. Such trading systems are subject to special regulations in order to ensure their security and resilience as well as monitoring and thus to limit the risks they pose to the orderly market, for example through erroneous orders. In MiFID II, Art. 4 in Para. 39f and Art. 17 concern algorithmic trading.

MiFID II was implemented in this respect in the KWG, BörsG and WpHG.

Art. 4 MiFID II Art. 17 MiFID II BaFin FAQ on algorithmic trading and high frequency trading

EMIR

EMIR subjects standardized OTC derivatives to a clearing obligation in order to ensure transparency and thus monitoring and security of the market. As an exception, intragroup transactions in particular may not be subject to the clearing obligation.

In Germany, the WpHG has been adapted to EMIR.

Regulation ESMA info page

SFTR

The SFTR builds on the EMIR concept and creates transparency in the area of securities financing transactions through notification and reporting obligations to monitor risk and combat shadow banking.

The German legislator has largely incorporated the requirements of the regulation into the German Investment Code (KAGB).

Regulation ESMA info page

CSDR

In recognition of the systemic importance of central depositories for securities, the CSDR has removed obstacles to cross-border transactions through harmonization, created a register of authorized depositories and harmonized the requirements.

ESMA info page