Significant Changes to German Investment Law - Part I: Capital Investments and Securities

On 16 July 2021, the Act to Further Strengthen Investor Protection (Gesetz zur weiteren Stärkung des Anlegerschutzes) was published in the Federal Law Gazette. The Act amends the Capital Investment Act (Vermögensanlagengesetz – VermAnlG), the Capital Investment Code (Kapitalanlagegesetzbuch – KAGB), the Securities Prospectus Act (Wertpapierprospektgesetz – WpPG) and other laws. In this first part, we will look at the changes for capital investments and securities.

1. Prohibition of blind pools in capital investments (Section 5 (2) VermAnlG)

The legislator wants to counteract the special risks inherent in blind pool investments. In the case of blind pool investments, the investment object is not yet determined when the prospectus or the information sheet is drawn up. Therefore, retail investors cannot assess the risk. Capital investments that are structured as blind pool investments may no longer be offered to retail investors in the future. This prohibition does not apply to institutional investors who have more extensive knowledge and information sources.

In the future, the specific investment object must be determined. It is not sufficient to design the capital investment in such a way that it is limited to a certain industry (so-called semi-blind pool constructions).

BaFin has already started the consultation of a leaflet on the prohibition of blind pool constructions in the Capital Investment Act (Consultation 07/2021).

A comparable prohibition is not apparent for securities. Meaning this arguably gives the possibility to make a capital investment a security sui generis through tokenisation and thus escape the prohibition. In addition, there is still room for SPACs (special purpose acquisition company) in Germany.

2. Distribution of capital investments only through intermediaries (§ 5 para. 3 VermAnlG)

In the future, the self-distribution of capital investments by the provider/issuer will also be prohibited. In such cases, there is no suitability or appropriateness test. In the future, capital investments may only be distributed by investment advisors and investment brokers according to the German Banking Act (Kreditwesengesetz – KWG) or the Investment Firm Act (Wertpapierinsitutsgesetz – WpIG) or financial investment intermediaries according to Industrial Code (Gewerbeordnung – GewO). Those intermediaries are subject to the obligation to conduct a suitability or appropriateness test.

Under the changes law, a comparable regulation for securities is not apparent, so that a capital investment that is made into a security sui generis through tokenisation will probably not be subject to this requirement.

3. Obligation to appoint a fund allocation controller (§ 5c VermAnlG)

After the market got impacted by a couple of scandals, the legislator has decided to introduce the obligation to appoint an appropriation controller for certain capital investments.

This applies to so-called other capital investments as well as to precious metal capital investments which were only introduced on 1 July 2021 by the Financial Market Integrity Strengthening Act (Finanzmarktintegritätsstärkungsgesetz), insofar as this concerns the acquisition of a (right to an) asset or the lease of an asset, or a loan-based capital investment (participatory loans, subordinated loans, profit participation rights, registered bonds, other capital investments, precious metal capital investments) in which the investor funds are passed on to a third party for the purpose of acquiring a (right to an) asset or the lease of an asset. As assets, the legislator envisages, for example, containers and trees; which have gained popularity and attention in recent years. Other assets are land together with buildings, other immovable property or even animals. It does not matter whether the issuer acquires these assets itself; the transfer of funds for this purpose to a subsidiary or special purpose vehicle (SPV) is also covered.

The controller of the use of funds is supposed to eliminate a possible transparency deficit. Therefore, he or she must be independent; there must be no connections under company law or personal relationships. Additionally, the law limits the possible persons who can be considered as controllers of the use of funds: Only lawyers, notaries, tax advisors, auditors or certified public accountants or companies formed by these professionals are permitted to apply for this function. However, the auditor appointed for the issuer is ruled out, as these functions should not be mixed. The application of funds controller can only work for an issuer for ten years; after that, the application of funds controller must be changed for new issues - ongoing issues, however, may continue to be supervised.

The law also specifies the procedure for the release of funds. The issuer must set up an account that may only be accessed jointly with the controller of the application of funds (so-called "and" account). Funds may only be released after an audit by the controller, the result of which must be sent to BaFin in a report.

The following points must be stated in this report:

a) Amount of investor funds collected,
b) Amount of investor funds invested in investment properties,
c) Amount of investor funds used for other expenses,
d) Enumeration of other expenses and description of the use of investor funds for the other expenses,
e) Enumeration and description of the investment properties already acquired or the rights thereto or the investment properties already leased; and
f) the sum of uninvested investor funds.

4. Facts subject to publication after termination of the offer (Section 11a VermAnlG)

The obligation of the issuer after the termination of the public offer of a capital investment to immediately notify BaFin and the media of any fact that directly relates to it or the capital investment issued by it and is not public knowledge, if it is likely to significantly impair the issuer's ability to fulfil its obligations to the investor, was already included in the Capital Investment Act in 2015 by the Retail Investor Protection Act. Now the legislator is adding standard examples of what facts are involved. These include in particular:

a) imminent insolvency of the issuer,
b) default in payment by the issuer to investors in investments,
c) opening of insolvency proceedings against the assets of companies against which the issuer has significant payment claims or whose insolvency may lead to the issuer's inability to pay,
d) the opening of insolvency proceedings against the assets of a member of the issuer's group of companies, if this may lead to a default in payment by the issuer to the investors or to the insolvency of the issuer,
e) default of material counterparties of the issuer.

These standard examples are not surprising. Additionally, the legislator mentions further examples in the explanatory memorandum to the law: the control of the use of funds reveals a non-scheduled use of the investor funds if this may significantly impair the issuer's ability to fulfil its obligations towards the investors. As far as the deviation from the planned use is only insignificant, it is not a fact to be published.

5. Publication of WIBs, VIBs and prospectuses

The adjustments to the Securities Prospectus Act (WpPG) are limited. In the future, BaFin will also publish the approved securities information sheets, approved sales prospectuses for capital investments and the approved capital investment information sheets on its website. These will remain publicly accessible there for 10 years. Updates and supplements will be available there, too. This new regulation is flanked by Regulation (EU) 2017/1129, which also regulates the publication of securities prospectuses by BaFin. This is intended to provide investors with better access to the relevant prospectuses and information sheets.

6. What’s next?

The Act will enter into force, with some exceptions, on 16 August 2021 (one month after its announcement). Only the provisions relating to the transmission to BaFin and the publication of sales prospectuses and information sheets (pursuant to WpPG and VermAnlG) by BaFin will not become applicable until the beginning of 2022.