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Selling investment funds in Germany – Legal and regulatory aspects to be considered

June 2015

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© Allen & Overy 2015 The contents of this document are confidential

General Overview

With a strong economy and a thrifty population, Germany is now, more than ever, an attractive target market for fund

managers wishing to win further assets for their funds. However, despite EU legislators’ endeavours to harmonise the legal

framework for the marketing and selling of UCITS and AIF products, the rules under German law differ substantially from

those in other European countries.

The present client briefing is aimed at illustrating the different channels of distribution that may be available for the

purpose of selling your UCITS and AIF funds to German retail clients respectively (semi) professional clients. In addition,

it provides you with an overview of the legal and regulatory aspects which need to be taken into account when marketing

these products in Germany.

Non-German investment funds, be they UCITS or AIFs, can be marketed in Germany provided they have been registered

with the Federal Financial Services Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht – the BaFin).

In Chapter 1 you will find a description of what needs to be considered when passporting a UCITS or AIF fund into

Germany for marketing to retail investors respectively to semi-professional and/or professional investors in Germany.

Chapter 2 includes a description of different distribution channels which can be used in Germany, be it through a German

bank or in the form of direct selling through the Internet. Chapter 3 sets out the critical legal aspects to be considered

when negotiating distribution agreements with German banks or independent financial advisors (IFAs) and shows

different distribution structures and their impact on the particular arrangements to be made. Finally, in Chapter 4 we

explain the specific marketing rules that apply to all distribution channels, eg know-your-customer rules, cancellation

rights, etc.

Selling investment funds in Germany | June 2015

© Allen & Overy 2015 3

Contents

1. The German investment fund market 4

1.1 Marketing of UCITS funds and AIFs 4

1.2 Selling unregistered UCITS or AIFs to German investors 7

2. Distribution channels 7

2.1 Banks 7

2.2 Broker pools/independent financial advisors 9

2.3 Fund platforms 10

2.4 Funds of funds 11

2.5 Unit-linked discretionary portfolio management 12

2.6 Direct distribution through the internet 13

3. Distribution agreements 14

3.1 Parties 15

3.2 Legal status of the distributor 15

3.3 Obligations of the third-party distributor 15

3.4 Obligations of the fund or its global distributor 16

3.5 Fees/commissions 16

3.6 Liability 16

3.7 Termination 16

3.8 Applicable law/jurisdiction 16

3.9 Order flow/settlement 17

4. Marketing rules 17

4.1 Information and advisory obligations 17

4.2 Money laundering/Know-your-customer rules 17

4.3 Obligation to offer the sales documents to investors 18

4.4 Rescission rights 18

5. The Allen & Overy investment funds practice in Germany 19

6. Contact information 20

The German Allen & Overy LLP Funds team 20


4 © Allen & Overy 2015

1. The German investment fund market

Following the partial harmonisation of the investment sector in the EU and the subsequent major changes in national law

(liberalisation and deregulation of the capital markets), the German investment funds industry has over the last 30 years

seen tremendous growth. This is illustrated by a rising number of retail funds and special funds (ie, funds with investors,

all of which are typically legal, non-natural persons), rising volumes of assets under management and the establishment of

new investment companies.

Following the shock of the global financial crisis, there were positive inflows from German investors into funds in 2009

and 2010. However, especially in the second half of 2011, German private investors again deinvested from investment

funds. 2012 was a mix of periods of net inflows and net outflows, largely correlated with the ups and downs of stock

markets. In contrast, 2014 was a very successful year for new business generated by European funds, especially from

German investors. Out of EUR634 billion of new net inflows EUR123 billion, ie 19,4%, were generated from German

investors.1 Likewise, 2015 could become a very prosperous year, with retail funds registered in Germany already enjoying

the highest monthly net sales in February 2015 since January 2007, namely around EUR9,400 million.2 It is important to

note that German private investors have no reservations about investing into non-German funds. German investment funds

already account for the smallest part of investments by German private customers into newly established mutual funds –

the large majority of fund investments go to Luxembourg.

1.1 Marketing of UCITS funds and AIFs

Only UCITS funds and AIFs which have been notified to BaFin can be marketed to investors in Germany (for reverse

solicitation please see 2.2 below).

1.1.1 Notification for marketing

The German Investment Code (Kapitalanlagegesetzbuch – KAGB) provides for different notification regimes, one for

UCITS funds and several regimes for AIFs (most of which are based on the AIFMD).

1.1.2 Notification of UCITS funds

In comparison with the notification of AIFs for marketing to retail investors, the notification of UCITS funds is a fairly

simple and swift process.

(a) Nomination of a paying and information agent

As provided for under the UCITS directive, a non-German UCITS fund must make any arrangements necessary to ensure

that payments are made to its investors in Germany and that the repurchase and redemption of its units is effected in

Germany. If a non-German UCITS fund issues fund units, at least in part, as printed definitive certificates (gedruckte

Einzelurkunden), it is required to designate at least one German credit institution or German branch of a credit institution

with a registered office abroad through which the payments intended for the unit holders can be made and through which

the redemption of fund units can be processed.

In any event, a non-German UCITS fund is required to appoint an information agent through whom German unitholders

can obtain information about the UCITS fund, including its financial statements.

In practice, if a German paying agent is required, both functions are most often taken over by the same entity.

1 BVI-Statistik Summary 4/2015 of 15 April 2015. 2 BVI-Statistik Summary 4/2015 of 15 April 2015.



(b) Notification duty

A non-German UCITS must notify its home state regulator of its intention to market its units in Germany.

The notification letter, which is to be sent to the home Member State regulator who will then transmit the notification file

to BaFin, must be accompanied by:

– the latest version of the fund rules or instruments of incorporation, translated if necessary either into German or into a

language customary in the sphere of international finance (ie English);

– the latest version of the prospectus, translated if necessary either into German or into a language customary in the

sphere of international finance (ie English);

– the latest version of the key investor information document (KIID), translated into German;

– the last published annual report and any subsequent semi-annual report, translated if necessary either into German or

into a language customary in the sphere of international finance (ie English); and

– evidence of payment of the notification fee (EUR115 per fund or, if applicable, per sub-fund).

From a regulatory point of view, a UCITS fund may decide to use either English-language or German-language documents

for the German market. Only in the case of the KIID does the KAGB provide that the document must be in the German

language. If, apart from the KIID, German versions of the documents are provided, these versions are legally binding, ie

unitholders could base damages claims on an incorrect or incomplete German prospectus. In practice, BaFin will also find

it acceptable it parts of the sales documents are provided in English only (eg the reports) while other sales documents are

filed in German (eg the prospectus) as long as the KIID is provided in the German language. The same applies with regard

to shareholder announcements, which may also be in English language even if the sales documents are all provided in the

German language.

The prospectus version used for the German market, be it in English or German, must include specific information for

German unitholders as laid down by BaFin. This comprises, inter alia, information on the German paying and information

agent, information duties and the relevant information media used for providing German unitholders with information

relating to regular events (eg convening notices for an AGM) as well as particular events (eg the closure of the UCITS

fund or a change made to its investment policy).

(c) Commencement of marketing

Within ten working days following the receipt of the notification letter and its attachments listed above, the home Member

State regulator must transmit these documents to BaFin and immediately notify the UCITS fund of the transmission. Upon

receipt of this notification the UCITS fund may commence the marketing of its units in Germany.

(d) Ongoing obligations

Once the UCITS fund has been notified as above, it must comply with ongoing obligations which, inter alia, regulate the

filing of (semi-)annual reports and updated documentation and the payment of the annual notification fee, currently

EUR494 per fund or, if applicable, per sub-fund.

In addition, the UCITS fund should ensure that it meets all relevant information and publication requirements which are

imposed by the German Investment Tax Act (Investmentsteuergesetz) in order to be tax-transparent. Otherwise, German

unitholders might suffer adverse tax consequences and refrain from investing in a product which does not comply with the

necessary reporting obligations.



1.1.3 Registration of AIFs for marketing to retail investors

The registration of an AIF for marketing to retail investors in Germany is substantially different from the notification

procedure for a UCITS fund. It faces many hurdles and registration is only possible if, inter alia, the following

requirements are met:

– The AIF and its AIFM have their registered seat in the same jurisdiction, which must provide for effective public

supervision for the protection of the investors.

– The AIF and its AIFM are fully AIFMD-compliant.

– The AIFM has appointed a depositary for the safeguarding of the AIF’s assets which assumes all the functions and

duties provided for under the AIFMD.

– The AIF is comparable with a type of German AIF which is marketed to retail investors, which means that the non-

German AIF must only invest in assets eligible for this kind of German AIF and also comply with the investment limits

and restrictions provided for under the KAGB for this specific type of German AIF.

The registration of an AIF is time-consuming and costly, particularly because in most cases the fund rules and the

information document (ie sales prospectus) need to be amended to satisfy German requirements. Therefore, we generally

recommend considering other distribution mechanisms (eg repackaging through Luxembourg-based securitisation

vehicles) before starting such a cumbersome registration procedure.

1.1.4 Notification of EU-AIFs for marketing to semi-professional and/or professional investors

Unlike the registration procedure for marketing to retail investors, the notification of an EU-AIF for marketing to semi-

professional and/or professional investors in Germany is a more straightforward process if managed by an EU-AIFM. The

notification procedure provided for under the KAGB is based on Art. 32 of the AIFMD. The notification fees amount to

EUR772 per fund or, if applicable, per sub-fund.

Within this notification procedure, BaFin mainly focuses on the AIFM’s measures taken to ensure that the notified AIF is

not distributed to retail investors in Germany, either through (third party) distributors or through electronic means, eg via

the internet. In this regard, particular attention must be paid if units of such a notified AIF are bought by a portfolio

manager acting on the basis of an individual portfolio mandate. BaFin has officially confirmed that marketing to retail

investors in Germany takes place if an individual portfolio manager (ie a professional investor) subscribes to units of an

AIF on the basis of an individual portfolio management mandate with a retail investor, which subscription is considered to

be a placement of AIF units with a retail investor.

As regards semi-professional investors, these are a specific German type of investor, namely ones who fulfil certain

criteria laid down in the KAGB relating to the volume of their investments, their experience with and knowledge of the

proposed investments as well as their awareness of the risks associated with them. Investors who qualify as semi-

professional investors within the terms of the KAGB do not qualify as professional clients within the terms of MiFID. This

fact needs to be considered in practice if registering an EU-AIF for marketing to semi-professional investors in Germany,

eg if using a website which is dedicated to professional clients within the terms of MiFID for informing German semi-

professional investors of the AIF.



1.2 Selling unregistered UCITS or AIFs to German investors

According to the KAGB, the term “marketing” is defined as the direct or indirect offering or placement of fund units.3

However, no marketing is deemed to exist and, therefore, no notification/registration duty is triggered if eg (a) an

investment fund is mentioned by name only without any further information, (b) only the NAV, the prices of an

investment fund unit which are calculated on an organised market or the redemption and issue prices are indicated or

published, (c) the basis of taxation is published in accordance with § 5 of the German Investment Tax Act or (d) if

management companies fulfil their legal publication duties in the German Federal Gazette or their exclusive information

duties vis-à-vis existing investors of the respective investment fund in accordance with the KAGB.

As a general rule, with regard to semi-professional and professional investors in Germany, the KAGB provides that

marketing only occurs if the offering or placement takes place on the initiative of the management company or on behalf

of the management company. As a consequence, any subscription of a (semi-) professional investor to units of an

unregistered UCITS or unregistered AIF on a reverse solicitation basis does not qualify as marketing under the KAGB.

According to oral information from BaFin, UCITS funds and AIFs which have not been notified to the German regulator

cannot be sold on the basis of a reverse solicitation exemption to retail investors. BaFin bases this restrictive view on the

fact that the reverse solicitation exemption which derives from the marketing definition provided for in the AIFMD has

only been transposed into German law with regard to semi-professional and professional investors and that if the German

legislature had wanted to allow reverse solicitation in the case of a retail investor it would have explicitly considered this

fact in the respective provision of the KAGB. Notwithstanding this strict view, BaFin states in its official written guidance

that merely reacting to an order, ie receiving and settling a subscription order without having solicited such an order, does

not constitute marketing.

2. Distribution channels

In the following, we would like to give you an overview of the different types of channels of distribution and different

possible distribution partners, and also to give you a description of how fund shares are ordered, how these orders are

processed and settled and how the remuneration of German distributors is typically structured.

2.1 Banks

2.1.1 Background

Banks are still by far the most important category of fund distributors. The major German private banks (Deutsche Bank,

Commerzbank, HVB) all still have their own fund production firms. Equally, the co-operative banks (Volks- und

Raiffeisenbanken) own the highly successful Union Investment, and the savings banks (Sparkassen) own Deka Investment.

Nonetheless, the idea of ‘open architecture’ has taken hold in Germany, and, with the right incentives, almost all German

banks are happy to sell third-party funds through their branch offices.

2.1.2 Fund orders

Banks typically have a full banking licence, which enables them to choose whether to act as mere introducers (in MiFID

terms: receiving and transmitting orders) or as principal brokers, ie buying the fund units in their own names, but on behalf

of their customers.

3 For units subscribed to by an individual portfolio manager on behalf of its clients, please see point 1.1.4 above).



By being able to place orders in their own names, the banks enjoy a huge competitive advantage over other fund

distributors, notably IFAs (see 3.2 below). This is because investment funds only have to deal with one – solvent and

regulated – counterparty, as opposed to numerous – potentially insolvent and unknown – counterparties. Furthermore, the

banks are able to net buy and sell orders and then send one aggregate order to a fund or its transfer agent, thereby

significantly diminishing the workload for the fund or its transfer agent.4

2.1.3 Transfer agency

An investor who orders investment units through a bank will typically have a securities account with that bank, in which

the holdings are recorded. But at the level of the fund, there is just one shareholder of record, ie the bank.

This means that there is a two-fold legal relationship between the bank and the investor: on the one hand, the bank

executes the securities order; on the other, it has a continuous relationship with its account-holder. This latter relationship

is governed by the provisions of the German Custody Act.

Surprisingly, many banks are quite unaware of their obligations under the Custody Act when it comes to the safekeeping

of investment units. As a bare minimum, they must inform the transfer agent of the non-German fund that they are holding

the units only on trust for the account of their customers and that this should be marked in the shareholder register. This

statement is contained in a standard three-point declaration, which all banks are supposed to require from their transfer

agents, but which most banks do not demand.

2.1.4 Fees

For the transfer agent, having just one shareholder of record simplifies record-keeping greatly.

Generally, the bank will be allowed to order funds at net asset value, with no sales charge (Ausgabeaufschlag) being

levied. The bank will then be allowed to charge its customers its own commission, the maximum amount of which is

agreed in the distribution agreement with the fund and quite often expressed as a percentage of the order.

In the past, German funds were not allowed to charge redemption fees to their investors. While this is now legally

possible, many banks are not geared up to sell these funds, as they do not have systems that could capture the fees payable

on early redemption. We understand that so-called B-shares, which have no initial sales charge but rather a contingent

deferred sales charge, are still not being actively sold in Germany to retail investors.

Finally, the bank will require a portion of the management fee which the investment fund receives from its investors. This

‘retrocession fee’ or ‘maintenance fee’ is a classic kick-back or – in MiFID terminology – an inducement. Again, it is

amazing how German banks have in the past received these retrocession fees without worrying about disclosure to their

investors. Ever since the implementation of MiFID, the Securities Trading Act requires that investors are informed about

the payment of retrocession fees.5

4 Incidentally, there is quite often no contractual basis for this type of ‘internalisation’ effected at the bank’s level, but some banks seem to be

unconcerned by such a lack of legality. 5 Under general contract law, investors could ask their bank s to relinquish the part of the retrocession fee that relates to their fund holdings, but this

hardly ever happens.



2.2 Broker pools/independent financial advisors

2.2.1 Background

German retail investors have developed a certain preference for independent advice and access to ‘best-of-breed’ products.

Investors are demanding wider product choice and fund selection based on investment returns rather than brand names.

IFAs cater to these needs, and for some time have been able to grow their market share in fund distribution.

2.2.2 Fund orders

Most IFAs conduct their business under a licence under section 34f of the German Trade Act (Gewerbeordnung – GewO).

This licence is limited to the acceptance and transmission of customer orders to a credit or financial services institution or

the relevant investment fund. In other words, the IFA does not contract with the investment fund in its own name, but as

agent for the investor.

Consequently, where an investment fund accepts such an order directly, it bears the insolvency risk of the investor

(mitigated by delivery versus payment settlement), it needs to identify the investor for local know-your-customer rules,

and it needs to record the individual investor in its shareholder register. The investment fund should also be aware of the

cancellation rights of the investor (see Chapter 5).

A further risk may evolve from the use of the direct debiting system (Lastschriftverfahren), as the investor may, within a

certain timeframe, revoke the payment made by direct debit. As a result, the fund may issue units without having received

the purchase price.


Many investment funds are still content to accept and process such individual orders, but others prefer to deal with banks

(or fund platforms, see below) only. Where an investment fund accepts orders directly and records the investors in its

shareholder register, it should take into account that the subsequent transfer of these investors to a German custodian

(acting as a type of trustee) is virtually impossible.6

More importantly, the direct order system has significant disadvantages for customers who wish to buy funds from several

investment managers: they have to open TA accounts with several funds, they receive no consolidated reporting (unless

the IFA produces it ), and they find it much more difficult to prepare their tax returns.

The drawbacks of this business model have led many IFAs to join one or more fund platforms through which they can

route their orders (cf 3.3 below).

2.2.4 Fees

Where a fund accepts an order directly from the customer, it will charge the customer the NAV plus the initial sales

charge. The investor pays the total purchase price to the fund, typically through an account kept with the German paying

agent. The initial sales charge is then paid in whole or in part to the IFA for its introduction. This means the IFA does not

handle any money from investors, which is a precondition for its exemption from the licensing requirements under the

German Banking Act.

6 Many German investment managers (KVGs) have in the past also maintained custody accounts for their investors (not to be confused with

depositary banks, which keep the assets of funds in safe custody). KVGs increasingly feel the costs associated with the maintenance of custody

accounts, in particular IT costs. Therefore, they wish to transfer their customer accounts to specialised fund platforms, such as Ebase or Fondsdepotbank, which can run the accounts on a cost-effective basis as a result of economies of scale.



In addition, the IFAs demand a share – often quite large – of the management fee in the form of a retrocession fee.

2.3 Fund platforms

2.3.1 Background

IFAs are still an important distribution channel in Germany for foreign investment fund managers. Other German

distribution channels were previously closed to non-German funds and the establishment of proprietary operational entities

in Germany was considered difficult and expensive. However, with the use of German funds of funds and open

architecture, the German fund market has changed significantly.

Initially, banks aimed to counteract their customers’ growing interest in IFA-based services. Their answer to the growing

market share of IFAs was a (limited) open architecture. Banks first opened their doors, tentatively, to third-party products

through the use of German funds of funds. This allowed them to meet the growing demands for third party products within

their channels.

Under pressure from customers for a more extensive choice of funds, many banks widened their distribution activities by

using open architecture and opened up to third-party (non-German) products by establishing fund-platforms.

In addition, the non-German funds became more and more reluctant to accept fund orders directly from IFAs in light of the

TA requirements imposed on them (many thousands of individual investors instead of just one bank).

These developments led to the creation of fund platforms catering for the needs of IFAs and fund managers alike.

2.3.2 Structure of fund platforms/fund supermarkets7

Fund platforms are banks: they have a (limited) banking licence allowing them to render brokerage and custody services,

but not to take deposits. Many fund platforms belong to the major banks, which include Ebase (belonging to

Commerzbank), and Attrax (belonging to Union Asset Management Holding AG). Others, such as Augsburger

Aktienbank, are independent banks that have carved out the highly specialised niche in which they operate. Finally, major

fund companies such as Fidelity have established their own fund platforms.

As almost all fund platforms are banks (or at least passported investment services firms), the legal framework under which

they operate is identical to the one described for banks above.

Fund platforms enter into distribution agreements with investment funds and – unless they operate exclusively on a B2C-

basis, which is rare – they will appoint sub-distributors, primarily IFAs. The IFAs then recommend to their customers that

they open a multi-fund account with the fund platform and pass on any purchase order to the fund platform as messengers

for their customers. The fund platform then executes the trade in its own name, but on behalf of the customers, just like the

more traditional banks.

2.3.3 Fees

Fund platforms operate on the same remuneration model as the one described in 3.1.4 above. They buy units at NAV from

the funds and charge their customers, ie the end investors, a commission. In addition, they receive a retrocession fee from

the fund manager.

7 There is no structural difference between a fund platform and a fund supermarket in the way these terms are used in this briefing. The difference is

that the fund supermarket aims to offer all investment funds registered for public distribution in Germany, whereas a fund platform often has only a limited number of investment funds on offer.



Under what is often a highly complex arrangement, they share these commissions with the IFAs that have introduced

customers to the platform.8

2.4 Funds of funds

Funds of funds are back in favour – primarily for tax reasons:

If a German tax resident individual holds fund shares directly, no matter how long the investor holds the shares, there is a

taxation charge on the capital gains at a flat rate of 25%, the so-called Abgeltungssteuer. Consequently, a German tax

resident investor who holds a portfolio of different investment fund units will be taxed whenever he switches from one

fund to another.

If the switch is done within one fund of funds, however, the capital gains received at fund of funds level will be tax free for

so long as they are not distributed.

Consequently, banks and portfolio managers have created hundreds of new funds of funds with German investment

managers (Kapitalverwaltungsgesellschaft – KVG) and advised their clients to gradually switch their fund holdings into

such funds of funds.

2.4.1 Fund orders

The KVG which manages the fund of funds orders the fund units of the target fund in its own name for the joint account of

the unit holders.9 This means that the counterparty is not the fund of funds (which has no legal personality, but is the

equivalent of a Luxembourg FCP), but the licensed German management company (KVG).


The transfer agent of the target fund will have to record only one shareholder of record, ie the KVG. To ensure that the

KVG’s depositary always has complete control over the fund of funds’ assets, the account with the transfer agent must be

established in the name of the depositary, not in the name of the KVG.

2.4.3 Fees

The KVG purchases units of the target fund either at NAV or by paying a sales charge, which it can then charge to the

fund of funds as third-party costs.10

As a matter of strict law, the KVG must credit the fund of funds with all retrocession fees which it receives from the target

fund’s manager. This at least is the view of the BaFin, and most KVGs comply with this requirement.

8 There has been a rather marked consolidation among fund platforms. This is because a typical transaction nowadays involves far too many parties

wanting to receive a share of the - limited - commissions: the IFA, its pool organisation, the fund platform, possibly another clearing entity, and the

fund itself. Only by way of a consolidation will the remaining platforms be able to generate such volumes of business that even the small percentage of the commission which they receive for each trade will add up to sufficient income to maintain the costly infrastructure.

9 Technically speaking, the order is given in the KVG’s name but it acts for the joint account of all unitholders in the fund of funds. 10 It appears questionable why a KVG that does order units of a fund directly from the fund or its global distributor should pay any sales charges, as

these sales charges are meant to cover the costs for third-party distributors. However, this is not uncommon in German practice.



2.5 Unit-linked discretionary portfolio management

2.5.1 Background

Before the introduction of funds of funds, any investor wanting ‘best-of-breed’ investment funds, but with little knowledge

of which funds to choose, only had the option of retaining the services of a portfolio manager specialising in fund picking.

Initially, with the arrival of funds of funds, the importance of unit-linked discretionary portfolio management declined. But

there are now, also driven by the aforementioned Abgeltungssteuer, many portfolio managers who offer this type of

service, some for very wealthy individuals, so it may be worth devoting some attention to this particular distribution

channel.

A portfolio manager qualifies as a financial services institution (investment services firm) and thus requires a portfolio

management licence under the German Banking Act. While it is questionable as to whether the portfolio manager also

requires a licence for contract brokerage (Abschlussvermittlung) to conduct its business, most portfolio managers have

such a licence in any event.

As contract broker, a portfolio manager receives a power of attorney from his customer to manage all or part of the

customer’s assets and to make dispositions over the customer’s accounts with third-party banks. The portfolio manager

itself does not keep accounts for its customers, but merely manages accounts with other banks or funds.

2.5.2 Fund orders

The portfolio manager gives instructions not in its own name, but in the name and on behalf of its customers.


Where the customer’s fund custody account is held with a bank, the bank then purchases the fund units in the manner

described in 3.1above. Here, the portfolio manager will typically not have a distribution agreement with the fund itself, and

the fund may not even be aware of the portfolio manager’s involvement, treating the order as just another order received

from a bank.

But there are also portfolio managers who order fund units directly from the investment fund and in that respect they are

similar to IFAs.11

Under these circumstances they will often have their own distribution agreements in place with a fund.

2.5.4 Fees

The best portfolio managers receive a portfolio management fee from their customers (‘fee-based advisory and

management’).

But many portfolio managers will - either in addition to such fees received from their customers or as their sole source of

income – require sales charges and retrocession fees from the investment funds they order on behalf of their customers.

2.5.5 Disclosure of conflicts of interest

In this context, it is very important that the portfolio manager informs his customer clearly and expressly that he receives

fees from the fund, thereby disclosing the potential conflict of interest. This is important not only for the portfolio manager

himself, but also for the fund, for the following reason:

11 The difference between a typical IFA and a typical portfolio manager is that the IFA merely transmits orders as agent, whereas the portfolio manager

gives the order, albeit in the name of his customer.



Several courts have had to decide cases where a bank maintained a custody account for a customer and executed his

securities orders as a principal broker. These orders were given by the customer’s portfolio manager under a power of

attorney. The portfolio manager did not disclose to the customer that he received a kick-back of the brokerage

commissions. On learning of this arrangement, the customer sued the bank and required compensation for all losses

sustained in the course of his securities transactions; not only commissions, but also losses through adverse market

movements and the average interest he theoretically would have received if the monies had been invested in investment-

grade bonds. He argued that he would never have instructed the portfolio manager had he known that the bank “colluded”

with the portfolio manager. The German courts held that the bank must indemnify the customer for all his losses, including

market losses and deemed interest.

In 2006, the German Federal Court of Appeals (Bundesgerichtshof – BGH) held that the same reasoning applies to funds

paying retrocession fees to financial intermediaries.

Investment funds should therefore not only impose disclosure obligations on the portfolio manager in their distribution

agreements, but also ensure, through some form of due diligence, that this disclosure actually takes place. Otherwise, the

funds may find themselves in a situation where they have to compensate customers for all of their losses, including a

deemed loss of return on a less risky investment.

2.6 Direct distribution through the internet

Conditions under which a distribution through the internet qualifies as marketing

The KAGB prohibits a non-German investment fund from marketing its units in Germany without prior notification to the

BaFin (see above). In an announcement of 2 June 1998, the BaFin set out the conditions under which an offer on the

internet qualified as a marketing of investment units in Germany and thus required the notification of the relevant

investment fund prior to its distribution through the internet. In the absence of contrary guidance received from the BaFin,

one may assume that the following principles laid down in the announcement still apply for assessing if there is a

marketing of funds via the internet which requires notification of the respective funds to the BaFin:

– internet sites in a foreign language that are clearly not directed towards German investors (for example, those that do

not mention any German addresses or special information or disclaimers) are not considered to constitute marketing or

advertising in Germany;

– internet sites in German will in general be considered to constitute marketing in Germany. Exceptions may be possible

for sites clearly directed only towards investors in other German-speaking countries.

– unsolicited emails to recipients in Germany will be considered to constitute marketing in Germany, even if the email,

because of its language and content, appears not to be meant for German investors. If the email is sent to a bulletin

board/newsgroup it would be necessary to look at the content of the mail and the target group of the board/newsgroup.

2.6.1 Licence requirements when distributing through the internet

In the context of distributing funds through the internet, it is important to know that, according to a circular from the BaFin

published on 16 September 2003 and revised on 1 April 2005, any non-EU entity providing cross-border financial services

which is actively soliciting German clients requires a licence.

Before September 2003, the BaFin officially took the view that providing financial services to German investors in

Germany exclusively through the internet without a physical presence in Germany did not trigger a German licence

requirement. The BaFin has since taken the view that non-EU market participants who intend to market their services in

Germany are required either to incorporate a subsidiary in Germany and apply for a banking or financial services licence



or to establish a branch in Germany. In contrast, service providers domiciled in the EU may use their EU passport and may

either establish a branch or provide the relevant services on a cross-border basis without having a physical presence in

Germany. Consequently, a distribution of fund units through the internet would automatically qualify as the provision of

cross-border financial services and would thus require a licence.

The legal consequences of acting without a licence differ from the consequences associated with the marketing of non-

registered fund units in Germany. The conduct of banking business or the provision of financial services without the

necessary German banking or financial services licence is a criminal offence (and could lead to a fine or, in theory, even

imprisonment), whereas the marketing of fund units in Germany without having registered the fund qualifies as an

administrative offence and may only be subject to a fine.

While this circular clearly indicates, however, that where a non-German service provider is approached by a German

resident or entity (ie, the business relationship is established on the initiative of the German customer) to provide banking

or financial services, no banking or financial services licence is required, for the purpose of the KAGB this concept of

reverse solicitation only applies in the narrow exceptions set out under point 2.2 above.

3. Distribution agreements

Negotiating distribution agreements with German third-party distributors can be a time-consuming, frustrating and costly

exercise. In most cases, it is not a commercial issue that delays the signing, such as fees, but misconceptions about German

law and the way funds are being ordered.

International investment managers who have experience of selling funds in their home jurisdictions often wish to use their

own standard distribution agreement for Germany as well. The biggest mistake they make is to use the ‘one size fits all’

approach, neglecting the fact that it is virtually impossible to use an agreement drafted for use by banks (which order funds

in their own name, do not receive a sales charge from the fund and maintain customer accounts) for IFAs (who merely

pass on orders, receive a sales charge and maintain no customer accounts) too. Add to this the complexity of dealing with

funds of funds, or insurance companies that wish to wrap funds into an insurance wrapper, and you realise that several

standard agreements are required to cover every conceivable situation.

But is it necessary to have your own standard agreements? Why not just rely on your counterparty, using its standard

agreement? This approach has its merits, and, when dealing with the likes of Commerzbank, which has huge distribution

power, your firm may actually be required to use the other counterparty’s agreement, anyway.

However, even a few of the bigger banks or platforms use very badly drafted agreements, which are one-sided, inaccurate

or plain wrong (for example, most standard agreements do not bother to mention the fact that the fund in question is not a

German fund, but a non-German UCITS, leading to all sorts of implications). Standard distribution agreements used by

smaller institutions are occasionally completely unsuitable.

Even though this entails incurring some costs, it may therefore be advisable to have your own standard agreements,

covering initially perhaps banks (including fund platforms) and IFAs. The agreements should be in bilingual form (English

and German), so that changes can be reviewed by your English-speaking legal or compliance department and your German

counterparty alike.

In the following paragraphs, we describe the basic necessary content of a standard distribution agreement, covering in

particular those sections that differ from one type of distributor to another.



3.1 Parties

Although this appears to be the easiest part, in practice it is often the most difficult to negotiate.

On your own side, it will often not be the fund itself, but a (global) distribution company. This company, when based

outside Germany, can act either on a cross-border basis or through a German branch office. Legally, there are no

differences, but you should know that it can take many months of dealing with the bureaucratic requirements before a

branch office can be established.

Moving on to your counterparty, bigger banks often insist that they enter into the agreement not only in their own name,

but also on behalf of – disclosed or as yet undisclosed – group companies. This approach entails the risk that your fund

units end up being distributed in a country where they should not be distributed, for whatever reason, and careful wording

is required to reduce this risk.

In addition, you may already have a distribution agreement with, for example, Deutsche XYZ Bank Switzerland, but not

its head office. Statements such as ‘all previous agreements are hereby terminated’ are of little use if you cannot be sure

that the Swiss entity has consented to such termination.

3.2 Legal status of the distributor

At the outset, the agreement should expressly state what regulatory status the third-party distributor has (eg a bank, an IFA

with a trading licence, or an insurance company).

It is possible to stipulate within the agreement the way in which fund units are ordered and how orders are settled, but we

think that the agreement is more transparent if these issues are covered in an annex.

It is common practice to state that the distributor is not authorised to represent the fund or its global distributor and that it

is consequently not a permanent establishment for tax purposes.

In addition, the third-party distributor very often retains the right to appoint sub-distributors. If the agreement contains no

further provisions on liability, the third-party distributor will, under civil law principles, be liable for its sub-distributors’

acts and omissions just as it is for its own. For this reason we do not recommend raising this issue as it could be interpreted

by the distributor as an invitation to limit its liability by including express references on liability in the agreement.

3.3 Obligations of the third-party distributor

Good distribution agreements set a framework in which a third-party distributor can operate. This includes the use of

marketing material prepared by the distributor, the protection of intellectual property rights, proper data protection, etc.

The third-party distributor should commit itself to providing the sales prospectus and financial reports to investors prior to

subscription and to informing investors about investment risks in compliance with the German Securities Trading Act

(Wertpapierhandelsgesetz – WpHG).

Also, the third-party distributor must abide by the selling restrictions set out in the prospectus.12

12 Typically sales prospectuses contain selling restrictions, in particular covering the prohibition to sell investment funds in the U.S. Rather than

repeating these selling restrictions in the distribution agreement, the restrictions set out in the prospectus, as amended, should just be referred to in the agreement.



3.4 Obligations of the fund or its global distributor

This section of the distribution agreement generally contains provisions such as:

– a duty to provide prospectuses and other documents in sufficient numbers (free of charge);

– a duty to provide the distributor with financial data on the fund, such as issue and redemption prices, in a prescribed

format;

– a duty to support the marketing activities of the distributor, eg through training; and

– a prohibition on poaching customers or sub-distributors of the distributor.

3.5 Fees/commissions

Again, rather than setting out complex fee arrangements in the main body of the agreement, we recommend that they be

put in an annex. This also allows changes to be made much more easily.

German third-party distributors will generally agree to quarterly payment of fees or commissions, and they are familiar

with using three-month averages as a basis for the calculation of fees.

Typically, German distributors will ask for the continuing payment of retrocession fees after the termination of the

agreement (on average, for a further three years following termination of the agreement).

3.6 Liability

The German provisions on liability set out in the German Civil Code (Bürgerliches Gesetzbuch – BGB) are sufficient to

protect the interests of the investment fund, and no further language on liability is required.

The third-party distributor may wish to limit its liability. However, in practice it might be difficult to limit the distributor’s

liability for German civil law reasons. Likewise, it is hardly possible for the investment fund to eg limit its liability vis-à-

vis the distributor for the correctness and completeness of the sales prospectus.

3.7 Termination

Many distribution agreements are entered into for a fixed period. However, every agreement can be terminated for cause

during the term of the agreement. Cause exists where it would create undue hardship for one party to continue to be bound

by the agreement.

But even where an agreement is terminated for cause, fee or commission claims that have arisen during the term of the

agreement remain payable (although such claims may be set off against counterclaims for damages, etc).

3.8 Applicable law/jurisdiction

In our experience, none of the important third-party distributors will agree to any law other than German law to govern the

agreement.13

Likewise, all distributors will insist that German courts have at least non-exclusive jurisdiction over any and

all claims arising out of the agreement. Arbitration clauses are not used in fund distribution agreements.

13 One important exception is Attrax, the co-operative banks’ platform, whose standard agreement is governed by Luxembourg law.



3.9 Order flow/settlement

For each distribution channel there are different ways of processing orders and settling the trades. In an annex to the

distribution agreement, the parties should describe in great detail how the orders are processed and settled, including:

– the legal capacity in which the funds are ordered (as principal or agent);

– payment details;

– cut-off times;

– the use of clearing agents, such as Clearstream; and

– confirmations required by the transfer agent or the fund’s depositary bank.

4. Marketing rules

4.1 Information and advisory obligations

Investment funds inform their retail investors about the risks associated with an investment in their prospectuses. But even

if the investor receives a copy of the prospectus prior to posting his order, this is not sufficient: the third-party distributor

of the funds must also inform and possibly advise the investor about the risks associated with the investment.

This duty to inform and advise investors follows from section 31 of the Securities Trading Act, which is the German law

provision implementing Article 19 of MiFID. This provision applies to so-called investment services firms, generally

speaking all banks, fund platforms and investment brokers licensed under the German Banking Act.14

However, it does not

directly apply to non-German investment funds.

4.2 Money laundering/Know-your-customer rules

Following 11 September 2001, there has been a marked increase in the awareness of both the authorities and the

banks/asset managers of money laundering risks. This section sets out the rules to be taken into account by non-German

asset managers who wish to sell their fund products to German customers.

In Germany, anti-money laundering obligations are mainly based on two pieces of legislation.

Under section 261 of the German Criminal Code (Strafgesetzbuch – StGB), any person who either:

– wilfully or recklessly hides or conceals the origin of property deriving from a crime, in particular, drug dealing, fraud,

embezzlement or corruption; or

– obstructs or prevents the discovery or confiscation of such property, or an investigation into its origin,

may be punished by a fine or imprisonment for a term of up to five years. The same applies to any person who wilfully or

recklessly takes such property for himself, or who procures such property for a third party, or who deposits or makes use

of it for himself or for a third party, if he has knowledge of its origin.

The second important part of the money laundering legislation in Germany consists of the German Act on the Detection of

Proceeds from Serious Crimes, the so-called ‘Money Laundering Act’ (Geldwäschegesetz – GwG), which implements the

Third Money Laundering Directive (2005/60/EC).

14 IFAs with a mere licence under the GewO are not investment services firms and are therefore not directly covered by this provision. However, banks

and fund platforms either delegate their information and advisory duties under the Securities Trading Act to the IFAs, or rely on the IFAs to inform their customers in line with the provisions of the Securities Trading Act in order to avoid civil law liability.



The GwG imposes extensive identification and reporting duties on German credit institutions, financial services

institutions and insurance companies. Compliance with duties arising out of the GwG is supervised by the BaFin. The

GwG does not apply to non-German investment funds distributing their units to German investors.

However, the GwG has an indirect impact on non-German investment funds insofar as they can be sure that all of their

investors are examined and identified by their distributors, provided these distributors qualify as credit or financial services

institutions. Where the distributor is an IFA with a mere licence under the GewO and introduces investors directly to the

fund, however, no statutory customer identification will have taken place in Germany.

4.3 Obligation to offer the sales documents to investors

Whenever a UCITS fund is marketed to a German investor, the UCITS fund’s KIID must be offered to the investor. This

does not mean that the KIID has to be handed over, but it must be offered in such a way that, if the offer to be provided

with the KIID is accepted, the distributor must be in a position to hand over the KIID. The same applies with regard to the

fund’s sales prospectus and its semi-annual and annual reports. Upon request of the investor these documents must be

made available to the investor, ie the distributor must be in a position to hand over these documents to the investor if

requested. Similar information duties apply whenever an AIF fund is marketed to retail investors in Germany.

To avoid being held liable for not offering the requested documents, many third-party distributors use subscription forms

in which investors confirm that the relevant sales documents have been offered to them, but that the investor did not

actually wish to receive the documents. Under German civil law, such clauses are null and void, as it is thought that they

unduly shift the burden of proof to the investor. Only a separately signed statement showing that the investor has in fact

received the sales documents would be binding and admissible proof in court.

Where there has been a failure to offer the sales documents, the third-party distributor would be primarily liable, although

the possibility of the investment fund also being held liable cannot be excluded.15

4.4 Rescission rights

A private investor subscribing to investment units is generally bound by his subscription order. In exceptional

circumstances, the investor may have a right under Sec. 305 KAGB to rescind the order.

This right to rescind provided for under Sec. 305 KAGB applies where the investor has been induced to purchase funds

through oral negotiations other than at the permanent business premises of the person selling or procuring the sale of the

units. For all practical purposes, this would be a sale at the investor’s home. However, the right of rescission does not

apply where the investor has expressly invited the salesperson to come to his home.

Note that even if the right to rescind is exercised, the investor does not receive back the full amount invested, but merely

the NAV as per the day on which the right to rescind is exercised plus any sales charges paid.

Nevertheless, the investor must be informed in writing of the right to rescind the order.

Under certain circumstances further rights of rescission provided for under the BGB must be considered in cases where

Sec. 305 KAGB does not apply.

15 Legally speaking, one could consider the third-party distributor an agent of the fund, so that the fund is responsible for the agent’s failure to comply

with legal requirements.



5. The Allen & Overy investment funds practice in Germany

Allen & Overy LLP Germany acts for major investment companies – both national and international. We regularly assist

such companies in introducing their products to the German market and in establishing distribution networks throughout

Germany. Another core part on our team’s work is the structuring of investment funds, including a particular focus on real

estate and loan funds.

Areas of expertise include:

– Registration and listing of UCITS funds

We are particularly active in assisting foreign and domestic investment fund companies in registering all different types

of UCITS funds for marketing in Germany under the KAGB. We have excellent long-standing contacts with the BaFin,

which have often proved helpful in solving and avoiding problems and delays. In addition, we have assisted many

ETFs with their listings on the Frankfurt Stock Exchange and have excellent long-standing contacts with the FSE.

– Distribution agreements

We assist our clients in both the preparation and conclusion of distribution agreements and general terms and

conditions and are familiar with the standard distribution agreements of all major fund distributors.

– Assisting in the negotiation of Master-KVG agreements

Having represented foreign fund managers in their negotiations with virtually all Master-KVGs, we know their style,

their preferences and where they are (in)flexible. We therefore help our clients to save time and money.

– Paying, representative and agency agreements

We advise on the conclusion of paying, representative and agency agreements, and we have drafted standard

agreements for our clients.

– Revision of marketing material

We have wide-ranging experience in revising marketing material and advising on German shareholding disclosure

procedures.

– Sales offices

Our team has considerable experience and expertise in the registration and establishment of sales offices.

– Translation team

A team of translators specialising in funds-related translations is available. They support us in preparing translations of

sales prospectuses and financial reports as well as any requisite marketing material.



6. Contact information

The German Allen & Overy LLP Funds team

Investment Funds Law

Frank Herring

Partner

Tel +49 69 2648 5310 [email protected]

Valeska Karcher

Senior Associate


Dr Detmar Loff

Counsel Tel +49 69 2648 5311

[email protected]

Marco Zingler

Senior Associate Tel +49 69 2648 5313

[email protected]

Laura Druckenbrodt Associate

Tel +49 69 2648 5373

[email protected]

Dennis Kunschke Senior Associate

Tel +49 69 2648 5895

[email protected]

Sandro Pittalis

Associate




Investment Tax Law

Dr Marcus Helios

Partner Tel +49 211 2806 7111

[email protected]

Klaus D. Hahne

Counsel Tel +49 69 2648 5474

[email protected]

Markus Ernst Senior Associate

Tel +49 89 71043 3105

[email protected]

www.allenovery.com

© Allen & Overy LLP 2015 I CS1506_CDD-42371

Allen & Overy means Allen & Overy LLP and/or its affiliated undertakings. The term partner is used to refer to a member of Allen & Overy LLP or an employee

or consultant with equivalent standing and qualifications or an individual with equivalent status in one of Allen & Overy LLP’s affiliated undertakings.

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