Launching a German Hedge Fund

Launching a German hedge fund offers the fund initiator the advantage of being permitted to engage in short selling on behalf of the fund. Other German fund categories governed by the German Capital Investment Code (KAGB) are prohibited from doing so. The ability to conduct short sales is a defining feature of hedge funds. Another characteristic is the use of significant leverage, for instance, through substantial borrowing or the use of derivatives.

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To establish (launch) or manage German hedge funds, either (German) AIF management companies (AIF-KVG) holding the appropriate BaFin licence/authorisation, or EU/EEA management companies operating under the European passport regime, are permitted. Alternatively, for AIF-KVG, a simple registration is sufficient instead of a full licence/authorisation, provided that assets under management (AUM) do not exceed the thresholds of EUR 500 million (without leverage) or EUR 100 million (with leverage) — the so-called “AIFM light” regime. Furthermore, it is possible to establish a hedge fund through a service-KVG; however, the fund initiator must generally hold the necessary authorisation to provide investment advice or portfolio management services.

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The hedge fund manager is free to determine the fund’s investment strategy, which must be set out in the fund rules. Typical strategies include equity long/short, credit long/short, equity long bias, managed futures/CTA, macro, fixed income arbitrage, and distressed/restructuring. In addition to liquid financial instruments, the asset manager is generally free — while observing the principle of risk diversification — to invest the fund’s assets in any type of asset, including real estate and unlisted corporate holdings. The fund’s assets may also be held exclusively by a prime broker.

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By definition, hedge funds are alternative investment funds (AIFs) structured as open-ended investment vehicles. This means that investors are, in principle, entitled to request the redemption of their units at any time, although certain restrictions apply.

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Hedge funds are classified as German special AIFs, meaning that only professional and semi-professional investors are eligible to invest in the hedge fund. Retail investors may only participate indirectly via a fund of hedge funds structured as a public fund. However, a fund of hedge funds may invest no more than 20 per cent of its value in any single target fund.

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From a corporate law perspective, German hedge funds may be structured as a separate pool of assets (Sondervermögen), a German investment stock corporation with variable capital, or an open-ended investment limited partnership. Moreover, the hedge fund may be managed externally by an AIF-KVG, or it may itself qualify as an internally managed AIF-KVG. The choice of the optimal fund vehicle primarily depends on the initiator’s objectives and tax considerations.