ESG – New compliance requirements under the Fund Location Act

On 20 January 2021, the German cabinet adopted a draft law to strengthen Germany as a business location for funds (in German). To achieve this objective, the law includes, inter alia, provisions for tax relief. Parts of the German Investment Code (Kapitalanlagegesetzbuch – KAGB) are to be made less bureaucratic and the available range of structuring forms for investment funds is to be extended (see our newsletter on the draft Fund Location Act (FoG) in German). An increase in the transparency of providers of alternative investment funds and their products with regard to environmental social governance (ESG) is also intended.

European context: Disclosure Regulation and Taxonomy Regulation

The draft amendment to the KAGB contained in the Fund Location Act refers in various places to the Disclosure Regulation (EU) No 2019/2088 and the Taxonomy Regulation (EU) No 2020/852. Both Regulations are considered to be key elements of European regulatory efforts in the context of promoting sustainable growth (European Commission, Sustainable Finance Action Plan of 8 March 2018, COM (2018) 97 final).

Who is covered by the ESG requirements of the Disclosure Regulation and the Taxonomy Regulation?

The Disclosure Regulation establishes harmonised rules for financial market participants and, in some cases, financial advisors regarding transparency in the inclusion of sustainability risks and the consideration of adverse sustainability impacts in their decision-making processes and in the provision of (pre-contractual) information on the sustainability of financial products. The term “financial market participants” and the related scope of the Disclosure Regulation are broad and cover, inter alia, insurance undertakings that offer an insurance-based investment product, investment firms and credit institutions providing portfolio management, AIFs and UCITS management companies and fund companies that issue pension products and institutions for occupational retirement provision. The Taxonomy Regulation is linked to the Disclosure Regulation and contains criteria for assessing the environmental sustainability of economic activities. The scope of persons and institutions governed by the Taxonomy Regulation, on the other hand, is broader and extends to government bodies of the EU, Member States, companies that are obliged to provide non-financial reporting and financial market participants within the meaning of the Disclosure Regulation.

Planned changes to the KAGB with reference to ESG

The Disclosure Regulation and the Taxonomy Regulation are directly applicable law and therefore do not require transposition into local law. Therefore, the proposed amendments to the KAGB merely complement the legal framework established by the Regulations. The following changes are proposed:

• Sections 121 (3) KAGB and 136 (3) KAGB, which govern the scope of the audit carried out by the auditor, are to be supplemented such that capital management companies will also be checked for compliance with the obligations imposed on them by the Disclosure Regulation (Articles 3 to 13) and the Taxonomy Regulation (Articles 5 to 7). The new transparency obligations relate to the management of sustainability risks, adverse effects and remuneration policies related to the integration of sustainability risks, as well as a set of pre-contractual information on the sustainability of financial products. They must disclose information on whether and, if so, why their financial products contribute to achieving environmentally sustainable objectives and to what extent the economic activity is environmentally sustainable. The German Federal Financial Supervisory Authority (BaFin) may also carry out such an audit in place of the auditor without any special reason.
  
  
• The draft of section 165 (2) no. 42 KAGB extends the minimum information in sales prospectuses for open investment funds and is intended to specify that the sales prospectus must establish transparency regarding the inclusion of sustainability risks, adverse sustainability effects and environmental and social characteristics in accordance with Articles 6-9 of the Disclosure Regulation and Articles 5-7 of the Taxonomy Regulation.
  
  
• The requirements in section 307 KAGB to disclose information to professional and semi-professional investors are to be expanded. In addition, pre-contractual information is provided on handling sustainability issues in accordance with Articles 6-9 of the Disclosure Regulation and Articles 5-7 of the Taxonomy Regulation.
  
  

Practical implications

With the transparency obligations described, ESG factors, which are increasingly being demanded by many investors as part of their investment decision, will play a greater role already at the marketing level. From the perspective of capital management companies, however, marketing to institutional investors is likely to be more bureaucratic, as the Bundesverband Alternative Investments e.V. (Federal Association of Alternative Investments e.V. (BAI)) has already criticised the Fund Location Act in an initial statement. Thus there is a certain contradiction with regard to the stated objective of the Fund Location Act.