Draft Bill on Fund Risk Limitation: What Fund Providers Need to Know

The Federal Ministry of Finance has published its draft bill on the Fund Risk Limitation Act (hereinafter "Draft Bill-FoRG"), which entails numerous amendments to the KAGB. In particular, the Fund Risk Limitation Act implements the amendments to the European Investment Fund Directives (Directive 2009/65/EC – so-called "UCITS Directive" – and Directive 2011/61/EU – so-called "AIFM Directive") through the new Directive (EU) 2024/927 (hereinafter "Amendment Directive"). The Amendment Directive must be transposed into national law by April 16, 2026.

Additionally, the Draft Bill-FoRG contains reforms to the KAGB independent of the Amendment Directive, such as the long-requested introduction of closed-ended retail funds in the form of a special fund (so called "funds in contractual form").

With regard to the KAGB, the Draft Bill-FoRG largely adopts the contents of the German government's final draft for a Fund Market Strengthening Act (FoMaStG) from November 2024, which was no longer passed due to the dissolution of the governing coalition (see our newsletter from October 24, 2024). However, the Draft Bill-FoRG also contains a number of innovations, such as the new possibility of dilatory defence under section 93 (3a) KAGB-E for capital management companies that manage investment funds in contractual form.

Providers of open-ended investment funds in particular must promptly check whether they need to adapt their sales documents and investment terms to the new version of the KAGB. The deadline for this is April 16, 2026.

In the following, we present selected changes to the KAGB in detail:

1. Lending by Investment Funds

The Draft Bill-FoRG introduces an EU-wide harmonized regime for lending by alternative investment funds (hereinafter "AIF"). The permissibility of lending is summarized in one place (section 20 (9) KAGB-E). In particular, as before, special AIFs and closed-ended retail investment funds may grant loans under certain conditions. 

The Draft Bill-FoRG modifies the conditions for the granting of loans for closed-ended retail investment funds. According to the revised number 8 of section 261 (1) KAGB-E, such a fund may grant shareholder loans in the amount of up to 30 % of its capital if the loans granted do not exceed the acquisition costs of the equity interests held in the company.

The term "shareholder loan" is now legally defined in section 1 (19) no. 15a KAGB-E as a loan granted by an AIF to a company in which it directly or indirectly holds at least 5 % of the capital or voting rights and which may not be sold to third parties independently of the capital instruments held by the AIF in the same company.

According to the new number 10 of Section 261 (1) KAGB-E, a closed-ended retail investment fund may also grant loans of up to 50 % of its capital.

The previous restrictions and conditions for lending by special AIFs pursuant to section 285 (2) and (3) KAGB are deleted, as the requirements for lending by special AIFs are conclusively regulated in sections 29 and 29a KAGB-E. This serves the 1:1 implementation of the Amendment Directive, which does not impose any additional requirements for lending by AIFs marketed to professional investors. This is intended to create a level playing field for lending AIFs that are marketed cross-border in accordance with the AIFMD.

At the same time, key terms such as "lending", "special purpose lending company" and "lending AIF" are defined by law (section 1 (19) no. 24b to no. 24 d) KAGB-E). The term "lending" covers both direct lending and, under certain conditions, indirect lending via third parties and special purpose vehicles. A "lending AIF" is a fund whose strategy consists primarily of granting loans or whose granted loans account for at least 50 % of the net asset value (see section 1 (19) no. 24d KAGB-E).

For lending - both by lending AIFs and other AIFs – the draft bill of the FoRG sets out special requirements for risk management (see section 29a KAGB-E). These include, among others, maximum lending limits for certain borrowers, such as financial companies, the prohibition of lending to certain companies, such as outsourcing companies in accordance with section 36 KAGB, and maximum leverage limits (175 % for open-ended AIFs and 300 % for closed-ended AIFs of the AIF's risk calculated using the commitment method).

In addition, a mandatory retention is introduced for the transfer of loan receivables. When loans are transferred to third parties, the capital management company (hereinafter "KVG") must retain 5 % of the nominal value of each loan for a certain period (section 29b (1) KAGB-E). This "skin-in-the-game" mechanism is intended to ensure that funds continue to bear their own risk after the transfer of loans and thus maintain incentives for sound lending. 

According to section 30 (3a) KAGB-E, lending AIFs should generally be closed-ended funds. By way of exception, a lending AIF may be an open-ended fund, provided that the AIF management company managing it can demonstrate to the German regulator BaFin that the liquidity risk management system of the AIF is compatible with the investment strategy and redemption policy of the AIF management company, which should be adequately documented in good time.

The explicit prohibition on the granting of consumer loans by AIFs (section 16a KAGB-E) should also be emphasized. 

In practice, this means that capital management companies must promptly check whether there is a need for adjustment with regard to the launch of corresponding investment funds or product structuring and in the internal organization, which should be implemented with sufficient lead time.

2. Limitation of Liability of the KVG in the Management of Investment Funds

According to the new section 93 (3a) KAGB-E, the KVG may refuse to fulfil liabilities arising from legal transactions carried out for the joint account of the investors of a fund in contractual form as long as and to the extent that it cannot satisfy itself from the investment fund. The objection does not have the effect of preventing default of payment (section 93 (3a) sentence 2 KAGB-E), and collateral provided for liabilities arising from legal transactions carried out for the joint account of the investors remains realizable. Section 93 (3a) KAGB-E is structured as a so-called "dilatory" defense. This means that the KVG can only raise the defense as long as and to the extent that the liquidity of the investment fund is insufficient, e. g. because the sale of a property has not yet been completed.

The statutory limitation of liability is very welcome from an industry perspective. Although attempts have regularly been made to negotiate a corresponding right of objection for the capital management company by individual contract.  this could not always be enforced in practice. 

The new provision of Section 93 (3a) KAGB is intended to put the creditors of funds in contractual form on an equal footing with the creditors of investment companies. Under current law, there is a difference in the liability of capital management companies depending on whether the funds they manage are investment companies with legal capacity or funds in contractual form without legal capacity. In the case of investment companies, the capital management company is not liable with its assets, whereas in the case of funds in contractual form, the capital management company is liable with its assets if the liabilities cannot be covered by the claim for reimbursement of expenses under section 93 (3) KAGB. This difference in the liability regime has often led to the investment company being preferred over funds in contractual form in the area of special AIFs.

The regulation also facilitates the financing of funds in contractual form, as banks can refer to the investment fund as the debtor for the purposes of the European Capital Requirements Regulation (CRR).

3. Selection of Liquidity Management Instruments for Open-Ended Funds

Pursuant to section 30a (1) KAGB-E, a capital management company must select at least two suitable liquidity management instruments for each open-ended investment fund it manages. By way of exception, a capital management company may decide to select only one suitable liquidity management instrument for money market funds. Prior to selection, the management company must assess the suitability of the liquidity management instrument with regard to the investment strategy pursued, the liquidity profile and the redemption policy of the investment fund, which should be appropriately documented.

Section 1 (19) no. 25a KAGB-E contains a catalogue of what liquidity management instruments are within the meaning of section 30a KAGB-E. These include, for example, redemption restrictions, the extension of redemption periods or the separation of illiquid investments (so-called "side pockets"). Certain selected liquidity management instruments must be included in the investment terms of the investment fund. In addition to the information in the terms and conditions of investment, the sales prospectus for open-ended retail investment funds and the information document pursuant to section 307 KAGB must also be supplemented with certain information on the selected liquidity management instruments. In this respect, "the possibility and the conditions" for the use of the selected liquidity management instruments should be described.

Providers of open-ended investment funds must therefore promptly adapt their investment conditions and sales documents to include the topic of liquidity management instruments. For this article 2 of the Draft Bill-FoRG grants a transitional period until April 16, 2026.

4. Extended Reporting Obligations and Transparency

Section 35 KAGB-E largely revises the periodic reporting of capital management companies. As before, management companies must report detailed information on traded instruments, markets, risks and assets to BaFin.

What is new, in particular pursuant to section 35 (2) no. 4 KAGB-E, are numerous pieces of information on outsourcing agreements relating to portfolio management or risk management functions. This includes comprehensive information on the outsourcing company, the number of employees that the asset management company itself employs for the ongoing portfolio management or risk management tasks, a list and description of the activities that are outsourced in connection with portfolio management and risk management, as well as the number and dates of the regular reviews that the asset management company carries out to monitor the outsourced activities.

The bureaucratic burden in the case of the outsourcing of the "core disciplines" of portfolio management and risk management will increase further as a result of the new reporting requirements. However, the new reporting requirements in accordance with section 35 (2) KAGB-E in the version applicable from April 16, 2026 must be applied for the first time from April 16, 2027 due to a transitional provision.

The selection of liquidity management instruments in accordance with section 30a KAGB-E has also been reflected in the new version of section 35 KAGB-E. In accordance with section 35 (2) no. 2 KAGB-E, BaFin must be informed of the selection of liquidity management instruments and the corresponding strategies and procedures for each activation and deactivation. BaFin must be informed immediately of the activation or deactivation of liquidity management instruments in certain circumstances in accordance with section 35 (4a) KAGB-E.

Capital management companies should therefore promptly review their reporting system in accordance with section 35 KAGB to determine whether adjustments are required and adapt existing documentation accordingly. The equally important notification obligations under section 34 KAGB are only editorially adjusted.

5. Special Representative as a Targeted Supervisory Instrument of BaFin 

The new sections 40a-40d KAGB-E provide BaFin, for the first time, with a legal basis to appoint a special representative and entrust them with the performance of tasks at a management company. The special representative may be appointed for special reasons, for example in the event of poor business organization (section 40a KAGB-E). Unless the special representative is entrusted with the powers of a managing director or a member of a supervisory body, a legal entity may also be appointed as special representative.

The special representative is equipped with comprehensive rights within the scope of their tasks. For example, they may inspect the business papers and books of the capital management company. Furthermore, they are entitled to attend all meetings and assemblies of all bodies of the management company in an advisory capacity.

The special representative may be granted far-reaching powers by BaFin, ranging from monitoring individual business areas to the complete takeover of the tasks and powers of one or more managing directors of the management company. In particular, BaFin can instruct the special representative to take measures to restore a proper business organization, to monitor compliance with supervisory orders or to examine claims for damages against board members (section 40c KAGB-E).

For the affected companies, the appointment of a special representative represents a significant intervention on management and organizational sovereignty. For the duration of the appointment, the tasks and powers of the affected board members are suspended insofar as the special representative assumes them (section 40c (2) KAGB-E). The costs for the deployment of the special representative, including remuneration and expenses, are borne by the company (section 40c (7) KAGB-E).

6. New Fund Vehicles – Closed-Ended Retail Funds in Contractual Form

The new Section 139 KAGB-E creates the possibility for the first time to set up closed-ended retail AIF in contractual form. According to section 139 sentence 2 KAGB in its current version, only special AIFs offered to professional investors may be launched as closed-ended funds in contractual form. At the same time, according to the explanatory memorandum to the Draft Bill-FoRG, legal uncertainty will be eliminated, as it is now clear that ELTIFs (European long-term investment funds) can be launched in this legal form.

In practice, this means considerable simplification and cost savings in product structuring. In future, closed-ended retail funds can be launched and managed more quickly and with less administrative effort. In particular, it will not be necessary to establish a company and shareholder meetings are no longer required. 

Due in particular to the aforementioned improvement in the liability regime for the KVG pursuant to section 93 (3a) KAGB-E, it is therefore possible that closed-ended funds in contractual form will find significantly more market acceptance in future and will be used more frequently for fund set-ups.