In times of volatile markets, institutional investors are increasingly looking for flexible exit options from their fund investments. While the cancellation of fund units is often associated with considerable restrictions, the secondary market offers a promising alternative for an early exit from investments in special AIFs.
Establishment of a secondary market
In recent years, a secondary market for closed-end special AIFs has established itself as an important alternative to the classic call of shares. While institutional investors used to be severely restricted in exiting before maturity and effective and market-based price discovery did not take place, specialized trading platforms now offer new opportunities for efficient share trading. Existing investors no longer have to go to great lengths to find a buyer themselves. Secondary markets offer an attractive option to restructure portfolios without calling special AIFs. New investors, in turn, benefit from the opportunity to invest in real estate, for example, whose performance they can track.
The development was accelerated in particular by the current market conditions and digitalization. Volatile markets and changing valuations of investment assets have significantly increased the need for flexible exit options. At the same time, asset managers and capital management companies (KVG) want to avoid unscheduled disposals of assets. trading platforms, such as the “Private Markets Fund Exchange”, it is possible to broker investments in closed-end funds without major technical effort. The platforms allow professional and semi-professional investors to sell their shares via fixed-price or bidding processes.
Distinction between open-ended and closed-end special AIFs
According to German investment law, special AIFs can be issued in various legal forms. The German Capital Investment Code (KAGB) provides for three basic structures for this purpose: the special fund, the investment limited partnership (InvKG) and the investment stock corporation (InvAG).
Special AIFs may only be purchased by professional and semi-professional investors within the meaning of Section 1 KAGB. These are particularly wealthy and experienced investors or so-called institutional investors. Private investors, i.e. the general public, are not allowed to invest in special AIFs.
The KAGB defines open-ended investment funds as an AIF whose shares are repurchased or redeemed directly or indirectly from the assets of the AIF at the request of their shareholder before the start of the liquidation or phase-out phase and in accordance with the procedures and frequency specified in the terms of the contract, the articles of association or the articles of association, the prospectus or the terms and conditions of the issue. The possibility of trading the shares on a secondary market does not yet lead to an open special AIF.
However, AIFs can also waive such a redemption obligation and are then to be treated as closed-end investment funds. Such special AIFs are particularly suitable for investments in illiquid assets, such as real estate, ships, aircraft or even company shares that are not listed on the stock exchange (venture capital or private equity). According to Section 285 KAGB, the essential requirement is that the market value of the assets must be determinable.
In the case of open-ended special AIFs pursuant to section 282 KAGB, the requirement of risk mixing applies in addition to the requirement that the market value be determined, which does not apply to closed-end special AIFs.
Redemption obligation for open-ended special AIFs
The redemption of shares is the essential feature of open-ended investment funds. In the case of open-ended special AIFs, the KVG is generally obliged to redeem the shares. The frequency of the redemption option and the requirements that then apply must be set out in the fund documentation from the outset, although the investment conditions may also specify specific redemption dates.
The practical challenges of the redemption obligation are particularly evident in volatile market phases: If several investors want to redeem their shares at the same time, this can lead to forced sales of assets (“fire sales”), which can have a negative impact on the performance of the fund and the stability of the overall market. For this reason, limits can also be provided in the fund documentation in which the redemption obligation is suspended despite the wish to terminate the contract in order not to plunge the special AIF into a financial crisis.
No ordinary termination in the case of closed-end special AIFs
In the case of closed-end special AIFs, the ordinary termination of the investment is excluded. This means that it is not possible to redeem the shares at regular times, as is the case with open-ended special AIFs.
The investor is only entitled to extraordinary termination for good cause. However, high requirements must be placed on this and such a reason for termination will rarely apply.
Importance of a secondary market
Investors in special AIFs can therefore face challenges if they want to break away from their investment. In the case of closed-end special AIFs, this is already due to the fundamental exclusion of the termination or redemption of the unit.
However, investors in open-ended special AIFs can also have difficulties redeeming their units if, for example, many investors want to redeem their units at the same time and the special AIF does not have enough liquidity available to meet all redemption requests. In addition, the redemption periods can be relatively long, which is a hindrance if an investor wants to get out of the investment at short notice.
Especially in the case of closed-end special AIFs, which do not provide for a regular redemption of shares due to their structure, the secondary market opens up new perspectives. It significantly reduces the illiquidity risk and makes this form of investment attractive to a broader circle of institutional investors. The secondary market also offers advantages for asset managers: they do not have to make unforeseen sales that could weigh on the fund.
Another important aspect is the avoidance of “fire sales”. Secondary market trading can prevent forced fire sales of assets, which, according to the European Central Bank, can pose a significant risk to the stability of the real estate and financial markets. In addition, the secondary market enables more effective pricing, as sellers are no longer dependent on a single buyer or KVG.
Regulated secondary market
In order to be allowed to engage in secondary market trading of special AIFs, a licence for the provision of investment services and ancillary services is generally required (Section 15 WpIG). The decisive factor is that the fund units are financial instruments and services in connection with financial instruments are subject to authorisation. The relevant investment service is in particular investment brokerage. In this case, the provider of the secondary market transmits the declarations of intent of the buyer and the seller as a messenger as an intermediary. As a regulated institution, the secondary market provider in Germany is subject to comprehensive supervision by the Federal Financial Supervisory Authority. These include requirements for equity capital and risk management. In addition, the managing directors must be reliable and have sufficient knowledge and experience to operate such a marketplace. Finally, the requirements of the Money Laundering Act apply, which ensures that all customers active on the secondary market have undergone the required KYC check.
A provider in Germany that has such a licence to operate a secondary market is, for example, the trading platform “Fondsbörse Private Markets”, which directs its offer to professional and semi-professional investors.
Result
A secondary market for special AIFs offers an effective solution to the classic challenges of this asset class, especially with regard to liquidity and tradability. For closed-end special AIFs, the secondary market opens up the possibility of an early exit, while for open-ended special AIFs it represents an important alternative to the classic redemption of shares. Avoiding forced asset sales not only protects the performance of the funds, but also contributes to the stability of the overall market.
