GERMANY: BaFin completes closet indexing investigation

Saturday December 3 2016

The German Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht – BaFin) has completed its investigation into closet indexing having identified deficiencies in transparency. As a result of its investigation BaFin plans to increase transparency obligations for the investment fund industry and has also published a consultation on the matter.

Since April 2016, BaFin had been examining German equity funds with a volume of 10 million euros or more and with equity holdings comprising at least 51% for the use of closet indexing. The European Securities and Markets Authority (ESMA) had already conducted an investigation prior to this. The term “closet indexing” describes cases in which investment companies state that a fund is actively managed although it closely tracks a benchmark and therefore follows a more passive investment strategy. One point of criticism of this practice is that investors receive information that is incorrect or even misleading. Furthermore, investment companies have been accused of charging management fees which are inappropriate for a form of passive management.

BaFin plans to issue an announcement in order to increase transparency obligations for the investment fund industry. From mid-2017 at the latest, asset management companies will, in cases where equity holdings comprise 51% or more of the funds, have to state in their prospectuses whether retail funds are actively managed or merely track an index. If companies use a benchmark, then they will have to name it and also specify whether and by how much they intend for it to be exceeded or fallen below. Furthermore, it will be necessary to provide a chart in the prospectus that clearly depicts the long-term performance of the fund in comparison to the benchmark used.

BaFin’s higher transparency requirements are intended to enable investors to better assess the activity of investment fund products. It will also be necessary for asset management companies to communicate their management approach more clearly to investors in future because such additional information will have to be included in their prospectuses (a liability document). In general, prospectuses for funds currently contain no specific information in this regard.

Click on the above link to view the BaFin announcement.