Germany is moving quickly to legitimize crypto assets. A new milestone has now been reached with the passage and introduction of the Fund Location Act a few months ago. This new regulation allows certain funds (open domestic special AIFs with fixed investment periods) to invest up to 20% of their managed assets in crypto assets.

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While a large part of the international discussion about crypto markets is still focused on bans and regulation that hampers innovation, Germany is becoming more open to this new asset class. Granted, the financial industry is still in the early stages of integrating crypto investments, with current issues still revolving around infrastructure and the regulation, experience and trust associated with it. At the behest of the German Fund Association, however, the legislature has now opened a gate for traditional institutions that opens up the world beyond. The Fund Locations Act will bring significant changes as S-AIF managers now have a legal framework to include cryptocurrencies in their funds. This article gives an initial overview of the current prospects for special funds with regard to crypto investments, highlights the gaps that are still open and shows what can be expected in the short and medium term.

Structures of special funds (S-AIF)

In Germany there have been special funds as investment vehicles since 1969. S-AIFs fall under the institutional business, so that the regulation is much less strict than, for example, in the case of mutual funds. Therefore, the decision to initially give S-AIFs the opportunity to invest in crypto assets was to be expected. The main areas of application of S-AIFs include pension funds and insurance companies, but also family offices and corporates. They are a type of mutual fund for professional investors that are created for specific investment purposes, managed by a capital management company and not traded on public markets. The German S-AIF market has grown by more than 100% since 2011 and currently (Sept. 2021) has total assets of more than € 2.1 billion (Figure 1), of which more than € 1.9 billion in Special securities funds.

With the 20% approval for cryptocurrency allocation, the legislature is orienting itself to the existing limits in the Capital Investment Code (KAGB), which serve to prevent overallocation of funds in certain asset classes. The KAGB already provides for a limit of 20% for unlisted company investments, which has set the precedent for crypto currencies in the Fund Locations Act. In the first two months since the amendment came into force, investments by S-AIFs in cryptocurrencies were still low. This is due, on the one hand, to the asset managers’ short preparation time and, on the other hand, to the risk profiles and internal investment restrictions. Insurance companies, for example, have had a very strict investment policy in the past. As a result, they must first adjust their internal investment controls and determine how much risk capacity they have on crypto assets. Pension funds are theoretically somewhat more flexible, but have different insurance requirements. We therefore estimate that at least half of all S-AIF market participants will or must remain cautious and avoid crypto investments.

Family offices and companies that are not bound by insurers’ investment limits are most likely to benefit from this new law. In their investment models, however, assets in S-AIFs are typically used to cover pension obligations and therefore follow a risk-averse investment philosophy. Even if companies and family offices can theoretically use Bitcoin and Co. as part of their investment strategy to secure their retirement provision, they are likely to be cautious for the time being. A large part of the capital in S-AIFs of 200 and 300 billion respectively remains with the banks themselves, which invest their equity through Depot A S-AIFs (Figure 2). In this case, a more restrictive investment policy must be selected, as the CRR (Capital Requirements Regulations) provides for a risk premium for volatile investments.