During the last 15 years the hedge fund industry has become one of the most creative and rapid growing areas within the financial industry and has made it hard for regulators to mitigate the potential risks posed to investors and the financial system. In light of the financial crisis, international interest in the supervision and regulation of the financial industry has increased rapidly, particularly with regard to hedge funds and there is no doubt that international and European initiatives will influence hedge fund operations in European and German law. The aim of this thesis is to introduce the reader from a legal perspective to the general characteristics of hedge funds as well as the existing and expected legal schemes for the operations of hedge funds in European and German law. The thesis explains the characteristics of hedge fund schemes by describing their origin and terms of hedge funds used. In general, the reader will be introduced to the European and German legal landscape as well as to market participants in the hedge funds business by analysing applicable German law as well the practability of existing EU Directives and Regulations. Furthermore a brief summary of the financial supervisory framework will be presented as well as the role of hedge fund associations. The reader will also find a chapter analyzing and describing the proposed Directive for Alternative Investment Fund Managers (AIFM) by following its table of contents resulting in a comparative summary on expected European regulation and possible impacts to German law. Finally, I highlight two conclusions. First on the proposed AIFM Directive, which is still in draft, and therefore a statement of political intent, has no binding effect and I expect that the proposed regulations encompassed in the Directive will evolve significantly prior to the passage of new legislation due to lobbying by hedge fund associations and the United Kingdom (UK) government. The second conclusion is that Germany is already prepared to provide a regulatory framework for the operations of hedge funds in the context of the AIFM Directive. Also, existing hedge fund providers in Germany are already able to provide the required regulatory infrastructures when entering or offering hedge funds business in Germany, which could result in a competitive advantage to other EU Member States.

Text Sample: Chapter 3.1, German legislation: The InvG which reformed the investment fund industry in Germany has now been in place for more than 5 years, having been enacted on 1 January 2004. The principal objectives of the InvG were to implement amendment Directives 2001/107/EC and 2001/108/EC of the European Parliament and of the Council of 21 January 2002 amending Council Directive 85/611/EEC of 20 December 1985 on the co-ordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities (UCITS Directive). In relation to hedge funds the InvG should promote Germany as an investment fund market, put a stop to the exodus of investment funds to other European countries, and establish a strong and attractive regulatory regime for onshore hedge funds, regulated in the Sections 112-120 InvG. At the beginning of 2005 there were 15 hedge funds with EUR 0.5 million total AuM. The number of hedge funds domiciled in Germany at the end of 2008 amounts to 39 with a total AuM of EUR 1.5 million (see image 4). Compared to the 2008 market wallet of EUR 1.2 billion in German public and special funds, the market share of hedge fund is less than 0.1% in Germany, which is still behind the expected EUR 50 billion market wallet of the hedge fund industry. Hedge fund structures and rules: Hedge funds launched and marketed in Germany are subject to supervision under the InvG and may be approved as retail or institutional funds by the Federal Financial Supervisory Authority (BaFin). The Section 112 InvG defines funds with additional risks (single hedge funds) and Section 113 InvG funds-of-funds with additional risks (funds of hedge funds). Single hedge funds (SHFs) adhere to the principle of risk diversification and, in all other aspects they are not subject to any restrictions in the selection of the assets pursuant to Section 2 (4) Nos. 1 to 4 and Nos. 7 to 9 InvG. Further the contractual terms must provide at least one of the following conditions for the joint account of the investors: - Short selling of assets and leveraging by using unrestricted borrowings or derivatives - Investments in participations of companies which have not been admitted to a stock exchange or are not included in an organized market, will be limited to 30% of the value of the fund - The right of investors to redeem fund units may be restricted. It has to be noted that with respect to Section 112 (2) SHFs may not be marketed publicly but only by way of private placements (professional investors). According to Section 113 (1) Nos. 1-2 InvG, Funds of hedge funds (FoHFs) may in principle acquire units in domestic regulated SHFs and foreign investment funds with comparable investment policies as their target funds. With respect to SHFs, in addition to the principle of risk-spreading, the following other diversification rules apply as per Section 113 (1-5) InvG: - Borrowing only up to the limit of 10% of the fund value (to be provided in the contractual terms of the FoHFs). - No executions of short selling and leverage. - Only the hedging of foreign currencies associated with the funds assets is permitted. - No more than 20% of a FoHFs may be invested in a single target fund. - Only up to 49% of FoHFs value can be invested in cash deposits and money market instruments. In addition, pre-compliance checks apply to the fund managers to obtain minimum information about the target funds prior investing. For example, the purchase of foreign target funds is only permitted if the assets have been entrusted to a custodian bank for safekeeping or another comparable organization fulfils the functions of the custodian bank. In this context I would like to add the public marketing and distribution of foreign hedge funds (FHF) based on Section 139 (1) InvG as this is as a matter of fact is subject to a notification requirement. One of the main conditions of Section 139 (2) indent 8 InvG is providing proof that the foreign investment company and the investment company are subject to effective public supervision in their domiciled country in order to protect the investors. Furthermore foreign FoHFs have to provide extensive documentation about the company and the products, too. Similar to German SHFs the public marketing and distribution of FHFs is not permitted, which highlights the restrictive availability of hedge funds to retail investors in Germany.

• Alternative Investment

• Hedge Fund

• Regulation

• Law

• Funds

Marco M. Sperlich was born in Aschaffenburg, Germany in 1972. Education: The author attended the secondary modern school in Aschaffenburg and Dieburg Secondary School graduating in 1993. After passing the German federal armed force in 1994 the author started its studies at the University of Applied Science, Aschaffenburg and graduated in the areas of banking, insurance and properties with a diploma in business administration in the spring of 2000. During the course of its professional career 2007 until 2009, in addition to its full time work, the author completed the master programs - Master of Laws (LL.M.) at Frankfurt School of Finance & Management and Master of International Business & Tax Law (LL.M.) at Management Center Innsbruck. Professional Experience: In 2000 the author joined Salomon Brothers KAG mbh, a German investment management company and legal entity of Citigroup Inc. in Frankfurt as Business & Financial Analyst. In the autumn of 2003 the author moved to Citibank AG in Düsseldorf and was responsible for financial controlling of all Citigroup facilities in Germany and Austria. After 2004 the author accepted a position at Citigroup Global Markets Deutschland AG & Co KGaA in Frankfurt as Fiduciary Compliance Officer Germany and was appointed beginning of 2007 as Vice President of Citigroup Inc. Reason of the study: As the author was responsible for the Fidurciary Management area in Germany as well as the oversight and monitoring of Citigroup´s funds and securities business, the author´s scope is to introduce the reader from a legal perspective to the general characteristics of hedge funds as well as the existing and expected legal schemes for the operations of hedge funds in European and German law.