Germany: BaFin's Next Expanded Frontier? Expanding The Regulatory Remit To Financial Investment Intermediaries

Last Updated: 1 October 2019
Article by Michael Huertas and Holger Schelling

The German Federal Government is serious about its plans to place "financial investment intermediaries/brokers" (Finanzanlagevermittler) (referred to herein as FIBs) under the supervision of the Federal Financial Supervisory Authority (Bundesanstalt für FinanzdienstleistungsaufsichtBaFin). The German concept of a FIB is equivalent to what certain common law jurisdictions term an "(independent) financial adviser". Bringing these FIBs under greater supervision marks a step that a number of other EU-27 jurisdictions have already taken, often with quite an impact. This change will affect a vast array of financial products as well as relevant advice that is offered and is likely to be of interest to stakeholders beyond Germany. 

Currently in Germany, the Trade Offices or the Chambers of Industry and Commerce (Industrie- und Handelskammer - IHK) are responsible for supervising the activities of FIBs. The mandate of who is responsible depends on where these FIBs are domiciled in Germany. The aim is to transfer the supervision of FIBs to BaFin in order to further standardize the supervisory approach and quality, as well as bring this part of the market within the scope of the German Securities Trading Act (WertpapierhandelsgesetzWpHG), which is one of the key domestic pillars of financial services regulation.

Why now?

In the view of the Federal Government, the supervision of the activities of FIBs is currently inconsistent. If the status quo were left to continue, this would lead to a deterioration in the quality and standard of supervision. The transfer of supervision to BaFin is intended to make financial supervision more homogeneous. This assessment does not remain without criticism, and while it has left some FIBs "hot under the collar" the direction of change, even it requires action, could have been much worse, especially when compared to the actions of other EU-27 jurisdictions or comparable action taken in the UK. 

So what's changing?

During an unseasonably hot summer, the German Federal Ministry of Finance (Bundesministerium der Finanzen) published a paper agreed with the German Federal Ministry of Justice and Consumer Protection (Bundesministerium der Justiz und für Verbraucherschutz) outlining the key points of the project. The industry has been waiting for this for over a year. The project to transfer the supervision of FIBs to BaFin was adopted in the spring of 2018 in the new coalition agreement. This was followed on November 7, 2018, by the first draft bill to this effect, before the revised draft was published this year. 

According to the German government's key issues paper, the main changes concern §§ 34f and 34h of the Code of Trade and Commerce (Gewerbeordnung, GewO). The previous authorization conditions for financial investment brokers in §§34f and 34h GewO are to be replaced by an authorization condition in the WpHG. This will not result in any change in the content of the licensing requirements, which is in contrast to how other EU-27 jurisdictions approached similar issues.

The Financial Investment Brokers Ordinance (Finanzanlagenvermittlerverordnung, FinVermV) is also currently being revised in order to implement the requirements of EU Directive 2014/64/EU (MiFID II). The new provisions in the FinVermV are strongly aligned with provisions of the WpHG. Its new substantive legal provisions will be incorporated into WpHG and the associated statutory instruments i.e. "ordinances". 

In summary, the step to transfer the new regulations concerning the FIB into the WpHG is only consistent with the aims of achieving the aim of more homogenous supervision. The new law is then expected to be promulgated in mid-2020 before it enters into force on January 1, 2021.

Existing licenses remain valid – verification procedure 

The existing permissions granted under §§ 34f, 34h GewO shall initially continue to apply under the condition that, upon request by BaFin, the evidence required for the implementation of the verification procedure under the WpHG is submitted in good time. These shall be submitted by:

  • Sales companies − within six months of the BaFin assuming supervisory responsibility;
  • Other financial investment service providers1 − within six months of BaFin's request.

If the required evidence is not submitted within the six-month period, the existing permits under §§34f, 34h GewO may lose their validity.

The requirements which must be met according to the new WpHG regulation will not go beyond the requirements of §34f GewO (reliability, orderly financial circumstances, proof of professional liability insurance and proof of competence). Six months after the new provisions of the WpHG have come into force, the provisions of §§ 34f to 34h GeWO and FinVermV will no longer apply.

New section on financial investment brokers and fee-based financial investment advisors in the WpHG: financial investment service providers

The BaFin has also been quite clear that FIBs, despite being in their supervisory remit, should continue to form an independent category of supervised person. For this reason, a new section on "financial investment brokers" and "fee-based financial investment advisors" is to be introduced in the WpHG detailing fitness and probity, conduct of business and organizational requirements as well as auditing.

The existing FIBs i.e., financial investment brokers and fee-based financial investment advisors (in future to be referred to as "financial investment service providers") will, once these changes are completed, be divided into three groups: 

  1. financial investment service providers with their own license;
  2. distribution companies with extended requirements; and
  3. contractually bound intermediaries without their own permission.

The other changes that are introduced also include the concept of a "contractually tied broker" who will be regulated pursuant to the German Banking Act (KWG), another key pillar of Germany's financial services legislation. Such brokers are persons who act exclusively for the account, are under the responsibility of a sales company (a so-called liability umbrella), and do not require their own license, under the condition that the sales company itself has a (extended) license. This approach may be familiar to persons in jurisdictions that recognize a tied-agent concept, even if the German laws have their own specific considerations. 

The aim of introducing this new "contractually tied broker" is to provide smaller, mostly sole proprietor firms, who may be limited in their ability to obtain a BaFin license, with an alternative to the independent fulfilment of all their obligations and supervision requirements. Persons wishing to make use of that category are required to be able to demonstrate that appropriate insurance cover required for the liability umbrella is available on the market.

Checking compliance with substantive legal requirements

BaFin is responsible for checking whether new FIBs comply with substantive requirements, especially compliance with conduct of business rules, which are currently still regulated under Sections 12 to 23 of the FinVermV. Checks by the BaFin do not follow a regular cycle, but are carried out according to the circumstances and risk-related aspects. The risk is determined on the basis of self-declarations submitted annually by the financial investment service providers.

The IHKs will continue to carry out the "expert knowledge" examination i.e. as part of fitness and probity assessments

The IHKs will continue to be responsible for carrying out the expert knowledge examinations. This will take place on the basis of a task transfer in accordance with the WpHG. Therefore, holders of a licence under § 34f or § 34h GewO, who have already passed an IHK examination under §§ 1 ff. FinVermV, by proving an equivalent professional qualification in accordance with § 4 FinVermV or on the basis of the grandfathering regulation of § 157 Para. 3 Sentence 4 GewO, do not have to prove their expertise again within the framework of the WpHG licensing procedure.

Criticism 

In summary, the aim of the German Federal Government is to strengthen consumer protection by transferring supervision of financial investment service providers to BaFin. This is welcomed by many. However, there is also criticism: many find that supervision by the IHKs has been successful. IHKs are able to take on an advisory function for FIB in addition to their supervisory function. This is highly appreciated. Supervision by the BaFin would eliminate this advisory function − supervision, on the other hand, may become stricter.2

The Federal Association of German Insurance brokers (Bundesverband Deutscher Versicherungskaufleute, BVK) criticizes the fact that the transfer of supervision to BaFin creates double structures.3 This is because many financial investment brokers are also active as insurance brokers − and insurance brokers will continue to be supervised by the IHKs and not the BaFin. As a result, they are supervised by both the IHKs and the BaFin. This would not − as intended − make supervision more homogeneous, but on the contrary even more complicated.

It is also feared that the change will entail high costs for many FIBs, which could possibly lead to them leaving the market. In this context, it is also interesting to note that in the UK, after a strengthening of supervision of financial advisers (based on the Retail Distribution Review, RDR), there are now voices that fear that many financial advisers will withdraw from the industry.4 It remains to be seen whether there is anything similar to be feared in Germany after the transfer of supervision to BaFin. However, the planned transfer of supervision and the associated changes appear to be much more gentle and humane than the measures taken in the UK. At least the rules that apply to FIBs do not seem to become stricter. For the time being, this can be seen as a positive signal for the industry.

How best to prepare?

Fortunately, the new licensing requirements for FIBs in the WpHG will not contain any new requirements − in this respect, the FIBs do not have to provide any new evidence. Also, the existing permits under the GewO initially continue to apply. However, that being said, BaFin has the right to check the licenses – and will certainly do so. FIBs and especially sales companies – since BaFin will start their checks with them - must prepare themselves for this examination. 

For this reason − and to prevent an end to their licenses − FIBs should have the required documents and evidence at hand. This can help ensure that the BaFin check is carried out quickly and efficiently. In this way, FIBs can be assured as quickly as possible that their permits will continue to apply also under the WpHG and supervision of BaFin. The check of compliance with duties of conduct (§§12 to 23 FinVermV) is also transferred to BaFin. Sales companies are examined on an annual basis. The frequency of checks for financial investment service providers with their own licenses is determined on a risk basis − an annual self-declaration by the financial investment service providers is also taken into account. The financial investment service providers must be prepared to describe the most important parameters of their company. These include the type of products sold, the size of the company and the number of complaints.

The FIBs will also have to prepare themselves for the fact that the supervisory processes will be mainly digital in future. For example, BaFin can direct FIBs to electronic communication systems.

Outlook

While the legislative timeline for change is known, it remains to be seen where BaFin will begin to use its supervisory powers as part of its day-to-day supervision of this new category of supervised persons. Whatever the timeline, it is possible that some FIBs may have to prepare for greater supervisory scrutiny and a different tone than some might be used to, even if the the German Federal Government is trying to ensure that the transition of supervision is as smooth and humane as possible and is keeping the interests of the industry in mind.

Footnotes

1 The Key Issues Paper includes FIB and fee-based financial investment advisors under this term and divides them into 3 groups.

2 For example, The Federal Association for Financial Services (Bundesverband Finanzdienstleistung e. V.) sees as a problem that FIBs will no longer receive advisory services from IHKs in the future, since BaFin is a pure supervisory authority; See here.

3 See here and also see here.

4 See here.

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