Is there any legislation or proposed legislation in your jurisdiction under which financial institutions are prohibited from dealing in investments as a principal?
The German Banking Act (Kreditwesengesetz - KWG) has been amended by the Act on the Ring-Fencing of Risks and the Planning of the Recovery and Resolution of Credit Institutions and Financial Groups (Gesetz zur Abschirmung von Risiken und zur Planung der Sanierung und Abwicklung von Kreditinstituten und Finanzgruppen) to this extent. Under the amended KWG, certain entities must not conduct specified banking activities. Violation of the prohibitions is a criminal offence.
To which financial institutions do the prohibitions relate?
The scope of the prohibitions is limited to credit institutions within the meaning of Article 4 para. 1 No. 1 of the Capital Requirements Regulation (CRR Credit Institutions) and to entities (Entities) that are members of a group of institutions, a financial holding group, a mixed financial holding group or a financial conglomerate, provided that such group or conglomerate comprises at least one CRR Credit Institution (Group/Conglomerate). However, branch offices established under a passport of one of the Single Market Directives are not subject to the prohibitions.
Automatic applicability by lawThe prohibitions will apply automatically (with a grace period of twelve months) to CRR Credit Institutions or Entities, if the CRR Credit Institution or the Group/Conglomerate meet certain thresholds. The assets held for trading and the assets available for sale according to No. 9 IAS 39 (or, if the CRR Credit Institution or the Group/Conglomerate do not apply international accounting standards, the assets held for trading and the liquidity reserve according to German accounting rules) must exceed: (a) EUR 100 billion at the closing date of the accounts in the preceding business year: or (b) 20% of the CRR Credit Institution’s or Group/Conglomerate’s balance sheet total in the preceding business year, provided in the latter case the balance sheet total amounted to at least EUR 90 billion at the closing dates of the accounts in the last three business years.
If the aforementioned thresholds are met, CRR Credit Institutions and Entities must not conduct:
(a) proprietary business (Eigengeschäft), i.e. the purchase or sale of financial instruments on an own-account basis which does not constitute a service for others;
(b) loan and guarantee business with hedge funds and non-German Alternative Investment Funds (AIF) (or their management companies, respectively), in the latter case provided that the AIF employs leverage on a substantial basis within the meaning of Article 111 para. 1 Regulation (EU) No. 231/2013 (a delegated Regulation supplementing the Alternative Investment Fund Managers Directive); and
(c) high frequency trading, except for market making within the meaning of Art. 2 para. 1 lit. k) of the Regulation on short selling and certain aspects of credit default swaps.
Proprietary trading, i.e. the purchase or sale of financial instruments on an own-account basis as a service for others (which is a regulated activity under the KWG) is not covered by the prohibition.
Applicability by orderEven if the thresholds set forth at 2.1 above are not met, the German Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht - BaFin) may prohibit (with an appropriate grace period) CRR Credit Institutions or Entities to engage in:
(d) the activities listed at 2.1 (a) to (c);
(e) market making; and
(f) other transactions in financial instruments that are comparable from their type to the activities listed at (a) and (b) with regard to their risk intensity, if these activities may jeopardize the solvency of the Credit Institutions or Entities.
What exceptions to the ban on proprietary trading are contemplated by the legislation?
The exceptions to the prohibition are:
- hedging by the Credit Institutions or Entities of their exposure to client transactions, except for AIFs or their management companies;
- transactions for the purpose of managing interest rate, currency, liquidity and credit risks of the CRR Credit Institutions, a group of institutions, a financial holding group, a mixed financial holding group, or a combine (i.e., those credit institutions and financial service providers that belong to the same institutional protection scheme within the meaning of Art. 113 Capital Requirements Regulation); and
- transactions for the sale and purchase of long term participations and transactions that are not entered into for the making of profits by the short term use of actual or expected differences between sale and purchase prices or variation of market prices or interest rates.
Can any other entity within the relevant financial institution’s group of companies carry on the prohibited activity?
The prohibited activities may be transferred to an economically, organisationally and legally separated financial trading institution (Finanzhandelsinstitut); such institution may be a member of the relevant CRR Credit Institution´s/Entity´s group of companies, but is subject to certain additional organisational requirements.
When will the proposed legislation come into effect?
Generally, the new rules will enter into force on 1 July 2015. However, the provisions on applicability by BaFin´s order (see section 2.2 Applicability by order) will become effective as of 1 July 2016.