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Plans to implement MiFID II product governance rules including for EU/EEA branches in Germany

On 28 July 2014, the German Ministry of Finance published a draft of a new law for investor protection amending, inter alia, the German Securities Trading Act (the WpHG) and the German Investment Products Act (the VermAnlG).

1. Amendments to the WpHG

By amending several rules of the WpHG, the German Government intends to implement certain MiFID II rules nearly two years before EU Member States are required to implement the MiFID II provisions.

  • Scope: The WpHG will also cover structured deposits. The draft law does not define the term "structured deposit" but we assume that this term will be interpreted on the basis of Article 4(1) No 43 MiFID II. However, WpHG rules on general conduct of business rules (eg marketing rules) and particular conduct of business rules (eg the suitability or appropriateness test) do not apply to the distribution of structured deposits.
  • Product intervention: The WpHG will grant the German Financial Supervisory Authority (BaFin) far-reaching powers with regard to product intervention.1 BaFin may prohibit or restrict:

a) the marketing, distribution or sale of "certain2 financial instruments" or structured deposits, or financial instruments or structured deposits with certain specified features; or

b) certain types of financial activity or practice.

BaFin may, however, take these measures only if there are reasonable grounds.3

BaFin may use these powers immediately as a precaution even if the product or activity has not yet started. Measures taken will be published on BaFin's home page.

  • Target market: German investment services firms (including EU/EEA branches in Germany4) that manufacture financial instruments are obliged to define a target market for each financial instrument (on an ISIN-basis5) they intend to distribute in Germany and for each subsequent material modification to such a financial instrument.6 When defining the target market – based on internal approval procedures – the potential clients' investment horizon and risk-bearing capacity must be considered. In addition, all relevant risks of the financial instrument must be analysed, in particular default risk and volatility. German investment services firms must also ensure that the intended distribution strategy, eg whether the financial instrument should only be distributed by the manufacturing investment services firm or its branch or third party distributors is in line with the defined target market.

The target market for the financial instrument must be regularly assessed and in particular it must be ensured that the financial instrument still covers the needs of the potential target market and that the distribution strategy remains adequate to approach such target market. The manufacturing investment services firm must provide all distribution partners with sufficient information with regard to the manufactured financial instrument and its product approval procedure (including the potential target market).

Distributing investment services firms (including EU/EEA branches in Germany) must request the aforementioned information from the manufacturing investment services firm and must have in place adequate procedures to obtain such information.

Although the wording of the amended section 33 of the WpHG suggests that only German investment services firms (and branches of EU/EEA investment services firms) are affected, there are uncertainties. According to the discussion of these rules in the ESMA Consultation Paper, distributing German investment services firms may also ask non-German issuers to provide information regarding the potential target market.

Once again, it would appear that Germany is to act as a guinea pig, implementing new European rules while they are still under discussion at the European level. There is a risk that German investment services firms will have to amend their new implementation procedures again once the final MiFID II Level 2 measures are eventually finalised.

One further risk to highlight: the current version of the draft law does not contain any transposition rules for the WpHG. If the law enters into force as currently drafted, the investment services firms will have to apply the new rules immediately after the publication of the law, which is expected in Q1/Q2 2016. BaFin has stongly objected against the implementation of MiFiD II rules already – it remains to be seen where this will end.

2. Amendments to the VermAnlG

The scope of the VermAnlG (currently covering, in particular, participations,7 profit participation rights and registered bonds) will be broadened by including, inter alia, profit participation loans, subordinated loans and other investments that create a claim for interest payments and repayment of principal. As these products will qualify as investment products, a prospectus must generally be published in compliance with the VermAnlG in case of a public distribution; however, there are some new exemptions available, in particular focusing on crowd-funding situations. The prospectus must be approved by BaFin, or will be valid for 12 months only and must be amended if necessary (similar to prospectuses under the EU Prospectus Directive). Also, during the investment product's life cycle, relevant circumstances that might hinder the issuer from fulfilling its obligations must be disclosed to investors, provided that this information is not already publicly available.

Investment products with a duration of less than 24 months after acquisition by the "investor" will not be permitted. The investment products must have a cancellation period of at least 12 months. Investment products with additional payment liability will not be permitted to be distributed publicly.

Advertising and marketing of publicly distributed investment products will be severely curtailed and shall only be permitted if:

  • such advertising/marketing takes place in business and investor media; or
  • the addressee has given its consent to be provided with such advertisements/marketing; or
  • they are directed only to persons that have a licence pursuant to the German Banking Act, the WpHG, or the German Capital Investment Code or a relevant licence pursuant to the German Industrial Code.

BaFin's power to intervene with regard to investment products will also be expanded.

There will be limited grandfathering rules applying only to:

  • investment products that have been subject to the prospectus requirements of the VermAnlG before the amendments come into effect (the effective date), which can be distributed for a further 12 months;
  • investment products that were not to date covered by the VermAnlG but which will be covered from the effective date and have been publicly distributed before the effective date (pursuant to the draft law the new rules will apply as from 1 January 2015 but it is likely that the new law will only enter into force in Q1/Q2 2016); and
  • investment products that are issued after the effective date (the new rules are fully applicable).

Finally, as the new investment products will also be considered "financial instruments" in terms of the WpHG, investment services firms will have to comply with the conduct of business rules when distributing these new investment products.

  1. Pursuant to the new section 4b in WpHG.
  2. The draft law uses this MiFID II wording without defining what is considered a "certain financial instrument".
  3. Reasons similar to the ones in Article 43 (2) MiFID II bearing in mind that the measure must be proportionate.
  4. The term "investment services firm" will include branches of EU/EEA investment services firms in Germany.
  5. This has been heavily criticised by market associations and participants. To avoid an ISIN-based approval procedure and target -market definition one might consider clustering financial instruments and claiming that for every instrument in such a cluster the same (potential) target- market factors are relevant.
  6. Pursuant to the new sections 33 (3b) to (3d) of WpHG.
  7. If these are not AIF.
Legal and Regulatory Risk Note