Supervision of Financial Markets in Germany

1
Supervision of Financial Markets in Germany

• ISU 2006

2

• Dr. Jens Fürhoff
• Senior Director
• Bundesanstalt für Finanzdienstleistungsaufsicht
• German Financial Supervisory Authority
• Graurheindorfer Str. 108
• D-53117 Bonn
• Phone [phone]
• Fax [phone]
• E-Mail Jens.Fuerhoff_at_bafin.de

3
The new Federal Financial Supervisory Authority
(BaFin) 

• established on 1 May 2002
• the former
• offices for banking supervision
  (Bundesaufsichtsamt für das Kreditwesen - BAKred)
• insurance supervision (Bundesaufsichtsamt für das
  Versicherungswesen - BAV) and
• securities supervision (Bundesaufsichtsamt für
  den Wertpapierhandel - BAWe)
• have been combined in a single state regulator
• two offices located in Bonn and Frankfurt/Main

4
European Framework for Financial Supervision

• Maastricht Treaty of 1992 establishes European
  Union (EU) and stipulates basic rules within EU
• Article 105 of Maastricht Treaty Banking
  Supervision remains in national responsibility of
  member states (same applies to Insurance
  Supervision)
• Banking Supervision assymetric to Monetary Policy
• Maastricht Treaty gives Power of Monetary Policy
  to European Central Bank (ECB) in Frankfurt
• National Central Banks, including Deutsche
  Bundesbank, no longer directly involved in
  Monetary Policy decision making process
• Only President of Bundesbank represented in ECB
  Council

5
European Framework for Financial Supervision (2)

• Diversified picture of institutional organization
  of Banking Supervision in EU
• Ranging from Central Banks being completely in
  charge of Banking Supervision to UKs Single
  Regulator Concept with Independent and Integrated
  Supervisor being responsible i.a. for banking,
  securities and insurance supervision

6
Former System of Financial Supervision in Germany
Insurance Supervision BAV Federal
Insurance Supervisory Office (Bonn) about 350
people
Market Supervision BAWe Federal
Securities Office (Frankfurt) about 250
people
Banking Supervision BAKred Federal
Banking Supervisory Office (Bonn) about 650
people gt co-operation with Bundesbank in
day-to-day supervision
7
Options for change discussed in Germany 1999 and
2000

• Combine Banking Supervisory functions of BAKred
  and units involved with banking supervision in
  Bundesbank (around 600) under the roof of
  Bundesbank
• Create new and independent Supervisory Authority
  in charge of banking, insurance and securities
  supervision
• Various mixtures of the above

8
January 25, 2001Decision for an Integrated
Supervisor

• Ministry of Finance (MoF) Press Conference by
  Minister Hans Eichel
• BAKred, BAV and BAWe will be merged into one
  independent Federal Agency combining old offices
  duties and staff under one umbrella
• Name of the new agency (announced later)
• Bundesanstalt für Finanzdienstleistungsaufsicht
  BaFin (Federal Financial Supervisory Authority)

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January 25, 2001Decision for an Integrated
Supervisor (2)

• BaFin as an integrated regulator supervises
  German financial market as a whole
• Offices remain in Bonn and Frankfurt BaFin
  retains a double seat
• Bundesbank involvement in on-going day-to-day
  Banking Supervision continues details are
  spelled out in the new Article 7 of the Banking
  Act gt Modified Single Regulator
• single regulator because of integrated
  supervision of financial market as a whole
• concept combines advantages of single regulator
  with active role of central bank in banking
  supervision in order to maximize positive effects
  for financial stability

10
Reasons for BaFin

• Institutional make-up of supervisory framework
  has to reflect realities in the financial markets
  in order to generate proactive supervision
• Banks, insurance companies and securities firms
  competing in the same markets, for the same
  customers, with similar or identical lines of
  products, via the same distribution channels
• Convergence of products particularly advanced in
  mortgage loans, derivative trading, asset
  management and the combination of investment
  funds for capital formation

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Reasons for BaFin (2)

• Weakening of entry barriers into the financial
  markets increased blurring of business lines
  reform of German pension system from 2002 on a
  further catalyst for convergence of banking and
  insurance products
• Similar convergence between product vendors and
  distribution channels
• In essence vanishing cross-sectoral boundaries
  and traditional distinctions which used to apply
  across types of firms, types of product and types
  of distribution channels
• Organization and management of financial
  institutions have comparable structures

12
Reasons for BaFin (3)

• Due to credit and market risk transfers, risk
  assessment becomes more cross-sectoral in nature
• Overall level playing field issue same business,
  same risks, same rules
• Huge Financial Conglomerates takeover of
  Dresdner Bank by Allianz and increased
  participation by Munich Re in HypoVereinsbank
  two biggest financial conglomerates in the EU are
  German (Nos. 3 and 4 worldwide)
• Overall, increased number of mergers and
  acquisitions between/by banks and securities
  firms, purchases of fund managers by banks and
  insurance companies

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Reasons for BaFin (4)

• Consumer and investor protection strengthened by
  one supervisor for financial market as a whole
• More flexible payment structure in the future by
  taking supervision out of the Federal Budget
  (100 financed by supervised entities)
• Better representation of German interests
  internationally by co-ordination of BaFins
  cross-sectoral activities in international
  committees and groups

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Reasons for BaFin (5)

• costs General rationale for a single regulator
• Synergies of scale and scope in larger
  organisation
• More efficient supervision by avoiding
  duplications between sectoral supervisors
• Better internal resource allocation
• More effective and efficient conflict resolution
  between different objectives of supervision,
  especially prudential/ solvency and consumer
  protection
• Reduction of indirect supervisory costs

15
Implementation in 2002

• Draft bill was passed by Cabinet in fall of 2001,
  approved by Bundestag early 2002, not vetoed by
  Bundesrat in late March 2002, Bill enacted into
  law by April 30, 2002
• Political decision making process was difficult
  for several reasons and took more time than
  expected
• BaFin not operative as of January 1, 2002, as
  planned in 2001 now, BaFin operating since May
  1, 2002
• BaFin outside of Federal Budget paid for 100 by
  financial sector
• Budget for 2002 approved by August 30, 2002,
  budget for 2003 approved by November, 18 208 new
  staff by the end of 2002 and an estimated 228 for
  2003

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Financing of the BaFin

• The costs of the BaFin are 100 bourne by the
  supervisedindustry
• Fees (FinDAGKostVO)
• Allocation (min. 250,-)
• Banking 91 credit institutions, 9
  financial services institutions
• Insurance enterprises 100 insurances
• Securities Trading 76 credit institutions,
  5 brokers,
• 9 financial servises institutsions,
  10 issuers.
• Capital utilisation according to decision of
  admin. counsil

17
BaFins organisational structure
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BaFins organisational structure (2)
cross-sectoral departments
Department Q1 Financial Markets (Capital Markets
and Financial Instruments, Retail Markets and
Products, Financial Research and Stability,Germany
as a Financial Center)
Department Q2 Consumer and Investor Protection, Pe
nsion Schemes and cross-sectoral legal
matters
Department Q3 Integrity of the Financial System (e
nforcement against financial businesses without
licence, on-site inspections)
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BaFins organisational structure (3)

• Banking
• Supervision
• 4 Departments
• Solvency
• supervision
• of credit
• institutions
• Licensing,
• revocation and
• limitations of
• operations of
• credit institutions

• Insurance
• Supervision
• 5 Departments
• Licensing and
• solvency
• supervision of
• insurance
• companies

• Securities
• Supervision
• 4 Departments
• Market
• surveillance
• Insider supervision,
• transparency, rules
• of conduct
• Licencing and
• Supervision of
• financial services
• institutions and
• collective Invest-
• ment Schemes
• asset management

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Types of financial institutions and key
legislation I

• Credit institutions (Section 1 para. 1 of the
  Banking Act) conduct banking buisness comprising
  deposit taking, lending, principal brokerage
  service, safe custody business, investment fund
  services, the assumption of obligations to
  purchase claims under loans prior to maturity,
  guarantees, giros, underwriting of securities
  issues, prepaid cards and network money business
• Universal banks offering all of the
  above-mentioned business activities
• Categories of credit institutions private
  commercial banks, saving banks, cooperative banks
  and specialised banks (mortgage banks, building
  societies, investment fund companies)

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Types of financial institutions and key
legislation I

• Financial services institutions (Section 1 para.
  1 a of the Banking Act) conduct investment
  brokerage, contract brokerage, portfolio
  management, own-account trading for others,
  foreign (non-EEA) deposit broking, money
  transmission service and foreign currency
  dealing.

22
Ongoing requirements under the Banking Act

• Disclosure requirements change of management,
  change of control, the name and address of
  shareholders with a substantial interest in the
  institutions, the acquisition or disposal of a
  participating interest in another enterprise of
  at least 10, any changes in legal form,
  corporate name partnership agreemnt or coporate
  domicile etc.
• Prudential control (captial adequacy and large
  exposures) immediate reports of any loss which
  amounts to 25 of the liable capital monthly
  reports the data needed for checking the adequacy
  of own funds monthly reports of returns of
  balance sheets (to BaFin and German Central Bank)
• Adequate liquidity Financial services
  institutions and credit institutions are bound to
  submit at monthly intervals to the BaFin and the
  German Central Bank the data needed for
  supervising liquidity situation

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Securities and Asset Management Supervisory
Sector
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Objectives
Market Integrity
Investor Protection
Market Transparency
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Responsibilities 1

• Investigations of insider offences
• Investigations of price and market
  manipulation
• Monitoring all trading activities in
  securities and derivatives (Stock Watch)
• Monitoring disclosure of price sensitive
  information
• Monitoring disclosure of Directors Dealings

Market Integrity
26
Responsibilities 2

• Monitoring disclosure of price sensitive
  information
• Monitoring disclosure of Directors Dealings
• Monitoring disclosure of significant changes
  in voting rights
• Monitoring compliance with the Takeover Act

Market Transparency
27
Responsibilities 3

• Licensing and solvency control
• Monitoring rules of conduct
• Depository for offering prospectuses
• Monitoring compliance with the Takeover Act
• Supervision of investment fund companies
  (KAGG, AuslInvG)
• Admission of foreign organized markets

Investor Protection
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Supervision of Securities Trading
Three-Tier System of Exchange Supervision
BaFin overall surveillance on and off exchange
Exchange Supervisory Authorities (States)
Trade Surveillance Units of Exchanges (HÜSt)
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Exchanges in Germany
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Exchange Supervisory Authorities

• Legal and market supervision of stock exchanges
• Investigations of violations against Rules and
  Regulations of the stock exchange
• - Monitoring price formation processes
• - Detection of market abuses
• - Fraud prevention
• - Lawful conduct of exchange bodies
• Admission and monitoring of specialists
• Supervision of the Trade Surveillance Units

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Trade Surveillance Unit

• Monitoring trading on the exchange and the
  settlement of exchange transactions.
• Systematically and completely recording and
  evaluating data regarding exchange trading and
  the settlement of exchange transactions.
• Conducting any necessary investigations.

32
Securities Supervision

• Supervision over securities trading in accordance
  with the provisions of the WpHG.
• Counteract undesirable developments in securities
  trading which may adversely affect the orderly
  conduct of securities trading or provision of
  (non-core) investment services or result in
  serious disadvantages for the securities market.
• Issue orders designed and necessary to eliminate
  or to prevent such undesirable developments.
• The BaFin performs its functions and exercises
  its powers solely in the public interest.

33
Scope of the WpHG

• The Securities Trading Act (WpHG) applies to
  (Section 1)
• providing investment services and non-core
  investment services
• trading in securities, money-market instruments
  and derivatives on and off stock exchanges and
• changes in the percentage of voting rights held
  by shareholders of listed companies.

34
Provisions on Offences

• Imprisonment of up to five years for insider
  trading
• and market manipulation
• Fine of up to 1 m for misdemeanors
• Sections 38 and 39

35
International Cooperation

• General Provision
• Section 7 WpHG
• Special Provision
• Section 36c WpHG rules of conduct

36
Section 7 WpHG
Cooperation with the competent authorities
responsible for supervising stock exchanges or
other securities or derivatives markets and of
trading in securities, money-market instruments,
derivatives or foreign exchange in other
countries.

• Communication of facts required for the
  respective supervision
• For administrative or court proceedings connected
  with such supervision
• Specification of purpose for which such facts may
  be used
• Confidentiality must be guaranteed
• Requesting authority may not give away data to
  any other person or institution as to the
  responsible one for investigating or prosecuting
  the claimed offences

37
International Cooperation

• Bilateral Cooperation
• Memoranda of Understanding (MoU) with 27
  countries
• Exchange of Regulatory Information, Mutual
  Assistance
• IOSCO (International Organisation of Securities
  Commissions)
• CESR (Committee of European Securities
  Regulators) MoU
• European Passport (EU)

38
Memoranda of Understanding

• Bilateral agreements
• Legally non-binding
• Provision of mutual assistance
• Exchange of regulatory information
• Confidentiality obligations
• Contact persons

27 MoU CESR-MoU (27 members)
39
IOSCO

• Non-governmental association of the securities
  commissions of developed and emerging markets
• Founded in 1983, on basis of a pan-American
  organisation of 1974
• Membership of over 160 commissions from all
  continents
• Categories of membership
• ordinary members (e.g. BaFin)
• associate members
• affiliate members (e.g. Deutsche Börse AG)

40
Objectives of IOSCO

• The member agencies of IOSCO have resolved,
  through its
• permanent structures, to
• cooperate together to promote high standards of
  regulation in order to maintain just, efficient
  and sound markets
• exchange information on their respective
  experiences in order to promote the development
  of domestic markets
• unite their efforts to establish standards and an
  effective surveillance of international
  securities transactions
• provide mutual assistance to promote the
  integrity of the markets by a rigorous
  application of the standards and by effective
  enforcement against offenses.

41
Securities Sector

• Monitoring all trading activities in securities
  and derivatives (Stock Watch)
• Investigations of insider offences and market
  manipulation
• Monitoring disclosure of price-relevant
  information
• Monitoring disclosure of significant changes in
  holding of voting rights
• Monitoring rules of conduct
• Depository for offering prospectuses
• International cooperation

42
Insider Trading
Criminal offence according to Section 38 Section
12 Insider Securities Section 13 Insider
Information Section 14 Prohibition of Insider
Dealing Section 4 Regular monitoring
43
Insider Securities

• securities and
• derivatives
• which are traded
• on a German stock exchange or
• on an organised market in a member state of the
  European Union (EU) or another contracting
  state to the European Economic Area (EEA)
• (Section 12)

44
Insider Information

• Any information which
• relates to one or more issuers or
• relates to one or more securities,
• is non-public and
• could materially influence the price of the
  security if it became publicly known.
• (Section 13)

45
Insider

• Any person who
• by virtue of his or her membership of the
  management or supervisory body of the issuer,
• by virtue of his or her participation in the
  capital of the issuer (shareholders),
• by virtue of the designated purpose of his or
  her profession, employment or duties
• by virtue of kriminal activities
• has knowledge of insider information.
• (Section 38)

46
Prohibition of Insider Dealing

• Insiders and third parties (secondary insiders)
  who know of insider information may not
• take advantage of such knowledge to sell or buy
  insider securities.
• make available insider information
• recommend a third party to sell or buy insider
  securities.
• (Section 14)

47
Price- and Marketmanipulation

• It is prohibited to make incorrect statements
  about facts which are germane to the valuation of
  an asset if such information would be likely to
  have an effect on the stock exchange or market
  price of an asset. Silence is treated in the same
  way if there is a legal obligation for
  disclosure.
• Prohibited is it as well to carry out other
  actions aimed at the deception for the purpose of
  exerting influence on the price..
• Safe HarborBaFin will issue a List of these
  actions and omissions which on no account violate
  the prohibition.
• Sanction If action actually affects the price
  arrest up to 5 years or fine (criminal act), in
  case there is no influence measurable fine up to
  1 mio. (administrative offence).

48
Sources of Information

• Screening media news for insider information
• Receiving information from other authorities
• Continuously monitoring the information published
  as ad hoc announcements
• Automatic analysis through SWAP (Securities Watch
  Applications)

49
Ad hoc Disclosure

• Section 15 An issuer of securities
• admitted to trading on a German stock exchange
• must immediately publish
• any new information, which
• 1. has occured in the sphere of activity of the
  issuer
• 2. is not publicly known
• 3. is likely to have a significant influence on
  the exchange price

50
Way of Disclosure

• Previous information of the BaFin and the
  exchanges
• Publication via - an electronic information
  dissemination system and - on the internet page
  of the issuer
• Transmission of the publication

No other publication prior to the ad hoc
announcement is allowed
51
Exemptions

• 1. On decission of the issuer
• 2. If disclosure is likely to damage the
  legitimate interests of the issuer
• 3. Weighing up the interests of the issuer and
  those of the capital market

52
Insider Investigations
New information?
Material influence on the price?
yes
yes
Analysing charts with respect to prices and
volumes
Conspicuous?
Stop
Stop
Analysts
Suspicion confirmed?
53
Insider Investigations
Asking issuer about course of events
Examination and analysis of the replies
Asking credit institutions to disclose the
identity of customers
Asking other primary insiders
List of primary insiders
List of buyers/ sellers
Investigators
Comparison
Irregularities?
Stop
Handing the case over to the public prosecutor
Suspicious?
23
54
development of price and sales of X-AG
Price Sales
Ad hoc-announcement of 28.6.1996
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Reported details

• Identification of the party obliged to report
• Date of the transaction or price determination
• Time of the transaction or price determination
• Type of transaction purchase or sale
• Identification of customer/own account
  transactions and if own portfolio was affected
  (Yes/No)
• ID number and name of the security/derivative
• Nominal value
• With effect from 1 April 2003 additional
• Marker to identify the account holder
• Marker to identify the principal unless identical
  with account holder.

56
SWAP

• Securities Watch Applications
• Statistical analysis of the reported data in
  order to filter out irregularities in the
• turnover,
• price and
• yield
• of every security irrespective of any
  immediate cause

57
Directors Dealings Sec. 15 a WpHG

• Members of the management or supervisory bodies
  of an issuer which securities are listed on the
  exchange,
• their spouses, registered partners and relations
  in the first degree
• shall immediately notify the issuer and the BaFin
• of the acquisition or disposal of the shares of
  the issuer.
• Not applicable, if the acquisition is made on the
  basis of an employment contract or the aggregated
  value of the total number of transactions within
  1 year does not exceed 5.000,-.
• The notification has to be published on the
  issuers website for a period not shorter than
  one month.

58
Holdings of Voting Rights

• Section 21, 25
• Any person whose shareholding in a listed company
• reaches, exceeds or falls below of
• 5, 10, 25, 50 or 75 per cent
• shall immediately notify the company and the
  BaFin

The listed company must publish this notification
immediately in at least one supra-national
official stock exchange gazette.
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Exemption

• Section 25 (4)
• The BaFin may release the company from the
  disclosure requirements
• upon written request
• if disclosure would be contrary to the public
  interest or would cause considerable damage to
  the company

60
Rules of Conduct

• General rules of conduct Section 31
• Special rules of conduct Section 32
• Organisational requirements Section 33
• Documentational requirements Section 34
• Separate asset management Section 34a

61
Rules of Conduct

• Monitoring of rules of conduct Section 35
• Examination of rules of conduct Section 36
• Enterprises domiciled in EU or EEA Section 36a
• Advertising by investment services enterprises
  Section 36 b

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Prospectuses for Securities Offered for Sale
63
Prospectuses

• Prospectus Act
• For securities which are offered to the public in
  Germany for the first time
• the offeror shall publish a prospectus
• containing the information necessary to enable
  the public to make aproper assessment of the
  issuer and the securities,
• and deposit it with the BaFin before publication.

64
Takeover Act

• Monitoring of the procedure according to the
  WpÜG
• Examination of the offer documents as to their
  form
• and completeness and evident violations against
  the
• WpÜG
• BaFin may issue orders designed and necessary
  to eliminate or to prevent undesirable
  developments Prohibition of the Offer
• Sanction BaFin can pose fines up to 1 mio.

65
Offer Types

• 1. Tender offers to acquire securities of a
  target company, not intended to gain control
• 2. Take-over offerfor bids aimed at acquiring
  control over a target company (holding of at
  least 30 percent of the voting rights) bidder is
  required to make an offer for all outstanding
  shares
• 3. Mandatory Offer Control was gained by means
  of an acquisition bidder is required to make an
  offer for all outstanding shares.
• In (2) and (3) the consideration must be at
  minimum the equivalent of the 3-month-weighted
  average exchange price calculated by the BaFin.

66
Offer document

• To ensure appropriate information of the
  shareholders the offer document must contain e.g.
• information on the bidder,
• the consideration being offered,
• the purpose of the acquisition,
• means of financing,
• and post-acquisition plans for the target
  company.
• In response to an offer, the targets management
  board (Vorstand) must publish a statement,
  containing the likely effect on company affairs,
  a recommendation to the shareholders, a
  recommendation from the employees or their
  council.