PLC Global Finance update for January 2011: Germany

Practical Law UK Articles 2-504-6346 (Approx. 5 pages)

PLC Global Finance update for January 2011: Germany

by Simmons & Simmons

Review of 2010/What to expect in 2011

Curse or blessing? 2010 held interesting regulatory times

Jochen Kindermann and Sandra Pfister

The crisis in the financial markets has triggered a series of regulatory reforms at international, European and German level. These reforms were aimed not only at stabilising the financial markets but also at creating a regulatory basis that serves to prevent future crises. Consequently, the 2010 developments primarily relate to corporate governance and compliance, risk management and capital requirements.

February 2010: BaFin publishes its circular concerning marketing materials

In its circular 01/2010, BaFin has provided detailed guidance in relation to the content of marketing materials to be distributed by investment firms. Key aspects of the document dealt with the way information in relation to financial instruments has to be presented. In particular, issues like the simulation of past performance and the impact of costs on the performance of the products have caused lengthy and animated discussions which are ongoing to date. Meanwhile this circular has become part of the minimum requirements for compliance as further outlined below.

March 2010: BaFin presents new rules relating to the disclosure of net short selling positions

On 4 March 2010, BaFin issued a general decree under which market participants must notify it of not short selling positions in stocks of ten listed German financial companies as of a threshold of 0.2% and publish such notification as of a threshold of 0.5%. Notifications must be made by the holder of the net short position by the end of the next trading day and publications must be in an anonymous format on the BaFin website. The decree is due to be replaced by a position which would come into force in March 2012 which might, however, be subject to further amendments following an EU initiative on the same subject. It can be expected that the disclosure obligation will be expanded to all issuers listed on the regulated market of a German exchange.

May 2010: BaFin's comments in relation to the improvement of the investment protocol

In May 2010, BaFin published its comments based on market due diligence it had conducted on the potential to improve its recently introduced investment protocol. As a consequence of the deficits it identified, it can be expected that the investment protocol will be subject to further amendments and will require in particular a more detailed and individual description of the advice provided. This must also be viewed in the context of the EU PRIPS Directive (Packaged Retail Investor Products).

Also in May 2010, BaFin introduced a general prohibition on:

The naked short selling of shares in ten listed German financial companies.
Short sales of government bonds issued by governments of the Euro zone and listed on the regulated market of a German exchange.
The naked short selling of, in particular, CDSs where the reference liability is a liability of a member state of the euro zone provided they are not intended to create an effective hedge.

These general prohibitions, which were published without any significant advance warning, caused a lot of market turbulence. The ordinances have been replaced in July 2010 through the Act preventing abusive securities and derivative trades. Since then naked short selling in shares listed on the regulated market of a German stock exchange is prohibited.

June 2010

In June 2010, BaFin published its minimum requirements for the compliance function and further conduct, organisation and transparency obligations (MaComp). With this document, BaFin undertook a first step to further define the compliance function within an investment firm. The document also includes a number of tasks BaFin expects to be dealt with by the compliance function of an investment firm.

August 2010

Further to the cornerstones introduced by the German government as early as March 2010 and following conclusion of the consultation period, on 25 August 2010, the German government issued the draft Restructuring Act (Gesetz zur Reorganisation von Kreditinstituten –the "Restructuring Act"). The Restructuring Act sets out rules relating to the reorganisation or winding down of distressed credit institutions of systemic importance, among other things, by transferring assets and liabilities of a relevant institution (in whole or in part) to another entity to restructure the business of such institution and so as to avoid insolvency procedures. The Restructuring Act entered into force on 1 January 2011.

September 2010

In September 2010, the German government published the first draft of the so-called Act to strengthen investor protection and to improve operation of the capital markets (Anlegerschutz und Funktionsverbesserungsgesetz or AnlSFG). The AnlSFG, which is expected to come into force in spring 2011, includes a number of new legislative initiatives which will all have a significant impact on the German financial market. Key aspects of this act comprise the preparation of a product information document which has to be handed over to retail clients when providing investment advice. The document is broadly similar to the key investment document that is likely to be introduced in July 2011 as a consequence of the UCITS IV Directive (2009/65/EU). The first draft also included far reaching regulation for closed-ended funds. This has been melted down to registration requirements for distribution personnel, which is still subject to debate and has meanwhile become part of a separate legal initiative.

Another important aspect of the AnlSFG deals with further disclosure obligations concerning, among other things, CFDs. The vague definition which significantly expands the disclosure obligations in relation to economic positions in an issuer is still subject to discussions. The new requirement can be seen as a response to the Porsche/Volkswagen or the Continental/Schaeffler matter where, in particular, the non-disclosure of economic holdings created a misleading picture of the positions held by market participants. According to the draft, the new disclosure obligation will come into effect nine months after the AnlSFG comes into force.

The AnlSFG also introduces registration requirements for employees of investment firms providing investment advice or marketing financial instruments. In addition, compliance personnel will become subject to specific qualification requirements. Another key change to be introduced by the AnlSFG relates to changes of the rules for open-ended real estate investments funds. In particular, a two-year holding period as well as restrictions for institutional investors concerning the redemption of the units they hold will have a significant impact on the further development of this product in Germany.

November 2010

Following the implementation of the directive concerning rating agencies, BaFin confirmed the first registration of a rating agency in Europe. It is of particular importance that the relevant supervisory body is not one of the national supervisory authorities. It has been granted by the newly created European Securities Markets Authority.

Outlook 2011

It can be expected that the various initiatives at EU and national level will mean that the constant flow of new regulations will continue in 2010. The coming into force of the AnlSFG, the implementation of UCITS IV and further capital requirements for institutions are just a few initiatives which will have a significant impact on the financial market regulation.

Financial markets regulation

Significant changes to German investment law come into force in 2011

Dr Harald Glander

The German Investment Act (Investmentgesetz) will be significantly amended this year by two Acts. Both Acts are still in draft form and have not passed parliament yet; the German UCITS IV Implementation Act will align the German Investment Act with the requirements of the UCITS IV Directive (2009/65/EC). Furthermore, the Act to Strengthen Investor Protection and to Improve the Operation of Capital Markets (Gesetz zur Stärkung des Anlegerschutzes und Verbesserung der Funktionsfähigkeit des Kapitalmarktes – AnsFuG) will introduce significant changes to the regulation of German open-ended real estate funds.

In December 2010, the German government published the draft of the UCITS IV Implementation Act which will come into effect on 1 July 2011. The UCITS IV Implementation Act introduces rules on cross-border fund mergers, master-feeder fund structures and the controversially debated management company passport. It might be worth noting that German investment management companies (Kapitalanlagegesellschaften) will be required to produce a "key investor document" (KID) for UCITS funds and for all other regulated public funds as of 1 July 2011.

Earlier last year, in November 2010, the German parliament discussed the AnsFuG, another regulatory initiative. The AnsFuG includes a number of significant regulatory changes which fall outside the scope of any EU regulation. The AnsFuG amends the German Investment Act in respect to open-ended real estate investment funds. The German Investment Act in its current form requires German investment management companies to grant investors of open-ended real estate funds the right to redeem the fund shares on each business day. This has led to problems in the past and resulted in some investment management companies making use of their "emergency right" under the Investment Act and closed the fund (for example; redemptions were not accepted for a specific period of time). The AnsFuG introduces the option of the investment management company to redeem the fund units of open-ended real estate funds only on specific dates (at least once a year). Furthermore, it provides that redemptions exceeding EUR5,000 are only allowed after a two-year holding period. Redemptions exceeding EUR5,000 that are made after two years of investment, but before the fund units were held for three years, are subject to a mandatory redemption discount of 10% of the value of the fund units. If the redemption is made between three and four years of investment, this redemption discount is 5%. Only after holding an open-ended real estate fund for at least four years, an investor will have the right to fully benefit from a redemption of the units. Market participants are of the opinion that this will have a negative impact on the market for open-ended real estate funds in Germany.

Restructuring and insolvency

Upcoming changes in German insolvency legislation

Sandra Pfister

The proposed legislative changes aimed at facilitating and speeding up business rescue processes in Germany include:

Encouragement to negotiate debt restructurings prior to the commencement of insolvency proceedings

The first trend that emerged relates to the desire to encourage the debtor and its key creditors to negotiate the terms of a debt restructuring before the debtor enters into a more extensive insolvency procedure. In this regards, the proposed legislation contemplates the introduction of pre-insolvency restructuring proceedings, which would allow a debtor for a period of up to three months to develop and negotiate an insolvency plan with its creditors, subject to the protection of a statutory moratorium – a quasi German "chapter 11".

Setting a tight timetable for agreement of pre-negotiated restructurings

Under the proposed German legislation, a debtor choosing to initiate pre-insolvency restructuring proceedings will be granted a period of not more than three months in which to develop and negotiate an insolvency plan with its creditors.

Encouraging debtors to initiate restructuring negotiations while still cashflow positive

Under the proposed German legislation, the ability of debtors to pre-negotiate a restructuring with some degree of court protection would be conditional on the debtor having sufficient liquidity to meet its ongoing costs and expenses during the negotiation process. Also, the court would have the power to cut short the pre-insolvency restructuring period if the debtor becomes insolvent.

Strengthening the "debtor in possession" concept

The proposed legislative changes are intended to encourage the debtor's management to act early in order to address the financial challenges facing the company and the amended German self administration regime would allow the debtor's management to remain in control of the debtor's business while the restructuring is being negotiated, subject to a certain degree of supervision by a court-appointed trustee, the Sachwalter tasked with reviewing and facilitating the restructuring process.

Reducing the influence of dissenting creditors

Under the proposed German legislation, majority creditors would be able to influence the choice of the insolvency administrator (and thus the likely path of the restructuring process). Moreover, in considering whether to grant a self administration petition, the court would generally be required to follow the majority creditors' wishes. Also, the proposed reforms would limit those minority creditors' powers to object to an insolvency plan, unless they can show that:

The plan puts them into a materially worse position compared to the position they would be in without the plan.
Creditors cannot be compensated for a worse position by a payment specifically provided for in the insolvency plan.
The right of an individual creditor to seek the termination of the self administration process would be limited.

PLC Global Finance update for January 2011: Germany | Practical Law