German financial regulatory authorities have implemented new disclosure and monitoring obligations to align the country’s retail banking system with European Banking Authority (EBA) guidelines.
The German Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht - BaFin recently issued a circular proposal aimed at protecting the interests, objectives and characteristics of consumers in line with European product oversight and governance guidelines. The circular may have an impact and impose new compliance duties on manufacturers and distributors.
BaFin is accepting comments on the circular until February 28, 2023. The circular takes effect May 1, 2023. It will apply to products introduced to the market after May 1, as well as to all products already on the market that have undergone significant changes since the circular’s effective date.
The European Banking Authority (EBA) issued guidelines on the supervision and governance of retail banking products aimed at product manufacturers and distributors in 2015.
Initially there were doubts regarding a sufficient basis in European law, which is why BaFin did not initially adopt the guidelines in its German supervisory practice.
This has now changed with the European Court of Justice (ECJ) ruling of July 15, 2021, which clarified the validity of the guidelines. Following the ECJ ruling, BaFin is now implementing these guidelines in a circular closely aligned with the initial guidelines.
The circular is based on Section 15a (1) of the German Banking Act (KWG) and Section 27 (1) of the German Payment Services Supervision Act (ZAG). It regulates banking products (in particular real estate) consumer loan agreements, deposit products and payment services) and organizational requirements for internal control systems of institutions as defined by the KWG and ZAG. The regulations relate to internal processes, functions and strategies of a product, based on its entire life cycle. They aim to ensure the interests, objectives and characteristics of the target market, that is, the consumers for whom each financial product was designed. The guidelines impose specific rules on both product manufacturers and product distributors, and regulate disclosure and monitoring obligations of both.
What the regulations mean for product manufacturers
For the purposes of the Circular, product manufacturers are defined as companies that design products to be offered to consumers, and are also subject to specific categories of the KWG and ZAG listed in the Circular. Under the circular, they:
- Are encouraged to establish, implement and review arrangements for effective product monitoring and governance, which should be proportionate to the nature, scale and complexity of each product manufacturer's activities. In particular, they should meet the interests, objectives and characteristics of consumers, to avoid potential harm to them and to minimize conflicts of interest as far as possible.
- Must perform an internal control function on a regular basis. This involves ensuring that the rules are properly integrated, based on approval from the product manufacturer's governing body. Upper management is responsible for ongoing competent monitoring and optimization.
- Must design procedures and product monitoring according to, and in coordination with, the target market. To do this, they must first determine the target market and ensure that the product is compatible with the interests, goals and characteristics of each market. The regulations require product manufacturers to conduct product tests to assess how any given product might affect consumers.
- Must recognize: Once a product is launched, the ultimate responsibility for monitoring that product’s compatibility with consumer interests, goals and characteristics rests with the product manufacturer. They will be obliged to take necessary countermeasures as soon as a problem arises with the product or the imposed product monitoring. Product manufactures must also inform product distributors of the issue immediately.
- Must select a distribution channel suitable for each target market. They must identify prudent and adequately trained product distributors for the target market. Product manufacturers must monitor distributor activities to ensure products sell only in the defined target market, and sell outside the target market only in justified, exceptional cases.
- Will be required to provide product distributors with comprehensive information reporting on the respective product. This includes descriptions of the key features, risks and limitations, as well as the total price of the product. This product information must be clear, concise, and up-to-date, for product distributors to understand the product, identify the appropriate target market, and thus properly conduct their business.
What the regulations mean for product distributors
Product distributors, as defined by the circular, are companies that offer and/or sell the product to consumers. This includes divisions of the product manufacturer that are not involved in the design and serve exclusively to market a product. Product distributors:
- Must establish, implement and review internal rules for effective product monitoring and governance, specifically tailored to their own size and areas of responsibility. These rules exist to protect consumers in accord with laws governing product manufacturers. Such internal rules must be regularly reviewed and updated.
- Are subject to a documentation obligation, which means manufacturers must adequately document the measures they took for product monitoring, and these documents must be retained for at least five years and sent to the federal agency or the product manufacturer for auditing purposes upon request.
- Must integrate the rules into procedures and controls already carried out to date, and where necessary, the governing body must grant any approvals required for this purpose.
- Must demonstrate a strong knowledge of the relevant target market. This will be based on information provided by the product manufacturers from which distributors should determine whether a consumer belongs to the product's target market.
- Must develop their own information base, in addition to using information provided by the product manufacturers, to determine a product’s target market. They must engage proactively with manufacturers where, on an exceptional basis, they are considering offering the product to a consumer not within the identified target demographic. Distributors must report any potential problems between the product and the target market as soon as they are identified.
If product manufacturers or product distributors outsource some, or all, of their activities to third parties, they must ensure it happens in a manner compatible with outsourcing frameworks. In the case of outsourcing, the ultimate responsibility remains with the upper performance level of the institution operating the outsourcing. Individual consumers are not the subject of the Circular.