A. Bill of the “Law on shielding credit institutions and financial groups against risks and planning their restructuring and winding-up”

On 6 February 2013, the German government presented a proposal of a “Law on shielding credit institutions and financial groups against risks and planning their restructuring and winding-up”. In the government’s view, one of the key lessons of the crisis in the financial markets is the need for suitable tools for either restructuring or winding-up of struggling system-relevant banks and financial groups in a proper process. In addition banks should deal with any potential crisis and any organisational and business measures necessary to handle a crisis out of its own resources.

The draft legislation essentially covers three areas.

The first part of the bill relates to the restructuring and winding-up of banks and provides inter alia for regulation requiring system-relevant banks to set up restructuring and winding-up plans to be prepared for a crisis. These plans have to contain measures to be taken by the management in individual cases. The German Federal Financial Supervisory Authority (BaFin) may, together with the German Bundesbank, issue instructions to enable and facilitate the prompt introduction and rapid implementation of restructuring or winding-up measures.

The second part of the bill is the one to which the law owes its name of “Separate Banks Act”. The government believes that risk areas within banks shall be isolated from each other more effectively than in the past. Economic and legal separation of risky activities from retail banking could ensure the solvency of banks and secure the ongoing stability of the financial markets, while also enabling simpler winding-up of such activities. In the future, speculative trading will be conducted by an economically and legally independent company (financial trading institution) which is refinanced without relying on guarantees from its parent company and supervised on a caseby- case basis by the administrative or supervisory body of the parent. These financial trading institutions will not be allowed to provide payment services or operate an electronic payment business within the meaning of the German Payment Services Supervision Act (Zahlungsdiensteaufsichtsgesetz).

The third part of the bill aims at holding managers of credit institutions, financial services institutions and insurance companies criminally responsible in case the company gets into financial difficulties as a result of their mismanagement. The government points out that the protective purpose of core and ancillary criminal law has a different focus. As such, breaches of risk management obligations which threaten the stability not only of the individual bank but also of the entire financial system are currently not punishable under criminal law. Based on the existing regulations on risk management in banks (section 25a of the German Banking Act (KWG) in conjunction with the MaRisk risk management regulations) and insurance companies (section 64a of the Insurance Supervision Act (Versicherungsaufsichtsgesetz)), specific responsibilities shall now be defined for managers which set minimum risk management standards, backed by accompanying penal provision.

B. Impact on the companies affected

1. Recovery and resolution planning

The government’s proposal provides for additions to the existing sub-section 4a of the KWG (sections 47 – 47j KWG, proposed version) for preparing and implementing the restructuring and winding-up of financial institutions in crisis situations. The rules govern in particular the preparation and arrangement of restructuring and windingup plans in such banks and financial groups (banking groups, financial holding groups) which, by BaFin in agreement with the German Bundesbank, are categorised as being of systemic importance due to the fact that a threat to their continued existence could also result in a threat to the entire financial system. Is the institution instructed to prepare a restructuring plan, such plan must be presented within six months and regularly updated. Restructuring plans must in particular contain an assessment of the ability of the credit organisation or financial group to recover, a strategic analysis of the credit organisation or financial group, a presentation of possible measures and their conditions precedent and a presentation of the obstacles and it also has to show that the crisis can be overcome using the institution’s own resources and without stabilisation by the public sector.  

A separate winding-up unit is to be set up within BaFin which will review the resolvability of relevant institutions on an ongoing basis via a comprehensive set of tests, and in detail assess the ability to liquidate the relevant institution via insolvency proceedings or by way of a transfer order without posing a systemic risk and without using public funds or negatively impacting other financial market participants, creditors or depositors. BaFin will prepare a windingup plan for every institution that potentially poses a systemic risk which in particular will contain a strategic analysis and details of how essential and critical business activities can be separated both legally and economically from other functions to the extent required to guarantee continuity in the event that the credit institution is liquidated. The resolution plan has to be submitted to the German Bundesbank and the Federal Agency for Financial Market Stabilisation (Bundesanstalt für Finanzmarktstabilisierung) for their opinion and shall be updated at least once a year. The relevant banks are required to assist in the preparation of the winding-up plan by providing information (without their costs being reimbursed), but they are not entitled to demand that BaFin discloses the content of the winding-up plan to them.

2. Bank separation

The second core element of the government’s proposal is the introduction of bank separation in accordance with the findings and recommendations of the EU’s Liikanen Report from 2 October 2012 (high-level expert group on reforming the structure of the EU banking sector chaired by Erkki Liikanen).

Under the separate banks system, deposittaking institutions and groups which include deposit-taking institutions would be obliged to transfer certain activities categorised as speculative or risky to an independent trading entity if its trading activities in this respect make up more than 20% of its total balance sheet and the total balance sheet in each of the last three financial years exceeds EUR 90 billion (relative threshold) or if its trading activities exceed a balance sheet of EUR 100 billion (absolute threshold). Transactions categorised as speculative or risky include proprietary transactions (i.e. the acquisition and sale of financial instruments for own account which is not a service for any other party), loan and guarantee transactions with hedge funds or hedge funds of funds or their management companies and with alternative investment funds (AIFs) as well as proprietary trading transactions (i.e. the sale or purchase of financial instruments for own account as a participant in a domestic organised market or multilateral trading system using automated trading systems, with the exception of market-making activities).

Transactions which are entered into in order to hedge transactions with customers, which are for the purposes of the bank’s or banking group’s management of interest rates, currency or liquidity, or which are for the purposes of the acquisition or sale of long-term investments will continue to be permitted. However, BaFin can also prohibit these otherwise permitted transactions irrespective of the thresholds mentioned where there are concerns that they could pose a threat to the solvency of the bank, particularly relative to the volume of other business, to income or to the risk structure.

3. Criminal law provisions

By supplementing section 25c of the KWG and section 64a of the VAG extensive and detailed responsibilities for managers with respect to the implementation of the statutory regulations on risk management in financial institutions and insurance companies shall be established. According to these provisions and in order to observe the compliance with the above-mentioned rules BaFin would have the authority to order injunctions and impose fines in the event of a breach.

Negligent and wilful breaches of obligations by managers in relation to the abovementioned responsibilities would also be punishable under criminal law and sentenced with prison of up to five years or a fine, if those breaches of obligations jeopardises an institution’s viability or the ability to perform its obligations under an insurance agreement. The penalties apply whether or not the institution in question is system relevant or of a certain size or a threat to its existence actually results in a threat to the entire financial system.

4. Time frame

The regulations regarding restructuring and winding-up planning are intended to come into force the day after promulgation of the law. The rules on bank separation are scheduled to come into effect on 31 January 2014. Determining the transactions that will be prohibited for the affected institutions and setting up the trading entities to which the activities have to be outsourced must have taken place by 1 July 2014. Actual separation of business activities needs to be implemented by 1 July 2015. The new criminal law regulations for managers related to violation of risk management obligations are intended to apply from 2 January 2014.

5. Outlook

The ideas contained in the government’s proposal are in general to be welcomed. However, as these matters are also being considered at international level, taking unilateral action at national level makes little sense given the subsequent need to make changes to the law. Furthermore, measures that have already been agreed upon, such as Basel III and the European banking supervision, have not yet been implemented so that there would certainly be further need for action in other respects.

Fears that bank separation would weaken the established German universal bank system are unfounded. By creating two separate legal entities within the same banking group, the government’s proposal promises more transparency, less interconnection and increased stability. The universal banking system itself will be retained. However, the bill does not expressly regulate whether and to what extent a trading entity will be able to conduct other banking transactions which require authorisation or provide further financial services in addition to speculative or risky transactions.

Transferring trading activities to an entity which is legally independent may also cause significant tax-related problems, for instance because hidden reserves contained in the transferred business are subject to income tax. This transfer may also trigger the payment of VAT. The extent to which the trading entity may belong to a tax group also remains to be seen.

In contrast to the bank separation approach and crisis management regulation aspects of the bill, the part which deals with criminal sanctions for risk management failings is not consistent with European legislative plans or other international regulations. Accordingly, some observers believe that the planned criminal law provisions are unconstitutional because they do not pursue any recognised criminal law purpose and could be viewed as symbolic legislation and unilateral action that ignores the plans of other countries.