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16 September 2019

New mea­sures to fur­ther en­hance in­vestor pro­tec­tion

The Federal Ministry of Finance and the Federal Ministry of Justice and Consumer Protection have agreed on a package of measures to enhance investor protection. The measures expand the scope of BaFin’s powers for the supervision of financial products and their distribution. Capital investments are now subject to even stricter requirements.

Two persons sitting at a desk, one writing with a pen, one typing on a laptop
Source:  iStock/Chalirmpoj Pimpisarn

Protecting investors is one of the main objectives pursued by the German government in the area of financial market regulation. A lot has been done and achieved over the last few years, including the reforms that were introduced with the Retail Investor Protection Act (Kleinanlegerschutzgesetz) in 2015. The provisions covering capital investments (Vermögensanlagen) and closed-end retail funds (geschlossene Publikumsfonds) now offer a level of protection that is comparable to the level of protection for securities.

But financial markets are constantly evolving, and events such as the insolvency of a major investment fund company in Germany have made it clear that investor protection needs to be improved even further. To achieve this, the Federal Ministry of Finance and the Federal Ministry of Justice and Consumer Protection have agreed on a package of measures to enhance investor protection. These measures extend the powers of the Federal Financial Supervisory Authority (BaFin) for the supervision of financial products and their distribution. Capital investments are now subject to even stricter requirements. In addition, BaFin will be increasing its efforts to inform and teach consumers about finance as part of its mandate to protect the collective interests of consumers.

The following measures in particular have been agreed:

  1. Prohibiting incomplete prospectuses
  2. Prohibiting capital investments in the form of blind pools
  3. Restricting the distribution of capital investments to supervised intermediaries
  4. Extending BaFin’s powers to examine the accounts of capital investment issuers
  5. Requiring independent third parties to conduct audits on the use of funds in the case of direct investments
  6. Making use of product intervention powers in the context of capital investments
  7. Requiring closed-end retail funds to apply for authorisation from BaFin
  8. Transferring the supervision of independent financial investment intermediaries to BaFin
  9. Stepping up BaFin’s activities to inform consumers about capital investments

The objective of these legal and supervisory measures is to create a framework that allows retail investors in particular to make investment decisions as independently as possible while taking into account the amount of risk they can take. Where necessary and appropriate, the planned measures are aimed at increasing transparency, helping investors gain a better understanding of financial matters, ensuring that at least the appropriateness of capital investments is always assessed by competent intermediaries, prohibiting capital investments that raise significant concerns in terms of investor protection and standardising supervisory practices.

1. Prohibiting incomplete prospectuses

The publication of incomplete prospectuses was previously permitted under the Capital Investments Act (Vermögensanlagengesetz) if some of the terms of the offer, such as the amount of interest payments, were not included in the prospectus at the time of BaFin’s approval but subsequently added by the offeror on the first day of the public offer at the latest. Under new legislation which entered into force on 16 July 2019 (available in German only), such incomplete prospectuses are no longer permitted. The prohibition is aimed at protecting investors while increasing transparency. For instance, it is almost impossible to predict the performance of an investment if the prospectus does not state the terms of the offer, such as interest payments, the purchase price or the repurchase price. This is particularly true in the case of direct investments. Capital investment offers typically do not involve a price discovery process ahead of the offer, which means that there is no need for prospectuses to be incomplete.

2. Prohibiting capital investments in the form of blind pools

Blind pools now account for a large percentage of capital investments. In the case of blind pools, there is no specific information on what the funds raised from investors are going to be used for at the time when the prospectus is drawn up. Since it is unclear what they are investing in, it can be challenging for investors to value the investment properly. Investors have no clear overview of the business model, which can make it more difficult for them to estimate the likelihood of achieving the expected return. At this stage, no key (preliminary) agreements on the acquisition or production of the underlying assets have been signed. As a result, the investor does not know who the issuer’s main business partners will be, making it impossible for the investor to assess this, too. The significance of the prospectus is therefore reduced both in terms of transparency and liability, as the prospectus offers only vague information on what the funds are going to be used for. In addition, the scope of the information provided is far more limited than in other cases. For all the reasons above, publicly offering capital investments in the form of blind pools to retail investors will no longer be permitted.

If the investment goal is to achieve a return with a highly diversified portfolio but the details have not yet been finalised, the offeror may choose to establish a closed-end fund or invest in such a fund on behalf of investors. As closed-end fund managers based in Germany generally require authorisation, they fall under BaFin’s supervision. In addition, the products offered by closed-end retail funds established in Germany are supervised by BaFin, too.

3. Restricting the distribution of capital investments to supervised intermediaries

If capital investments are directly sold by the offeror, investment brokerage services and investment advice are not routinely provided. In such cases, there is also no assessment to determine whether these investments are suitable or appropriate for the investor. But at the same time, those offering capital investments have a strong interest in selling their products. To ensure that the appropriateness and suitability of these investments are always assessed in the future, the distribution of capital investments will be restricted to financial services institutions and financial investment intermediaries to ensure that investment brokerage or investment advice are always provided. These intermediaries are supervised by BaFin on an ongoing basis and must comply with special rules of conduct and transparency requirements. In addition, they are required to assess whether investments are suitable or appropriate. They must also have the relevant expertise to help investors make investment decisions and select the investments that meet their needs. As a result, investors will no longer have to rely solely on their own assessment of capital investments based on the prospectus or capital investment information sheet.

4. Extending BaFin’s powers to examine the accounts of capital investment issuers

When the Retail Investor Protection Act entered into force in 2015, BaFin was granted powers to order the examination of the accounts of capital investment issuers in cases where there is specific evidence of an infringement of accounting requirements. However, BaFin cannot issue such an order simply on the basis of mere speculation, vague grounds for suspicion or claims that cannot be proven. But if there is mounting suspicion of an infringement, BaFin should be able to request further information from the issuer or a third party. For this reason, BaFin’s powers to order the examination of accounts are to be supplemented with the right to request information and documentation in advance for clarification purposes – and not just for the purpose of examining accounts.

5. Requiring independent third parties to conduct audits on the use of funds in the case of direct investments

For investors, the annual reports of capital investment issuers are an important source of information on the issuer’s financial position, cash flows and results of operations. But in the case of issuers of direct investments in tangible assets, the annual financial statements and management reports do not provide sufficient information on the existence of these assets if the individual investors – and not the issuer – are the beneficial owners. Whether an issuer will be able to meet its interest payment and repayment obligations cannot be determined solely on the basis of the tangible assets’ existence. However, their existence is at least a necessary, but not sufficient, prerequisite in order for these obligations to be met. For this reason, the issuers of direct investments are to be legally obliged to instruct a qualified independent third party (such as a lawyer or an auditor) to audit how funds are being used. The findings of the audit are to be published by the issuer.

6. Making use of product intervention powers in the context of capital investments

If a capital investment raises serious investor protection concerns, BaFin can make use of its product intervention powers to restrict or even prohibit the marketing, distribution or sale of the investment. These are powerful tools that must be used with caution in cases where other investor protection measures do not suffice. In the middle of March 2019, BaFin released an article announcing that it is keeping a close eye on certain categories of investments, which may overlap, as there may be grounds for initiating a product intervention procedure when these investments are involved. BaFin is paying particular attention to (a) direct investments where investors become the (putative) owners of the assets in question and (b) (direct) investments abroad with restricted access to assets. When making use of its product intervention powers in such cases, BaFin must give the issuer/offeror the opportunity to comment on the matter after the product intervention procedure has been initiated. In some cases, being given the opportunity to comment or being notified of an impending product intervention measure is already enough for the offer to be withdrawn and for the offeror to stop or not even begin selling the investment in question.

7. Requiring closed-end retail funds to apply for authorisation from BaFin

The German Investment Code (Kapitalanlagegesetzbuch) makes a distinction between fund managers that have been granted authorisation and are fully subject to the provisions of the Code and those with a lower volume, which are only required to register with BaFin and are subject to less stringent requirements. The fact that some fund managers are registered with BaFin may give investors the impression that the fund managers and their products are supervised by BaFin on an ongoing basis. This is not the case, however, because they are subject to less stringent legal requirements and because BaFin does not have as much information about them. In order to ensure that fund managers are qualified at a consistently high level and to ensure compliance with statutory provisions, all closed-end retail fund managers will be required to seek BaFin’s authorisation in the future, and it will no longer be possible for them to simply register instead. Grandfathering provisions are to be laid down for the managers of closed-end retail funds that are already established and simply registered with BaFin.

8. Transferring the supervision of independent financial investment intermediaries to BaFin

As set out in the coalition agreement between Germany’s governing parties, the supervision of independent financial intermediaries will be gradually transferred to BaFin. This is aimed at ensuring consistent and high-quality financial supervision in the area of financial investment brokerage. Independent financial investment intermediaries have so far been supervised by trade offices ( Gewerbeämter ) or chambers of industry and commerce, depending on the Land . As independent financial investment intermediaries usually broker closed-end funds and capital investments in addition to open-end funds, transferring the supervision of these intermediaries to BaFin will help create a consistent investor protection framework for the distribution of these investment products.

9. Stepping up BaFin’s activities to inform consumers about capital investments

Investors need to be financially literate in order to understand and assess the information they are given. As part of its mandate to protect the collective interests of consumers, BaFin is drawing on its experience to inform consumers about financial topics. Further information can be found on the BaFin website. BaFin also publishes articles on financial topics on a regular basis. In addition, BaFin attends fairs and events that are relevant to consumer protection. Part of BaFin’s supervisory activities in 2019 will focus on strengthening the authority’s role in protecting the collective interests of consumers. In this context, BaFin will be stepping up its activities to provide consumers with information about banking and loans, investments and securities, and insurance and pension schemes by identifying the areas in which more targeted information is needed and by implementing consumer information initiatives.

More consumer surveys will be conducted for this purpose. These surveys will also cover capital investments and closed-end retail funds, which will allow the current informational needs and actual behaviour of consumers to be better taken into account in BaFin’s consumer information initiatives. In addition to the above, more “digital meet-ups” are also planned. During these meet-ups, those who are actively involved in providing training and support to senior citizens are given the opportunity to discuss current IT topics with various experts. The meet-ups focus on helping people acquire the skills they need in order to use digital media securely. BaFin has been involved in this initiative since 2017. The meet-ups are run by Digital-Kompass, a joint project between the German Association of Senior Citizens’ Organisations and the non-profit association Deutschland sicher im Netz e.V. The project is supported by the Federal Ministry of Justice and Consumer Protection. BaFin also intends to release a number of videos on its website to provide tailored information to other target groups on a range of financial topics, such as borrowing money, saving for retirement or making investments.