I. General Administrative Act

1. On the basis of section 4a of the German Securities Trading Act (Wertpapierhandelsgesetz – WpHG) as published in the announcement of 9 September 1998 (Federal Law Gazette I, p. 2708), last amended by Article 3 of the Act of 10 May 2016 (Federal Law Gazette I p. 1142), the following is ordered:

The contractual netting agreements described in Article 295 of Regulation (EU) No 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and investment firms and amending Regulation (EU) No 648/2012 ("CRR") (OJ L 321 of 30 November 2013, p. 6 et seq.), for which it has been agreed that in the event of default by one of the two parties, the institute or its counterparty would be entitled to receive or obliged to pay only the net sum of the positive and negative mark-to-market values of included individual transaction are to be settled as agreed by the counterparties, including persons, who as parties with particular duties act for and against a counterparty.

This order shall not apply to matters for which a legally enforceable claim or assessment has been achieved or judicial proceedings are pending or insolvency proceedings have been opened.

2. For the purposes of this General Administrative Act, the following definitions shall apply:

(i) "institution" means an institution as defined in section 1 (1b) of the German Banking Act (Kreditwesengesetz – KWG) as published in the announcement of 9 September 1998 (Federal Law Gazette I p. 2766), last amended by Article 14 (2) of the Act of 10 May 2016 (Federal Law Gazette I p. 1142), and any body established abroad which would be subject to the provisions of the KWG if it were based in Germany or if it conducted banking business or provided financial services;

(ii) "market value" means the value of an individual transaction calculated using marking to market or marking to model as defined in Article 4(1) no. 68 and no. 69 of the CRR;

(iii) "default" means any cases described in Article 178 of the CRR, in particular the elements described in Article 178(3)(e) or (f);

(iv) "individual transaction" means any financial service defined in section 104 (2) of the German Insolvency Code (Insolvenzordnung – InsO), any of the transactions mentioned in Article 273 (2) of the CRR and any transaction involving commodities and emission allowances which is only settled by delivery.

(v) The term "counterparty" includes institutions within the meaning of this General Administrative Act.

(vi) "settling" includes the ending of the individual transactions included in the netting, calculating the market values for the transactions and merging into a single equalisation claim.

3. This General Administrative Act enters into force on 10 June 2016 at 0.00 hrs. and will apply until 31 December 2016, 24.00 hrs.

4. This General Administrative Act is issued subject to reservation of revocation pursuant to section 36 (2) no. 3 of the German Administrative Procedures Act (Verwaltungsverfahrensgesetz – VwVfG).

5. This General Administrative Act shall be considered announced on the day after its publication pursuant to section 41 (4) sentence 4 of the VwVfG.

II. Grounds:

This Administrative Act is based on section 4a (1) sentence 1 of the WpHG.

Pursuant to this, the Supervisory Authority may, in consultation with the Deutsche Bundesbank, issue orders that are appropriate and necessary to eliminate or prevent undesirable developments that may be detrimental to the stability of financial markets or undermine confidence in the proper functioning of financial markets.

1. Facts

On 9 June 2016, the Federal Court of Justice (Bundesgerichtshof – BGH) issued the following ruling in an individual case in proceedings IX ZR 314/14:

• In response to the plaintiffs’ appeal, the decision of the 16th Civil Division of Frankfurt am Main Higher Regional Court of 5 December 2013 is reversed with regard to the matter of costs and to the extent that said court decided to the detriment of the plaintiffs.
• The defendants’ cross appeal is rejected.
• To the extent of the repeal, the matter is returned for renewed proceedings and decision, also regarding the costs of the appeal proceedings, to the Court of Appeals.
• The amount in dispute in the appeal proceedings is set at EUR 30,000,000.

The principle of the ruling as announced by the BGH is as follows:

“Settlement arrangements which are concluded by parties to equity option transactions in case insolvency occurs, where such parties are subject to German law and which are incompatible with section 104 of the German Insolvency Code (Insolvenzordnung – InsO), are in this respect invalid and therefore directly subject to the provisions of section 104 of the Insolvency Code.“

The grounds for the ruling are not yet available in written form. The assumptions made below about the consequences of the decision are based on the information currently available.

In a joint press release issued on 9 June 2016, the Federal Ministry of Justice and Consumer Protection (Bundesministerium für Justiz und Verbraucherschutz) and the Federal Ministry of Finance (Bundesministerium der Finanzen) explained that, should a comprehensive examination show that the ruling has consequences beyond the individual case in question, i.e. on the acceptance of the master agreement on the market and by supervisory authorities, the German Federal Government will directly initiate legislative measures aimed at prompt clarification or specification of the relevant provisions of insolvency law in order to ensure that the common master agreements continue to be recognised on the market and by supervisory authorities. The Ministries stated that this should ensure that the Federal Republic of Germany remains – alongside all other EU Members States – a jurisdiction where financial futures transactions can be effectively included in the common master agreements.

The Ministries’ statement is available on the website of the Federal Ministry of Finance.

Contractual netting agreements underlying the matter ruled on by the BGH are used in numerous master agreements. They are model clauses which are not only used in the German master agreement ruled on by the BGH but in the same or a slightly altered form in numerous other model agreements as well. These model clauses are intended for model master agreements such as those issued by the International Swaps and Derivatives Association (ISDA). BaFin assumes that this type of contractual clauses are used in a very high number of contracts which are subject to the InsO in the case of insolvency. It is not currently possible to estimate whether the oft-used contractual clauses are affected by the BGH's ruling and if so, which ones.

2. Prerequisites of section 4a (1) sentence 1 of the WpHG

Given that the consequences of the BGH's decision cannot yet be conclusively estimated and that this raises many questions regarding the application of European legal provisions which could lead to significant uncertainty for financial market participants and thus to a loss of confidence in the proper functioning of financial markets, BaFin has decided to issue this General Administrative Act in order to prevent such an undesirable development and to restore confidence in the proper functioning of the financial markets and avoid negative effects on financial market stability.

a) Uncertainty about the scope of the decision

It is currently impossible (as the grounds for the decision are not yet available, among other reasons) to determine conclusively which of the many contractual netting agreements currently in use by financial markets participants will fall within the scope of the decision of the BGH. Even once the grounds for the decision have been published, questions of distinction and interpretation may remain unanswered.

This leads to significant uncertainty for financial market participants. It is probable that this uncertainty could lead financial market participants to refrain from carrying out further business activities under the existing agreements against this background. This situation could persist beyond the publication of the grounds for the decision, until the legislative amendment announced by the ministries is available.

However, since the transactions concluded under the existing master agreements form a very significant part of the activities of the financial market and that it is not possible to conclude different contracts at short notice, BaFin expects that the proper functioning of the financial markets could be significantly disrupted by the uncertainty about the consequences of the court decision and that this could lead to major market turmoil.

b) Uncertainty about possible consequences in European law

Apart from the uncertainty about the scope of the decision, there is significant uncertainty about the application of provisions regarding the existing provisions of European law in the area of contractual netting agreements.

aa) Article 7(1) of Directive 2002/47/EC of the European Parliament and of the Council of 6 June 2002 on financial collateral arrangements

A possible invalidity of contractual netting agreements might contravene Article 7(1) of Directive 2002/47/EC of the European Parliament and of the Council of 6 June 2002 on financial collateral arrangements (OJ L 168 of 27 June 2002, p. 43) ("Financial Collateral Arrangements Directive"). Pursuant to this, the Federal Republic of Germany is obliged to ensure that a close-out netting provision based on a contractual agreement can take effect in accordance with its terms notwithstanding the commencement of insolvency proceedings in respect of a counterparty. The Financial Collateral Arrangements Directive was transposed into German law by the German Act Transposing Directive 2002/47/EC of 6 June 2002 on Financial Collateral Arrangements and Amending the Mortgage Bank Act and other Acts of 5 April 2004. As shown in the explanatory memorandum, the intention of the legislature in this law was in particular to comply with the requirement of Article 7 of the Financial Collateral Arrangements Directive and to carry out at least those amendments of insolvency law necessary to ensure close-out netting (Bundestag documents 15/1853 of 29 October 2003, p. 12). In this context, a very clear indication of the possibly significant consequences for the German financial market which would be associated with a restrictive implementation of the Financial Collateral Arrangements Directive has already been given.

bb) Article 25 of Directive 2001/24/European Parliament and of the Council of 4 April 2001 on the reorganisation and winding up of credit institutions

Furthermore, the invalidity of contractual netting agreements might contravene Article 25 of Directive 2001/24/EC of the European Parliament and of the Council of 4 April 2001 on the reorganisation and winding up of credit institutions (OJ L 125 of 5 May 2002, p. 15). The aim of this provision is to protect the integrity of regulated markets and the predictability of the law applicable to netting agreements (Bundestag documents 15/16 of 25 October 2002, p. 19-20, draft bill of the Federal Government on new legal provisions of international insolvency law). The explanatory memorandum shows the intention to protect contractual netting, not least because of its effects on banking supervisory law. The invalidity of contractual netting agreements would have consequences for the German financial market which are not possible to estimate.

cc) Directive 2014/59/EU of the European Parliament and of the Council of 15 May 2014 establishing a framework for the recovery and resolution of credit institutions and investment firms

Equally, the invalidity of contractual netting agreements could be incompatible with the provisions regarding the application of the bail-in of creditors tool relating to liabilities resulting from derivatives pursuant to section 93 of the German Recovery and Resolution Act (Sanierungs- und Abwicklungsgesetz – SAG), which are based on Directive 2014/59/EU of the European Parliament and of the Council of 15 May 2014 establishing a framework for the recovery and resolution of credit institutions and investment firms (OJ L 173 of 12 June 2014, p. 190 et seq.) (BRRD). Under section 93 of the SAG, the bail-in of creditors within the meaning of section 90 of the SAG – i.e the write-down of eligible liabilities or their transformation into equity instruments – may only be applied to liabilities resulting from derivatives and other financial services within the meaning of section 104 (2) of the InsO after prior or simultaneous cancellation of the transactions and the resolution authority or an independent valuer appointed by it determines the value of the terminated transactions in line with the methodologies and principles laid down in section 93(4) of the SAG. Essential elements of this valuation will in future be defined in the delegated regulation of the European Commission on the valuation of derivatives pursuant to Article 49(4) of the BRRD (see EBA Final Report of 17 December 2015, EBA/RTS/2015/11). Of significance in this context is the fact that, pursuant to section 146 of the SAG, without delay upon implementing the bail-in of creditors, the resolution authority must determine whether and to what extent the bank's counterparties have been disadvantaged by comparison with the situation which would have arisen upon the initiation and implementation of insolvency proceedings ("no creditor worse off" principle). If contractual netting agreements were invalid, the valuation which would be hypothetically carried out in this context would have to take into account that the claim due to non-performance pursuant to section 104 (3) of the InsO is to be calculated on the basis of the market or exchange prices on the second working day following the opening of insolvency proceedings. If the hypothetical valuation pursuant to section 146 of the SAG comes to the conclusion that the creditor has suffered a loss due to the cancellation and transformation or write-down of his claim, because, for example, the valuation undertaken for the purposes of the bail-in of creditors pursuant to section 93 of the SAG was done on the basis of other prices, he would be entitled to compensation from the restructuring fund pursuant to section 147 of the SAG. A lack of netting agreements corresponding to the wording of the contractual agreements therefore does not only prevent the European valuation standards application to the settlement of derivatives from being applied, it also gives rise to a risk that the restructuring fund would have to be made use of more frequently than intended by the European legislature.

dd) Article 296(2)(a) of the CRR

It is of particular significance that an invalidity of the contractual netting agreements could give rise to an insoluble conflict with the provisions of the CRR over the supervisory recognition of contractual netting agreements. Article 296(2)(a) of the CRR restricts the recognition to contractual netting agreements that provide for the termination, settlement and netting of the individual transactions included already at the time of the counterparty’s default. In effect, the decision of the BGH leads to a continuation of netting pursuant to section 104 (2) of the InsO but shifts its timing to the time of the opening of insolvency proceedings. Article 178 of the CRR, which defines the term "default" for the purposes of the CRR, makes it clear that filing to open insolvency proceedings is already to be regarded as an event indicating the default of the obligor. A contractual netting agreement which specifies a close-out netting only for the time when insolvency proceedings are opened, possibly months later, is not in compliance with these requirements. However, if the bringing forward of the time to the default leads to the contractual agreement being invalid, the validity of the contractual netting agreement, which pursuant to Article 296(2)(b) of the CRR must be proven with legal opinions, is lacking.

ee) Regulation (EU) No 648/202 of the European Parliament and of the Council of 4 July 2012 on OTC derivatives, central counterparties and trade repositories

In the case that contractual netting agreements would become invalid without replacement, a further conflict could arise in the scope of Regulation (EU) No 648/202 of the European Parliament and of the Council of 4 July 2012 on OTC derivatives, central counterparties and trade repositories (OJ L 201 of 27 July 2012, p. 1 et seq.) (EMIR). Article 11(3) of the EMIR requires financial counterparties to introduce risk-management procedures that prescribe, among other things, the timely and appropriately segregated exchange of collateral. The details of the collateralisation requirement will in future be defined in the Commission Delegated Regulation with regard to regulatory technical standards on risk-mitigation techniques for OTC derivatives contracts not cleared by a CCP ("RTS collateralisation"), which is based on Article 11 (15) of the EMIR (see EBA Final Draft Regulatory Technical Standards of the European Supervisory Authorities of 8 March 2016, ESAs 2016 23). The draft of Article 11 and 23(4)(a) of the RTS collateralisation assumes that the legal enforceability of contractual netting agreements is an essential prerequisite for the requirement for the provision of collateral. If, in the course of the review pursuant to Article 32(2) of the RTS, the party subject to the clearing obligation is of the view that the contractual netting agreement is not enforceable with the necessary collateral, the collateralisation requirement does not apply (at least within the limits determined in Article 11 of the RTS). However, Article 11(1) in conjunction with (4) of the RTS only intends this exception for third countries. Therefore, the possible assessment of netting agreements as not enforceable under German law would not necessarily lead to an exemption from the collateralisation requirement. Such an estimation could lead to a significantly increased collateralisation requirement due to Article 17 of the RTS. Article 17 of the RTS, which applies to the calculation of initial margins, defines the margin period of risk, i.e. the time period from a) the most recent exchange of collateral until b) the transactions included in the netting set are closed out and the resulting market risk is re-hedged. If an invalidity of the contractual netting led to an institution only being able to carry out the replacement pursuant to section 104 (3) of the InsO when insolvency proceedings are opened, a significantly higher collateral requirement could be the result due to the extension of the margin period of risk.

ff) Summary

In order to combat uncertainty arising from the inability to assess the decision of the BGH, BaFin has issued this General Administrative Act in order to clarify that netting under the existing master agreements which fall under the scope of this administrative act must be carried out in accordance with the wording of the contractual agreements until further notice.

c) Potential loss of confidence in the functioning of financial markets, consequences for their stability

The uncertainty about the scope of the BGH's decision described in subparagraph a) and the open issues with respect to the application of provisions regarding the existing provisions of European law in the area of contractual netting agreements presented in subparagraph b) may cause substantial uncertainty among financial market participants.

This, in turn, may cause market participants to shy away from concluding transactions under the existing multitude of master agreements at least temporarily, but more likely for a longer period. The uncertainty regarding potentially stricter capital charge requirements or margining obligations may make market participants unwilling to commit to transactions affected for the time being and even possibly lead them to prematurely terminate or close out existing contracts using the legal possibilities at their disposal. This uncertainty is set to affect all transactions concluded under agreements that might be subject to German insolvency law. The question which agreements are subject to German insolvency law may in some cases not be easy to answer, which would contribute to more uncertainty.

The transactions under current master agreements are an important part of financial market activities and many participants use them to hedge their risks, in addition to relying on such transactions for a significant part of their business. It is possible that particularly German undertakings and institutions that in many instances would be subject to German insolvency law in the case of insolvency might no longer be considered as potential contracting parties by foreign financial market participants. This would have major consequences in terms of risk coverage as well as economic opportunities of German institutions and undertakings and might affect the German real economy, and in any event the German and international capital market. If German undertakings were to be no longer selected as contracting parties for such transactions, or selected as such only to a limited extent, this would exclude significant and important market participants, which would in turn be detrimental to the proper functioning of the market.

The proper functioning of financial markets is particularly threatened by the fact that the transactions under master agreements are concluded by institutions and undertakings on an on-going basis and at high frequency. An abrupt halt to these activities as a result of the legal uncertainty described would have consequences for market liquidity and, ultimately, for the financial market infrastructures, which are not possible to estimate. Such an abrupt halt to market activities could cause major turmoil on the financial markets and so lead to a significant disruption of financial stability.

d) Undesirable development

In the aforementioned scenario, BaFin has recognised an undesirable development within the meaning of section 4a (1) sentence 1 of the WpHG, due to the uncertainty regarding the consequences of the BGH’s decision. Section 4a (1) sentence 1 of the WpHG is supposed to provide rules for just such situations where the proper functioning of the financial market is rocked by the lack of mutual trust of market participants.

Section 4a (1) of the WpHG explicitly allows BaFin to act to prevent undesirable developments before they actually occur.

The uncertainty described above could be detrimental to the activity on the financial market, warranting BaFin taking action as the market supervisor pursuant to section 4a of the WpHG.

The legislators' explicit expectation of the power to issue orders pursuant to section 4a (1) of the WpHG is that BaFin will calm the financial markets in cases of uncertainty in order to avert market disruption and failure. This is the objective of this General Administrative Act.

e) Proportionality of the General Administrative Act

aa) Appropriateness

The measure taken via this General Administrative Act is appropriate to eliminate uncertainty caused by the BGH's decision and avert the potential loss of confidence in the proper functioning of the financial markets as described above. The General Administrative Act ensures that, until such time as the planned legal regulation comes into force at the latest, the contractual netting agreements used by institutions will remain legally effective and enforceable in the case of insolvency of either of the parties if they deviate from the rules set out in section 104 of the InsO. In particular, the fact that the netting agreements provide for the closing out and valuation of individual transactions to be tied to a point in time prior to the opening of insolvency proceedings must not have a negative impact.

bb) Necessity

This General Administrative Act is also necessary as there is no apparent milder means that would be as suitable to rectify the potential consequences of a loss of confidence in the proper functioning of financial markets described above. Only the clarification that netting pursuant to the existing master agreements within the scope of this Act may continue to be exercised pursuant to the contractual wording ensures that the market participants will continue their market activities as usual and that there will be no turmoil on the market due to a sudden halt caused by uncertainty.

cc) Reasonability

The General Administrative Act is also reasonable. So far, no market turmoil has been registered with regard to the contractual netting agreements in place for a while now. The continuing existence of the netting possibility pursuant to the existing master agreements as safeguarded by the General Administrative Act creates legal certainty. It does not change the status quo and ensures compliance with European and international market practices.

Only in individual cases where legally enforceable claims or assessments existed or proceedings were pending before this General Administrative Act was issued, the confidence of those seeking legal protection with respect to, for instance, titles acquired, is secured in that it is conducive to legal peace and such individual cases (especially due to the effect of this General Administrative Act) will not pose a threat to the confidence in the proper functioning of the financial markets in the future.

Consequently, the General Administrative Act is appropriate, necessary and reasonable.

3. Possibility of revocation

The possibility of revocation (section 49 (2) of the German Administrative Procedure Act (Verwaltungsverfahrensgesetz – VwVfG)) takes account of the eventuality that a relevant change to the InsO may come into force, restoring legal certainty and thus eliminating the cause for this order.

4. Publication

The publication of the General Administrative Act shall take place on 9 June 2016 in the form of a publicly exhibited copy and on the BaFin website. The announcement of the General Administrative Act shall take place publicly as it would be impractical to inform everyone involved. BaFin does not have information as to which institutions and undertakings have entered into agreements including the relevant netting agreements and which have developed business activities pursuant to those agreements which fall into the scope of this Act. BaFin is unable to derive the affected group on the basis of its supervisory activities as the fact of entering into master agreements including the relevant netting agreements which are subject to the provisions of German insolvency law is not subject to authorisation or notification requirements.

5. Consultation with the Deutsche Bundesbank

The General Administrative Act is issued in consultation with the Deutsche Bundesbank (section 4a (1) sentence 1 of the WpHG).

6. Hearing dropped

Since any actions required to prevent a crisis that might jeopardise the financial system must be taken as quickly as possible, BaFin has decided in its reasonable discretion to refrain from hearing the parties affected by this General Administrative Act in accordance with section 28 (2) nos. 1 and 4 of the VwVfG. Due to imminent danger, it is necessary in the public interest that this General Administrative Act enters into force immediately in order to ensure confidence in the proper functioning of financial markets.

7. Immediate enforceability

Please note that objections and appeals shall not have a suspensory effect (section 4a (4) sentence 4 of the WpHG).

Instruction on available remedies

Objections to this General Administrative Act can be submitted to BaFin in Bonn or Frankfurt am Main within one month of its announcement.

Frankfurt am Main, 9 June 2016

Felix Hufeld