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Erscheinung:15.07.2014 Jörg Begner, BaFin

Fee-based investment advice: New rules to enter into force in August

The new legal requirements for fee-based investment advice will come into force on 1 August 2014. Until now, fee-based investment advice has not been subject to specific regulations. The Fee-Based Investment Advice Act (Honoraranlageberatungsgesetz) adds this term – in addition to conventional investment advice – to the Securities Trading Act (WertpapierhandsgesetzWpHG), providing a legal definition of "fee-based investment advice" for the first time.

Going forward, such advice will be subject to requirements which extend beyond those for conventional investment advice. This article provides a brief overview of the new requirements.

The new rules are intended to increase transparency with respect to fees or commissions paid for investment advice. Clients should understand who pays for advice so that they can make an informed decision between commission-based investment advice and fee-based investment advice. Commission-based investment advising is currently the predominant model on the German market. Under this model, the adviser is paid by the providers or issuers of financial instruments. Although advisers are legally obliged to disclose to clients any inducements received, many clients remain unaware of this relationship.

The client's interests

The term "fee-based investment advice" itself reveals the most significant requirement being placed on such services: investment advisers who recommend products in return for a fee may receive payment only from clients, because fee-based investment advice should be given solely in the client's interests.

In exceptional cases, commissions may in fact be paid out, but only if a narrow set of requirements has been met – and any commissions must be passed on to the client in full immediately after they are received. Such exceptions may be made when neither the recommended financial instrument nor a comparably suitable one is available free of commission. In such cases, providers of fee-based investment advice can recommend the appropriate financial instrument to their clients and avoid a conflict of interest by passing on the commission. As non-monetary inducements such as incentive trips cannot be passed on to clients, providers of fee-based investment advice are generally prohibited from accepting them.

Conduct of business obligations

The Fee-Based Investment Advice Act also sets out additional conduct of business obligations. The range of financial instruments that can be accessed by a fee-based investment adviser is therefore subject to special requirements. Such advisers must base their recommendations on sufficient market knowledge, which they are required to obtain.

In addition, the range of offerings which the advisers' recommendations are based on must also be sufficiently diversified with regards to providers and issuers of financial instruments. This means that providers of fee-based investment advice may not exclusively offer their own financial instruments, instruments from their own group or instruments from providers or issuers with whom the advisers are closely affiliated. In these cases as well, the advice provided must be market-oriented.

Avoiding conflicts of interest

In order to prevent conflicts from arising between the interests of clients and those of institutions or issuers/providers, fee-based investment advisers are prohibited from offering only instruments which they issued themselves. The new requirements also prohibit fee-based investment adviser from offering only financial instruments from sellers or issuers who are closely affiliated with the advisers' investment firm or with which they are otherwise economically linked.

This requirement is intended to prevent fee-based investment adviser from recommending only instruments from their group or association. However, these advisers may continue to recommend such financial instruments if they are suitable for their clients – the Act simply requires that advisers refrain from limiting their choice to financial instruments in this category. Fee-based investment adviser should not have a smaller number of financial instruments on offer overall than conventional investment advisers. Additionally, advisers must inform their clients that a recommended financial instrument is an instrument from a group or association and that the advisers or the issuers affiliated with them generally have an interest in completing the transaction.

In order to prevent fee-based investment advisers from recommending a transaction for the purposes of generating margin profits for their institution, section 31 (4d) sentence 1 of the WpHG prohibits conducting recommended transactions on a fixed-price basis. An institution's intention to generate margin profits in fixed-price transactions acts, in principle, as an opposing force to the independence of fee-based investment advisers, who are supposed to act only in their clients’ interests.

Such transactions are permitted only in cases where a fee-based investment adviser recommends a financial instrument issued by the adviser itself. In such cases, a reverse exception is necessary in order for an investment adviser, for example, to recommend and later purchase its own issues. Moreover, completely prohibiting fixed-price transactions – including those for own issues – would necessitate engaging a third party, which the foregoing exception renders unnecessary. Requiring this type of indirect extra step in the purchasing chain for own issues would not be expedient.

Organisational obligations

The criterion that fee-based investment advisers should be exclusively bound to their clients' interests can also be found in the requirement under section 33(3a) sentence 1 of the WpHG that fee-based investment advice be segregated from conventional investment advice in terms of organisation, functions and staffing – unless fee-based investment advice is the sole activity. This segregation ensures that fee-based investment advice is provided independently and is not influenced by commissions-based investment advice.

Sales targets within the meaning of section 33(1) no. 3a of the WpHG may not adversely affect the interests of advisers' clients. For this reason, unavoidable conflicts of interest arising in fee-based investment advising which result from the foregoing cannot be remedied by disclosing them. Sales targets which conflict with the interests of clients may therefore not be set for fee-based investment advice.

Legally protected designation and public register

"Fee-based investment advice" is a legally protected designation. This is intended to enable clients to recognise this qualified type of investment advice and to trust that the firms providing fee-based investment advice will comply with the special conduct of business obligations. Institutions may therefore designate their services as fee-based investment advice only if BaFin has entered them in the register of fee-based investment advisers. BaFin will register only those institutions which have submitted proof in the form of an audit certificate that they meet the special requirements for the provisions of fee-based investment advice.

Beginning on 1 August, investors will be able to view the register of fee-based investment advisers on BaFin's website and gain insight into which institutions provide fee-based investment advice. Pursuant to section 33 (3a) sentence 3 of the WpHG, these institutions must also list on their websites which of their branches offer fee-based investment advice. This will enable clients to specifically request this type of investment advice.

If an institution continuously fails to comply with the special conduct of business obligations and organisational requirements for the provisions of fee-based investment advice, BaFin may delete the institution's entry in the register. The institution will then no longer be permitted to carry the legally protected designation “fee-based investment adviser”.

Regulation

The Federal Ministry of Finance will issue a Regulation containing more detailed provisions, such as those pertaining to the manner and time at which clients must be notified whether fee-based investment advice is being provided, whether an adviser is recommending group or association issues and whether the adviser or the issuer stands to profit from the completion of a transaction. The Ministry has already distributed a draft Regulation in order to factor in the concerns of affected parties.

Requirements for fee-based investment advice

  • Only remunerated by the client
  • Access to a sufficient range of financial instruments available on the market (market overview)
  • Advisers also recommend issues from other issuers/providers
  • No fixed-price transactions except in own issues
  • Separation in terms of organisation, functions and staffing
  • Entered in the register of fee-based investment advisers

Additional information

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