Dr Thorsten Becker, Dr Chan-Jae Yoo, BaFin
Product intervention: New tasks for securities supervision
For a few months now, BaFin has had a new tool at its disposal: product intervention. It is now able to restrict or even prohibit financial instruments, structured deposits or financial activities and practices if these present a significant investor protection concern or a threat to the stability or integrity of the financial system or financial markets.
Product intervention was introduced with the German Retail Investor Protection Act (Kleinanlegerschutzgesetz, only available in German) as section 4b in the German Securities Trading Act (Wertpapierhandelsgesetz – WpHG). This also explicitly established collective consumer protection as a supervisory objective. It is part of the Federal Government's action plan for increased consumer protection in the financial market, which was a reaction to negative developments on the unregulated capital market, among other things.
The German legislature has therefore adopted European legislation early: the Markets in Financial Instruments Regulation (MiFIR) introduces the product intervention right for all EU Member States on 3 January 2017 and is directly applicable. The provision of section 4b of the WpHG is based on the wording of the MiFIR product intervention provisions and serves to bridge the time period until these come into force.
Increased consumer protection
BaFin's product intervention powers now enable it to take effective action against undesirable developments on the capital market. The first Markets in Financial Instruments Directive (MiFID I), whose provisions are still found in part 6 of the WpHG, laid the focus of the conduct of business, organisational and transparency obligations for consumer protection on distribution supervision. It thus placed less emphasis on the issuers of financial instruments and more on the intermediaries who distribute them. However, the effect of toxic financial instruments in the financial crisis and the negative role of certain capital investments in the case of the insolvent wind power operator Prokon showed that it is not just the integrity of investment services enterprises which has to be ensured but that it is also necessary to be able to act against products which, for example, raise significant investor protection concerns. The new provision of section 4b of the WpHG therefore closes major loopholes in application.
Powers of intervention
The new section 4b of the WpHG prescribes various intervention options for the authorities. For one thing, BaFin can intervene in the marketing, distribution or sale of a particular financial instrument or a structured deposit, i.e. it can carry out product intervention in the more narrow sense of the word. However, it is also able to intervene in certain forms of financial activity or practice (behavioural intervention). Restrictions and prohibitions are possible.
It should be noted that BaFin can also issue prohibitions and restrictions even before the start of marketing, distribution or sale. This means it can step in at any point of the value chain and the product/distribution process, if the necessary conditions are fulfilled. BaFin is also flexible regarding the design of the measures themselves: it can attach conditions to prohibitions and restrictions or put constraints on them. When BaFin has decided to take a measure, it must first notify the issuer of this and publish a notice to this effect on its website.
However, BaFin cannot take action without good cause. It can only order restrictions and prohibitions if certain conditions are fulfilled. First of all, there must be grounds justifying the assumption that there is a reason to intervene. Then the prohibition or restriction must be appropriate in the specific instance and correspond to the principle of proportionality. BaFin therefore has to take the specifics of the individual case into account when it orders a measure, such as the risks, the level of knowledge of the market participants and investors concerned and the anticipated effects of the measure. This ensures that BaFin takes sufficient consideration of the interests of the market participants concerned when it makes its decision.
The provision specifies four grounds for intervention:
- The product or conduct gives rise to significant investor protection concerns.
- The product or conduct poses a threat to the orderly functioning and integrity of financial markets or commodity markets.
- The product or conduct poses a threat to the stability of the whole or part of the financial system within at least one EU Member State.
- A derivative has a detrimental effect on the price formation mechanism in the underlying markets.
The recipient of a production intervention does not just have to be an individual or a supervised investment services enterprise. On the contrary, the product intervention has no recipient specified in advance. This means that it also applies to independent agents as well as direct distributors of financial instruments and structured deposits. BaFin can limit measures to individual market participants or direct them at an indeterminate group of recipients by means of a general administrative act.
This broad scope is intended to prevent providers operating in market segments with different supervisory regimes from engaging in regulatory arbitrage.
Effective market monitoring is essential if the product intervention right is to be exercised properly. It complements the findings which BaFin gets from, for example, its ongoing supervision, from customer complaints, the annual institution inspections and on-site visits to investment services enterprises. The information which BaFin collects from its market monitoring allows it to identify problematic products and conduct, categorise and above all prioritise these.
BaFin uses various methods of continuously monitoring current developments on the capital markets. For example, it holds talks with market participants, evaluates press and expert articles and makes use of databases and market studies. It also receives information from the Deutsche Bundesbank and the European Central Bank and exchanges information with other national and international supervisory authorities, in particular the European Securities and Markets Authority (ESMA). The financial markets watchdog of the consumer organisations, which started its work a few months ago and is supported by the Federal Ministry of Justice and Consumer Protection, is intended to become an important source of information for BaFin. Its role is to gather findings about consumers' position in the financial markets and in the digital world using consumer complaints, empirical examinations and an online portal, and to set up an early warning system.
When the European product intervention right comes into force at the beginning of January 2017, replacing section 4b of the WpHG, the regulations will remain largely the same in content.
However, there could be changes resulting from the switch to the European procedural law. When MiFIR comes into force, ESMA and the European Banking Authority (EBA), which will be responsible for structured deposits, will get their own powers of intervention. They will be able to use these if the national authorities do not take product intervention measures or if ESMA/the EBA believes that the actions taken are not adequate. In addition, ESMA and the EBA will receive a control function: national authorities will have to notify ESMA and the EBA as well as the competent authorities in other Member States in advance of proposed interventions. Whichever of the two European authorities is responsible will ensure that the national intervention is justified and proportionate and adopt an opinion on this. National authorities are not obliged to follow this but must publish a notice explaining their reasons if they do not do so.
The specification of MiFIR in the delegated acts of the European Commission could also give rise to changes in the scope of the product intervention right. The Commission has to specify criteria and factors to be taken into account in determining whether the conditions necessary to intervene are present, that is, whether there is a significant investor protection concern or another threat. The first drafts of this standard are expected in autumn 2015. It is supposed to come into force with MiFIR in January 2017. ESMA advised the Commission on the possible content of the act in December 2014 (Technical Advice), so market participants were already able to get an idea of the criteria and factors which the Commission could specify.
These will act as guidelines for the practical implementation of the product intervention right. However, the relevant market situation and specific crises will also influence the decision about interventions.