Topic BaFin 15 years of BaFin: A constantly evolving financial supervisor
- Launch in 2002
- Turbulent market environment
- Capital requirements for banks
- Global systemically important financial institutions
- Solvency II
- Low interest rates
- European supervisory system
- Single Resolution Mechanism
- Capital markets
- Collective consumer protection
- Unregulated capital market
- Illegal investment schemes
- IT security
- BaFin: continuous development
- Public relations and dialogue
- Integrated financial supervisor
Crises, major reforms and new responsibilities: BaFin is turning 15. It has experienced a lot in these years, has been through some turbulent times and has always kept evolving and adapting itself to new conditions.
bsThe internationalisation of regulation and supervision has played a central role in this process. For example, BaFin is now one of the European Supervisory Authorities (ESAs), a partner of the European Central Bank (ECB) and assists in shaping global supervisory standards in international bodies. The Financial Stability Board (FSB), the International Organization of Securities Commissions (IOSCO), the Basel Committee on Banking Supervision (BCBS) and the International Association of Insurance Supervisors (IAIS) are particularly noteworthy in this regard. Moreover, international rules and standards now influence all aspects of BaFin’s day-to-day supervisory practice. There is no alternative to this complex web, since the issues and risks which supervisors have to face nowadays do not stop at national borders.
BaFinJournal is taking the anniversary as an opportunity to look back on the key milestones in this development, from the early days to the present. In short statements, BaFin President Felix Hufeld and the other members of the Executive Board venture to look ahead to the central challenges of the coming years.
Launch in 2002
BaFin came into being in 2002. Some unusual proceedings at a session of the German Bundesrat meant that the authority was born at lightning speed: since the representatives of some federal states had left the chamber early in protest over the introduction of the German Immigration Act (Zuwanderungsgesetz), the draft Act on Integrated Financial Services Supervision (Gesetz über die integrierte Finanzdienstleistungsaufsicht) was passed by the Bundesrat without debate.
BaFin officially started work on 4 May 2002, with 1,050 staff members led by President Jochen Sanio. The authority brought together the Federal Banking Supervisory Office (Bundesaufsichtsamt für das Kreditwesen – BAKred), the Federal Insurance Supervisory Office (Bundesaufsichtsamt für das Versicherungswesen – BAV) and the Federal Securities Supervisory Office (Bundesaufsichtsamt für den Wertpapierhandel – BAWe). For historical reasons, the remits of these bodies had been delineated in a way which was no longer appropriate for times in which banks, financial services providers and insurers were increasingly competing for the same customers with similar products and financial conglomerates were being formed. The aim was therefore to create a single, integrated financial supervisory authority. Right from the start, this left BaFin facing the Herculean task of merging three independent supervisory offices with differing organisational and personnel structures over two locations into one single, effective authority.
Turbulent market environment
However, it was not just organisational issues which posed challenges to BaFin from day one. The new integrated financial supervisory authority also had to deal with an extremely difficult market environment. Earlier, in 2001, the bursting of the dot-com bubble – a period of excessive speculation in the "new economy" – heralded a global recession. Then the terrorist attacks of September 11, 2001, caused worldwide turbulence on the stock exchanges, with financial stocks being among the most severely affected. There were also dramatic drops on the German stock index, the DAX, hitting some life insurers which had invested heavily in stocks particularly hard. The repercussions of the terrorist attacks revealed weaknesses in the international financial system.
In 2007, strong turbulence erupted on the financial markets once again, posing a serious risk to financial stability. The bursting of the US housing bubble triggered worldwide losses and insolvencies among companies from the financial sector, including the major American bank Lehman Brothers Inc. in September 2008. It was only possible to prevent other collapses by means of state interventions. Some credit institutions in Germany ran into serious difficulties too.
The financial sector worldwide suffered from the effects of the crisis. Dangerous gaps in the international regulatory system became apparent and needed to be closed, so regulation was significantly tightened at both a global and European level.
Capital requirements for banks
The further development of capital regulations for the global banking sector was one of the most important packages of reforms. In 2004, the BCBS decided on the set of reformed rules known as Basel II, with Basel III1) following at the end of 2010. The latter brought in higher capital and liquidity requirements as well as robust qualitative requirements for capital instruments.
The implementation of Basel III was and remains a feat of strength which BaFin contributed to from the start. In Europe, it was achieved through a comprehensive overhaul of the supervisory framework, consisting of the Capital Requirements Regulation (CRR) and the accompanying Capital Requirements Directive (CRD IV) – a massive package of regulation which meant a fundamental change in EU banking supervisory law.2) Both the CRD IV and the CRR are complemented by numerous Technical Standards. The CRD IV Implementation Act (CRD-IV-Umsetzungsgesetz - only available in German) entered into force in Germany at the beginning of 2014. The CRR, by contrast, applies directly in all Member States.
Overall, the reforms have strengthened the banking system. At the annual press conference, BaFin President Felix Hufeld warned against the “rolling back” of regulation. Rather than putting the case for renewed deregulation, it was now necessary to consider whether the numerous reforms introduced since the outbreak of the crisis were having the desired effect, he said. He also stated that in the negotiations to finalise Basel III, BaFin was advocating meaningful limits on the risk sensitivity of the framework while maintaining it as a regulatory principle. This involves in particular making regulation more comparable and examining whether model approaches are still necessary or if their structures generate capital requirements which are too low. "We want to find a sustainable, joint solution – one which we can all live with, which is not the same thing as a compromise at any price," Hufeld said.
The issue of whether the regulation of the post-crisis period is both sufficient and appropriate is also on the table at the European level. At the end of November 2016, the European Commission presented a wide-ranging package of proposed reforms affecting the CRD IV and CRR, among other things. With it, the Commission wants to reinforce the principle of proportionality as well as continuing to implement the Basel III provisions.3) Proportionality is understood to mean supervision which is appropriate and suited to each institution and its risk profile. It is a subject which is of special significance to BaFin, which believes that while the Commission's proposals are a step in the right direction, they do not go far enough.4)
Global systemically important financial institutions
Since the financial crisis, regulators have been keeping a particularly watchful eye on global systemically important financial institutions (G-SIFIs)5), i.e. institutions which are so large, so complex, so interconnected with other market participants, so irreplaceable in their functions or internationally active to such an extent that the stability of the global financial markets could be jeopardised if they were to run into difficulties.
International supervisors are making intensive efforts to strengthen such institutions, but if the occasion arises they deal with their resolution as well. The Basel III framework therefore introduced higher or additional requirements regarding loss absorbency and the planning of recovery and resolution as well as more intensive supervision for global systemically important banks (G-SIBs). The IAIS has introduced Basic Capital Requirements (BCR) for global systemically important insurers (G-SIIs), which must be complied with from the beginning of 2019 and which will be replaced by a significantly more risk-sensitive Insurance Capital Standard (ICS) from 2020. In addition, the IAIS will revise its higher loss absorbency (HLA) requirement by 2021 and this will apply to G-SIIs from 2022. The identification of non-bank non-insurer global systemically important financial institutions (NBNI G-SIFIs) is also an important topic. The FSB, in conjunction with IOSCO, has drawn up a proposed framework on the matter.6)
The basis for the recovery and resolution of SIFIs was laid down by the FSB in 2011 with its "Key Attributes of Effective Resolution Regimes for Financial Institution", which FSB members had to implement by 2015. German lawmakers pre-empted important aspects of the Key Attributes for banks in 2011 with the Restructuring Act (Restrukturierungsgesetz - only available in German). The German Ringfencing Act (Abschirmungsgesetz – RiskAbschG - only available in German), which lays down rules for recovery and resolution planning as well as for ringfencing, followed in 2013. Germany, alongside some other countries, was thus a forerunner in this field, playing a leading role in the international regulation of the recovery and resolution of institutions and financial groups. For instance, BaFin was able to contribute its expertise to the legislative process for the European Bank Recovery and Resolution Directive, which Germany had implemented ahead of time in the German Recovery and Resolution Act (Sanierungs- und Abwicklungsgesetz – SAG - only available in German).
While insurers suffered less than banks in the financial crisis, European supervisors nevertheless put them on a tighter leash to equip them for the future, further improving the 2009 Solvency II Directive with the Omnibus II Directive, so that Solvency II only fully came into force at the beginning of 2016. The new supervisory regime represents a paradigm shift away from a predominantly rules-based form of supervision and towards supervision which is rather principles-based and even more risk-based. The aim is to make risks more evident and thus more manageable.
German insurers started preparing for Solvency II early on.7) To give them the necessary guidance, BaFin was a constant presence in this process, hosting regular information events and, from 2014, publishing a series of announcements on various sets of topics.8) The authority is continuing this practice with, for example, a raft of interpretative decisions tailored to the specific features of the German insurance market.
Such efforts are important, because although the new system launched in Germany with the amendment of the German Insurance Supervision Act (Versicherungsaufsichtsgesetz – VAG - only available in German) had a generally successful start, it still poses a challenge to both undertakings and the supervisory authority. President Hufeld summed it up at this year's New Year press reception by saying, "Solvency II will probably never be a piece of cake".
Low interest rates
Hufeld also referred to the difficult market conditions, by which he primarily meant the low level of interest rates which has been persisting for years now. Low interest rates are putting increasing pressure on insurers, particularly life insurers. They are also a growing strain on Pensionskassen and Bausparkassen, which have long-term business models. For this reason, BaFin is supervising these undertakings particularly closely.
The longer the low interest rate environment continues, the more it also has an effect on banks' books, because the longer interest rates stay low, the greater the pressure on earnings, especially for institutions using a traditional business model, which primarily conduct deposit and credit business. BaFin therefore checks regularly whether the around 1,550 institutions it directly supervises have sufficient capital. Since 2016, it has specified a binding sum which is sufficient for each individual bank as part of its Supervisory Review and Evaluation Process (SREP).9)
European supervisory system
BaFin's work has not just been characterised by regulatory reforms, but major structural ones as well, including the setting up of a European supervisory system at the beginning of 2011, partly as a result of the financial crisis. The European Banking Authority (EBA), the European Insurance and Occupational Pensions Authority (EIOPA) and the European Securities and Markets Authority (ESMA) started work. They form the European System of Financial Supervision10) together with the European Systemic Risk Board (ESRB), which monitors macroeconomic developments and, in case of emergency, warns of systemic risks to the financial stability of the EU.
Another fundamental reform was undertaken in 2014: in November of that year, the Single Supervisory Mechanism (SSM) was launched as part of the European banking union, which is regarded as one of the most important European reforms since the introduction of the euro.11) Since then, the largest banking groups of the eurozone – currently 125 of them – have come under the supervision of an alliance led by the ECB. These banking groups, including 21 from Germany, are supervised directly by the SSM. There are now Joint Supervisory Teams for them, in which BaFin staff work side by side with supervisors from throughout the eurozone. The introduction of the SSM was, first and foremost, a reaction to the sovereign debt crisis, which escalated in 2011 and became the main risk to financial stability.
The SSM has represented a historic paradigm shift for European banking supervision and has raised many questions and areas of uncertainty. BaFin had to ensure transparency in this area. It participated intensively in the design of the framework for the cooperation of the ECB with national supervisory authorities and contributed to the development of a joint SSM Supervisory Manual.
Single Resolution Mechanism
The second pillar of the European banking union is the Single Resolution Mechanism (SRM). Standardised rules for the orderly recovery or resolution of crisis-hit European banks have applied since the beginning of 2015. As part of this, the Single Resolution Board (SRB), the European resolution authority, was also launched at the same time. The SRB can, if need be, decide on the resolution of banks subject to direct supervision by the ECB or which conduct cross-border activities in the eurozone. Its Chair is the former BaFin President, Dr Elke König.12)
As a national resolution authority, the Federal Agency for Financial Market Stabilisation (Bundesanstalt für Finanzmarktstabilisierung – FMSA) is represented in the SRB. Its resolution activities will be integrated into BaFin as an additional directorate from the start of 2018.13) The background to this is the German FMSA Reorganisation Act (FMSA-Neuordnungsgesetz – FMSANeuOG - only available in German), which was promulgated in the Federal Law Gazette (Bundesgesetzblatt) at the end of 2016.
Another major European project directly affecting BaFin, especially the Directorate for Securities Supervision, is the creation of a Capital Markets Union. The European Commission intends to establish a single market for capital in the EU by 2019, which will facilitate cross-border risk sharing, create deeper and more liquid markets and generate a greater variety of financing sources for the real economy. It is predicted that such capital will be of particular benefit to small and medium-sized enterprises as well as infrastructure projects while also generating growth and employment. BaFin is providing constructive support in the implementation of the action plan. The process is now nearly half-completed and in June this year, the Commission will present a report on the first half.14)
However, the Capital Markets Union is not the only major regulatory change involving securities supervision. A further reform has affected the supervision of alternative investment funds (AIFs) and alternative investment fund managers (AIFMs) and was given a new legal basis in Germany in 2013: the German Investment Code (Kapitalanlagegesetzbuch – KAGB - only available in German). The KAGB was brought into being by the German Act Implementing the EU Directive on Alternative Investment Fund Managers (Gesetz zur Umsetzung der EU-Richtlinie über die Verwalter alternativer Investmentfonds) (AIFM Directive) and replaced the German Investment Act (Investmentgesetz).15) It did not only fundamentally change the terminology, but also provided comprehensive regulation on the requirements regarding the management and safe custody of all types of collective investment undertakings for the first time i.e. both for AIFs and for undertakings for collective investment in transferable securities (UCITS). BaFin worked on ensuring transparency for the public in this area and answered numerous questions of interpretation.
Other regulatory challenges for securities supervision in recent years have included the European Market Infrastructure Regulation (EMIR), which came into force in 201216), and the revisions to the Market Abuse and Transparency Directives as well as their implementation at the national level with consideration for the Market Abuse Regulation. The implementation of the Markets in Financial Instruments Directive (MiFID) of 2004 and the new version of it, MiFID II, was and is a feat of strength for all involved.17) MiFID II and the accompanying Markets in Financial Instruments Regulation (MiFIR) contain numerous provisions strengthening investor protection. Both will be applicable as of 2018.
Collective consumer protection
The protection of consumers – that is, of investors as well as bank and insurance customers – has always been one of BaFin's duties. The authority seeks to ensure that transparent, understandable financial products and services are offered. In July 2015, the German Retail Investor Protection Act (Kleinanlegerschutzgesetz - only available in German) laid collective consumer protection down in law as one of BaFin's supervisory objectives.18)
BaFin established a new department at the start of 2016 in order to carry out its consumer protection mandate to the best of its abilities. This department deals with issues relating to consumer protection from all financial sectors,19) with its tasks including informing consumers about the different types of financial and insurance products, financial services and their risks. To do this, BaFin makes use of various means of communication, including a special section (only available in German) on its website and its consumer helpline (only available in German).
BaFin works closely with the financial markets watchdog (Marktwächter Finanzen)20), the Federation of German Consumer Organisations (Verbraucherzentrale Bundesverband – vzbv) and other actors involved in financial consumer protection. It has been regularly exchanging information with external experts on the Consumer Advisory Council since 2013.21) In addition, BaFin is committed to further developing collective consumer protection and actively formulating consumer standards on a European and international level.
Unregulated capital market
The main objective of the abovementioned Retail Investor Protection Act was to increase transparency, allowing consumers to make a better assessment of whether prospective investments are reputable and how likely they are to be successful, thus protecting them from financial losses.22) This is particularly important on the unregulated capital market, where providers are not subject to supervision by BaFin and have to fulfil fewer legal requirements than supervised companies. Actors who try to get around legal provisions by using improper arrangements turn up time and again on this market. Such business models may cause serious harm to investors as well as damaging the confidence in the financial market of consumers who have not been directly affected.
To prevent this, the Retail Investor Protection Act gave BaFin additional powers to, for example, restrict or even prohibit the distribution of certain products, to intervene more strongly in breaches of advertising provisions and to warn investors by publishing measures taken against market participants. Furthermore, issuers of investment products are subject to additional publication requirements (so-called ad hoc requirements) after the end of the public offer if the issuer's ability to fulfil its payment obligations to the investor could be affected.23) The Retail Investor Protection Act also reinforced BaFin's market monitoring of investment products, securities offers and advertising so that the supervisory authority can identify irregularities in a timely manner and take action, because BaFin's guiding principle of forward-looking, risk-based action also applies to the unregulated capital market, in accordance with its mandate.
The KAGB, mentioned above, also represented an important milestone in the regulation of this segment. Since its entry into force, many managers of investment products which were previously part of the unregulated capital market are now subject to registration or authorisation requirements.
Illegal investment schemes
The unregulated capital market should not be confused with illegal investment schemes run by providers conducting business which requires written authorisation from BaFin without actually having such authorisation. BaFin has a wide range of powers of investigation and intervention to put a stop to such business, ideally before customers suffer losses. These powers have been incrementally expanded since the authority was founded.
If facts are known which warrant the assumption that unauthorised business is being conducted, BaFin can demand information and documentation on all business matters and, with a judicial order, can also search business and private premises to investigate the facts of the case. Cases involving so-called Reichsbürger – i.e. persons who do not recognise the Federal Republic of Germany as a legitimate state – have been among those attracting particular attention recently.24)
If the suspicion is confirmed, BaFin intervenes. In the past 15 years, it has obliged several hundred providers of unauthorised business to cease operations and to settle the transactions undertaken. To enforce this, it has imposed coercive fines and even applied to the competent administrative court (Verwaltungsgericht) for orders of imprisonment. BaFin publicises many measures on its website in order to deter others with similar intentions from conducting unauthorised business and to warn consumers.
The ongoing digital revolution in the financial sector is also having a bearing on consumer protection. It brings risks as well as opportunities for companies and consumers.25) For some time now, fintech companies, which have innovative, technology-driven business models, have been encroaching on the market and challenging established players, although the latter are also relying increasingly on digital processes. Such players are entering into cooperation agreements with fintech companies, taking inspiration from fintech models and developing their own ideas.
Such ideas range from "robo-advice" – automated advice – through to application programming interfaces (APIs) for the uniform, structured exchange of data and the evaluation of huge amounts of information under the buzzword "big data". Crowdinvesting via internet platforms26) and virtual currencies such as bitcoin, which are based on distributed ledger technology,27) would also not be conceivable without digitalisation.
BaFin is focusing intensely on fintech companies.28) It first set up a project group on the issue in early 2016 and then transferred the group's tasks to a separate, central organisational unit at the beginning of this year. Additionally, there are numerous initiatives in the individual directorates relating to specific fintech issues. BaFin is also a member of the Fintech Council of the Federal Ministry of Finance.
Start-ups and fintech companies can contact BaFin via its website. BaFin offers concise, easily understandable information online on different fintech business models in order to facilitate these companies' introduction to supervisory topics. The supervisory authority also encourages direct contact by attending events and last year it hosted its own fintech conference, BaFin-Tech 2016, to exchange views and information with start-ups and company representatives.29) It also offers special workshops on a regular basis.
Both conventional providers and fintech companies face an immense challenge in constantly ensuring IT security, which entails both the protection of their own IT systems and ensuring the quality of the service providers to whom companies frequently outsource significant parts of their IT. Companies have to protect themselves from both unintended mistakes by staff members and the ever-growing danger of targeted criminal attacks. BaFin currently sees significant shortcomings in this area.30)
BaFin's expectations of banks as regards IT security was one of the items on the agenda at this year's "IT supervision of banks" event.31) These expectations will be formulated in detail in the supervisory requirements for IT (Bankaufsichtliche Anforderungen an die IT – BAIT), which BaFin conducted a public consultation on running until the beginning of May. Moreover, it will publish new Minimum Requirements for Risk Management (Mindestanforderungen an das Risikomanagement – MaRisk) for banks in the near future.
In early 2016, the Second Directive on Payment Services came into force, which also resulted in new IT security requirements.32) It regulates the business activities of payment service providers in the EU and, compared to the Directive on Payment Services of 2007, has further developed the European single market for electronic payments by adapting the provisions to the innovative payment systems that use the Internet and mobile technology. There are also new provisions governing information and liability which are intended to increase consumer protection. EU Member States have to transpose the provisions into national law by 13 January 2018. In Germany, this will be achieved with the amendment of the German Payment Services Supervision Act (Zahlungsdiensteaufsichtsgesetz – ZAG - only available in German).
BaFin: continuous development
As the financial industry and thus also BaFin's responsibilities undergo constant change, the history of BaFin itself has been a continuous process of evolution. The authority underwent its first significant overhaul six years after its foundation when, in 2008, its leadership structure was reorganised. President Jochen Sanio, who had until then headed BaFin on his own, was joined by four Chief Executive Directors. Since then, the President and the Chief Executive Directors have made up the Executive Board. Sanio retired at the end of 2011 and passed on the baton to Dr Elke König, who led the authority until the end of February 2015. She was succeeded by the current BaFin President, Felix Hufeld, who until then had been Chief Executive Director of Insurance Supervision.
BaFin also enhanced its organisational structure by, for example, adjusting its banking supervision in 2014 so that it could efficiently coordinate the tasks related to the SSM.33) It also reorganised its insurance supervision in the same year,34) placing a greater focus on the supervision of insurance groups. At the start of 2016, BaFin introduced a new structure for the authority as a whole,35) bundling functions and topics affecting all of its directorates in their own units. One example of this was setting up the Consumer Protection Department, as mentioned above, while another was the internal reallocation of the Department for the Prevention of Money Laundering. There were also significant changes within the individual directorates, designed to represent new tasks as well as possible and minimise areas of overlap.
Alongside President Hufeld, the BaFin Executive Board is currently composed of Chief Executive Directors Raimund Röseler (Banking Supervision), Dr Frank Grund (Insurance and Pension Funds Supervision), Elisabeth Roegele (Securities Supervision and Asset Management) and Béatrice Freiwald (Internal Administration and Legal Affairs). A further member of the Executive Board will be added from 2018 for the new directorate for resolution. BaFin currently employs almost 2,600 people. Apart from the around 1,550 banks it supervises directly, it also monitors about 700 financial services institutions, nearly 90 German branches of foreign institutions, about 540 insurers, 30 Pensionsfonds, 260 asset management companies and over 6,100 German funds.
Public relations and dialogue
BaFin's expanding duties put it more and more in the public eye: it receives and responds to thousands of enquiries from journalists and consumers on all sorts of issues each year. It uses various communication channels to inform the public. These include its website, BaFinJournal (only available in German) and printed publications such as the annual report and various brochures. Moreover, the supervisory authority regularly organises its own events and attends trade fairs and Börsentage. It also offers a visitors' service.
BaFin maintains a close dialogue with the companies it supervises and other market participants. It continuously exchanges information with companies during ongoing supervision and provides contact opportunities for specific target groups. Apart from the information pages for consumers and fintech companies discussed above, the contact point for whistleblowers merits special mention here. It allows whistleblowers to inform BaFin of breaches of supervisory law – anonymously, if they wish. Since the beginning of this year, it has also been possible to submit whistleblowing reports via an electronic reporting system.36)
Furthermore, BaFin holds special information events and workshops on a regular basis.37) At the end of January, for example, it organised a workshop for foreign banks to discuss specialist issues related to Brexit, the planned exit of the United Kingdom from the European Union. BaFin has added a special section to its website for them with information on Brexit and ways to contact the supervisory authority.38)
Integrated financial supervisor
Even though financial conglomerates have not achieved anything like the significance it was once thought they would, the creation of an integrated financial supervisor was still the only correct move in retrospect, because financial market players are connected with each other in a multitude of ways. Having a perspective across sectors allows BaFin to identify risks at an early stage, to analyse them in a consistent manner and to take targeted action where required. It can also make balanced decisions in cases when, for instance, there are conflicts between the aims of solvency supervision and consumer protection. Both of these advantages apply also, and indeed particularly, in relation to the further development of European and international supervisory law.
It remains to be seen what new challenges BaFin will be facing in the years to come. But one thing is clear even now: BaFin will continue to move with the times and will always take a flexible attitude to new developments and conditions.
Footnotes: (BaFinJournal is only available in German)