The German Risk Reduction Act (Risikoreduzierungsgesetz) is undeniably complex. This comes as no surprise as it is one of the laws in Germany with which important lessons from the 2007/2008 financial crisis have been incorporated into national law. It is common knowledge that the crisis raised many difficult regulatory questions.

On 28 December, the Risk Reduction Act introduced new rules in several areas of banking supervision law. The Act primarily transposes two European Directives into German law that were adopted in the summer of 2019 as part of the EU banking package: the CRD V and BRRD II (see info box “The German Risk Reduction Act and the European banking package”). These Directives bring about changes, via the Risk Reduction Act, which primarily have an impact on the German Banking Act (Kreditwesengesetz) and the German Recovery and Resolution Act (Sanierungs- und Abwicklungsgesetz). The provisions governing deposit guarantee schemes have undergone changes, too. An overview of the new key changes can be found below.

Impact on the German Banking Act

The Risk Reduction Act expands the provisions on the identification of risk takers in the Banking Act. It also implements new rules regarding the leverage ratio buffer and introduces an authorisation procedure for parent financial holding companies. In addition, the Risk Reduction Act specifies the provisions for setting additional own funds requirements within the Supervisory Review and Evaluation Process (SREP), incorporates guidance on additional own funds in the law and obliges large third-country groups operating in Europe to establish intermediate EU parent undertakings.

Identifying risk takers

The Risk Reduction Act expands the rules on the system for identifying risk takers in section 25a (5b) of the Banking Act. Regardless of their size, all institutions are now required to identify certain groups of persons as risk takers, including not only members of the management board and supervisory board, who are explicitly listed in the new section 1 (21) of the Banking Act, but also other individuals, such as employees with managerial responsibility for the institution’s key business areas. Significant institutions must also identify risk takers outside these groups of persons based on the broader criteria in Delegated Regulation (EU) 604/2014.

The criteria as to what constitutes a significant institution within this context are now centrally defined in section 1 (3c) of the Banking Act. Section 25n of the Banking Act is no longer applicable. As a result of the new definition in section 1 (3c), institutions may no longer prove, based on a risk analysis, that they are not a significant institution.

Leverage ratio buffer from early 2023 onwards

The CRR II, which is also part of the European banking package, introduces a leverage ratio that will be a binding Pillar I requirement from 28 June 2021. The leverage ratio (LR) amounts to 3% of the total exposure measure (approximately corresponding to total assets, which are adjusted for the calculation of the LR) and must be held in the form of Tier 1 capital. The CRR does not need to be transposed into national law in order to become effective as it is directly applicable as an EU Regulation.

In line with the CRD V, the Risk Reduction Act sets out the requirements for an additional leverage ratio buffer that only global systemically important institutions (G-SIIs) will be required to build up from 1 January 2023 onwards. The requirements for this buffer are now set out in section 10j of the Banking Act. Section 10j also sets out the consequences if an institution does not meet the LR buffer requirement. In such cases, the institution must draw up a capital conservation plan and have it approved by the competent authority.

Originally, the LR buffer was to become effective on 1 January 2022. However, European legislators joined the Basel Committee on Banking Supervision in postponing the effective date by a year due to the coronavirus pandemic.

Authorisation of parent financial holding companies

As set out in Article 21a of the CRD, the Risk Reduction Act introduces an authorisation procedure for mixed financial holding companies that are at the head of a regulated group; this is set out in the new section 2f of the Banking Act. As a result, the supervision of financial holding companies in the banking sector is intensified significantly.

Following an application by a company, the competent authority for group supervision decides whether the authorisation requirement applies; if the financial holding company has its registered office in another EEA country, the competent authority for group supervision takes this decision together with the competent authority in this country. BaFin is the competent authority for less significant institutions (LSIs) to the extent that supervision is carried out on a consolidated basis in Germany. The ECB is the competent authority for significant institutions (SIs).

Depending on the structure of the group and the level of involvement of the parent company, there may be cases where no authorisation is required. But once the competent authority has granted a financial holding company authorisation in accordance with section 2f of the Banking Act, the entity at the head of the group is responsible for ensuring that supervisory requirements are complied with at group level. At the same time, the supervisory authority has increased powers vis-à-vis these authorised financial holding companies.

As for financial holding companies that are subject to the provisions in section 2f of the Banking Act and that had already been established by 29 June 2019, the transitional provisions of section 64a (1) of the Banking Act stipulate that these companies can submit an application for authorisation by 28 June 2021.

Transitional provision for investment firms

Although it is not part of the CRD V implementation package, section 64a (3) of the Risk Reduction Act is still worth mentioning, as it introduces a transitional provision in the Banking Act for investment firms that fall under the scope of Regulation (EU) 2019/2033. Since these firms will have their own supervisory regime from 26 June 2021 with the German Act on the Supervision of Investment Firms (Gesetz zur Beaufsichtigung von Wertpapierinstituten), the Banking Act – in the version in force until 28 December 2020 – will remain largely applicable during the transitional period between 29 December 2020 and 26 June 2021. As a result, the firms concerned will not have to spend a significant amount of time and effort implementing requirements that will no longer be applicable six months later.

Changes to the Recovery and Resolution Act

The Risk Reduction Act changes one key aspect of the Recovery and Resolution Act: the MREL (see info box “Minimum Requirement for Own Funds and Eligible Liabilities”). Some of the requirements associated with the MREL have been amended, too.

In addition to the MREL, there are further subordination requirements that apply to large banks with total assets exceeding EUR 100 billion (top-tier banks). These banks are required to fulfil part of their MREL obligations (8% of total assets) with own funds and subordinated eligible liabilities. The MREL is no longer expressed as a single ratio relating to total liabilities and own funds but instead as two ratios. The MREL is expressed as a percentage of the total risk exposure amount and of the total exposure measure. As a result, the MREL relates to the same benchmarks as the supervisory own funds requirements.

To ensure the effective resolution of a group, the competent authority will – when determining the MREL – distinguish between the entities within a group for which resolution measures are to be taken and those that are not to be resolved. As a national resolution authority in the Single Resolution Mechanism (SRM), BaFin is responsible for the less significant institutions in Germany. The Single Resolution Board (SRB) is responsible for significant institutions and for less significant groups of institutions operating on a cross-border basis.

Resolution entities must fulfil consolidated MREL requirements for the resolution group as a whole with own funds and liabilities towards external creditors. For non-resolution entities, in turn, an internal MREL requirement can be determined on a case-by-case basis. The institutions must fulfil extensive reporting and disclosure requirements if resolution planning does not provide for liquidation in normal insolvency proceedings.

In addition, the resolution authority is granted extensive powers so that it can respond to infringements of the MREL requirements. For instance, the resolution authority has the power to prohibit certain distributions and to take early intervention measures such as the replacement of members of management.

Further changes to the Recovery and Resolution Act

In future, the resolution authority will not have to wait until the resolution of an institution has been initiated in order to suspend payment or delivery obligations (section 82 of the Recovery and Resolution Act), but will be able to impose a moratorium as soon as it has found that the institution is failing or likely to fail. This is to give the resolution authority up to two extra working days to assess whether resolution is in the public interest. It may also use the time it has gained to decide which resolution measures it will take or to ensure that resolution tools are being used effectively.

Under section 55 of the Recovery and Resolution Act, institutions and group entities are obliged to stipulate in the contractual provisions for eligible liabilities governed by the law of a third country that the parties to the agreement recognise that the bail-in tool may be applied. This section also stipulates that the institution may notify the resolution authority if the required bail-in recognition clause cannot be included for legal or other reasons. As a general rule, a liability cannot be considered an MREL-eligible liability without such a bail-in recognition clause.

Minimum denomination per unit

The Risk Reduction Act has also resulted in some amendments to the German Securities Trading Act (Wertpapierhandelsgesetz). For instance, the newly introduced section 65b of the Securities Trading Act stipulates that a minimum denomination per unit of EUR 50,000 generally applies for subordinated eligible liabilities under section 2 (3) no. 40a of the Recovery and Resolution Act and relevant capital instruments under section 2 (2) of the Recovery and Resolution Act if banks are selling them to retail clients. This provision implements Article 44a(5) of the BRRD and is aimed at ensuring, for the purpose of investor protection, that retail clients do not excessively invest in these instruments. For proportionality reasons, the minimum denomination per unit for the relevant capital instruments – within the meaning of section 2 (2) of the Recovery and Resolution Act – of small and non-complex institutions has been set at EUR 25,000.

Changes to deposit guarantee schemes

The Risk Reduction Act has also led to changes to the statutory compensation schemes set out in the German Deposit Guarantee Act (Einlagensicherungsgesetz). There are currently two statutory compensation schemes: the Compensation Scheme of German Banks (Entschädigungseinrichtung deutscher Banken GmbH), for private banks, and the Compensation Scheme of the Association of German Public Sector Banks (Entschädigungseinrichtung Öffentlicher Banken Deutschlands GmbH), for public sector banks. Once the Risk Reduction Act has entered into force, the Federal Ministry of Finance (Bundesfinanzministerium) intends to terminate the rights and obligations granted to the Compensation Scheme of the Association of German Public Sector Banks (see info box “Compensation schemes: transfer and revocation of sovereign rights and obligations”), which means that there will be only one statutory compensation scheme in future.

This change takes into account that promotional banks no longer fall under the scope of the CRD IV and CRR and thus no longer fall under the scope of the Deposit Guarantee Act. As a result, the Compensation Scheme of the Association of German Public Sector Banks comprises only five members instead of a previous 17 member institutions. Out of these five institutions, only one of them holds the majority of the deposits to be protected. To ensure that deposits continue to be adequately protected in the long term, German legislators had to reorganise the protection of deposits. The reasons for this are obvious: a deposit guarantee scheme is more stable the more member institutions it has and the more homogeneous their risk profiles are.