In June 2020, Wirecard AG filed for insolvency due to impending insolvency and overindebtedness. The events unfolding at the Aschheim-based financial services provider undermined trust in Germany as a financial centre. By adopting the FISG in May of this year, the German Bundestag and Bundesrat laid the foundations for fundamental reforms, including the reform of financial supervision in Germany. For BaFin, this means more competencies and more powers of intervention. The FISG was also adopted with the objective of modernising BaFin’s structures. First steps in this direction have already been taken.

Reforms under way

Back in July 2020, German Finance Minister Olaf Scholz presented the German government’s action plan¹ to combat financial reporting fraud and to strengthen controls over capital and financial markets. A few months later, in December 2020, the Federal Cabinet adopted its draft of the FISG, which implements main areas of the action plan. The German Bundestag passed the act on 20 May 2021, and approval was given by the German Bundesrat on 28 May. The FISG was drafted by the Federal Ministry of Finance (Bundesministerium der Finanzen – BMF) and the Federal Ministry of Justice and Consumer Protection (Bundesministerium der Justiz und für Verbraucherschutz – BMJV).

Most of the changes brought about by the FISG became effective on 1 July 2021. Below we explain some of the changes that are of major importance to BaFin:

BaFin given stronger role in financial reporting enforcement

In particular BaFin’s role in the area of financial reporting enforcement has been significantly strengthened as a result of the FISG. The relevant amendments to the German Securities Trading Act (Wertpapierhandelsgesetz – WpHG) enter into force on 1 January 2022. In future, the responsibility for ad hoc audits and spot checks will lie exclusively with BaFin. If there is reason to suspect violations of accounting rules, BaFin may approach a capital market company directly and at short notice – and check their accounts using forensic means.

BaFin has been granted additional public powers for this purpose, for example more extensive rights of access to information and rights to conduct searches and seize assets. BaFin will also be allowed to summon and question the members of the executive board of an audited company and its auditors. To be able to do this, it will hire more staff and recruit auditors and persons with forensic qualifications, amongst others. The goal of these measures is to identify suspicious circumstances – from incorrect accounting down to accounting fraud – as early as possible and clarify any irregularities, if necessary in collaboration with the public prosecutor’s office. In this way, cases like Wirecard are to be prevented from happening again.

Up until now, the Financial Reporting Enforcement Panel (Deutsche Prüfstelle für Rechnungslegung – FREP), an institution organised under private law, was responsible for looking into suspected violations of accounting requirements. BaFin was only called on to examine a company if the latter refused to cooperate with the FREP, disagreed with the results of the examination or if there were considerable doubts about the examination procedure or results of the FREP examination. This two-tier model has proved inefficient. The responsibility for financial reporting enforcement has now been assigned exclusively to BaFin.

BaFin’s position has also been strengthened in another area as a result of the FISG: from the beginning of 2022, BaFin will have direct powers of intervention in respect of companies to which important banking functions and procedures have been outsourced. The FISG spells out which direct rights to information and inspection rights have been assigned to BaFin and has extended the supervisor’s powers to issue orders. Up until now, BaFin’s only means of intervention was via the banks, but in future it will have direct powers to intervene in order to avoid or remedy irregularities at companies to which functions were outsourced. BaFin may now also impose administrative fines on such companies. If institutions outsource activities to companies domiciled in third countries outside the European Economic Area, both parties must contractually appoint a person authorised to accept service to whom inspection orders may be served by BaFin at short notice, for example. Furthermore, the FISG has reintroduced the notification requirement for material outsourcings, thereby ensuring that BaFin has a comprehensive overview of the outsourced activities and processes and accompanying (concentration) risks.

President’s role strengthened

The FISG also strengthens the role of the BaFin President – both in the strategic management of the authority as well as in organisational and budgetary questions. The BaFin Statutes will contain specified provisions on these new powers – as will BaFin’s Organisational Statute, which is based on this.

Mystery shopping

Mystery shopping will also be possible soon as a result of the FISG. Test buyers trained in this field act as if they were consumers seeking advice, or they acquire products for test purposes. Covert purchases of this kind give BaFin an impression of how companies behave towards their customers. BaFin will use this new tool in future to examine whether companies are complying with their statutory obligations in their dealings with consumers and (retail) investors.

Test purchases will therefore be made wherever financial services or financial products are being provided or sold to consumers or retail investors, in other words, wherever statutory consumer protection laws apply – whether in the fields of classic investment advice, loan granting or insurance distribution.

To commence piloting operations promptly, BaFin published a public tender on 28 May 2021 in which agencies were invited to tender for orders as part of an initial market probe. Regular mystery shopping operations are due to commence from 2022.

Staff members’ securities transactions

The introduction of the FISG has also resulted in another important change, which concerns the personal trading activities of BaFin staff members. From 1 July 2021, the FISG largely prohibits staff members from trading in financial instruments, such as shares and bonds, for their personal investments. In future, BaFin staff members will no longer be allowed to trade in financial instruments admitted to trading on a German stock exchange. Out of bounds now to BaFin staff members are all financial instruments issued by a financial corporation with its registered office or branch in the European Union, irrespective of whether the aforesaid financial instruments have been admitted to trading on a stock exchange or not. They are also not allowed to trade in financial instruments of companies or their group companies that are under BaFin’s supervision. Here, too, it is irrelevant whether these financial instruments have been admitted to trading on a stock exchange or not. Issues of non-listed companies are also covered by this ban. And finally, trading in derivatives on the aforementioned financial corporations is now also prohibited.

The FISG provides for only two exceptions – put simply, these are investment funds and transactions in the context of portfolio management.

The aim of the new rules is to prevent doubts from arising about BaFin’s integrity. The impression must be avoided that BaFin staff members are basing their personal investment decisions not just on objective criteria, that they are conducting insider dealing, using knowledge acquired through their work for BaFin to make personal financial transactions or allowing decisions in connection with their official duties to be swayed by personal financial interests.

In anticipation of the new requirements, BaFin tightened its rules for the personal trading activities of its staff members last year: since 16 October 2020, staff members assigned to risk category A have not been allowed to trade in financial instruments issued by corporations with registered office or branch in the EU. Risk category A encompasses all staff members who, on account of the tasks assigned to them at BaFin, have access to inside information. This is more than 85 percent of BaFin’s staff members.

Modern structures

The Wirecard case has also exposed a number of weaknesses in BaFin’s structures. In a project to modernise Germany’s financial supervisor, initiated by the BMF and prepared jointly with BaFin, these weaknesses are to be remedied. The project is to be completed by the end of this year, but considerable progress has already been made in some sub-projects. In May, for example, the new Focus Units commenced their piloting operations and are expected to start regular operations in August.

With its new Focus Units, BaFin wants to take an even closer look behind the facade of banks and other companies engaged in business models that appear to be extremely complex or highly innovative. BaFin will be able to gain first-hand knowledge more quickly and more precisely of the source of these companies’ incomes and pinpoint where risks are accruing. If BaFin comes across circumstances that lack transparency and is unable to obtain clarity on this, it will step into action and – if necessary – impose restrictions on the company’s business activities.

Besides the Focus Units, another key sub-project of BaFin’s modernisation process is the Task Force, which is due to be launched in mid-August and will work closely with the Focus Units. The Task Force is designed as a kind of rapid reaction force that is able to step into action from one moment to the next and carry out on-the-spot investigations. It will conduct these investigations itself and will also be able to perform forensic audits. This is uncharted territory for BaFin. Up until now, forensics has only played a role in the area of enforcement relating to unauthorised business.

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