Back to reason ‑ German administrative court rejects BaFin’s approach to licensing

Newsletter December 2005 Back to reason – German administrative court rejects BaFin's approach to licensing Contents: Why is this important? 2 Background 2 Why is the new judgment correct? 2 And now? 3 In a judgment of 27 October 2005, the Frankfurt Administrative Court (Verwaltungs- gericht)1 held that a company does not carry on licensable financial commission agency business unless the company is indeed a party to a commission arrangement. The This survey is only for the purpose of general information court also held a company does not carry on licensable investment fund business and is no substitute for legal advice. Clifford Chance therefore accepts no liability if, in reliance on the unless the company is also a qualifying investment fund company. This welcome information contained in this survey, you act or fail to act decision is in line with the prevailing views in German legal literature but rejects the in any particular way. If you would like to know more about the subjects covered in this publication or our much broader interpretation of German licensing requirements asserted by the German services, please contact your usual Clifford Chance contact or: Federal Financial Services Supervisory Authority (Bundesanstalt für Finanzdienst- leistungsaufsicht – "BaFin") and departs from the court's own earlier decisions and Peter Scherer Tel: +49 69 7199 1294 peter.scherer@cliffordchance.com previous decisions of the Higher Administrative Court of Hesse. Clifford Chance Under section 1 para. 1 sentence 2 no. 4 of the German Banking Act (Kredit- Königsallee 59, 40 215 Düsseldorf wesengesetz – "KWG") a person needs a banking licence to carry on what is described Mainzer Landstrasse 46, 60 325 Frankfurt am Main Theresienstrasse 4-6, 80 333 München as financial commission agency business (i.e. principal broking business). However, the www.cliffordchance.com administrative court held that the entity in question would only need a licence if there was a commission arrangement within the meaning of sections 383 et seq. of the German Commercial Code (Handelsgesetzbuch). Similarly, under section 1 para. 1 sentence 2 no. 6 of the Banking Act a person needs a banking licence to carry on investment fund business but the court held that this requirement does not apply if the company performing the relevant business does not qualify as investment fund company within the meaning of the German Investment Act (Investmentgesetz). Clifford Chance Partnerschaftsgesellschaft von Rechtsanwälten, Wirtschaftsprüfern, Steuerberatern und Solicitors Sitz: Frankfurt am Main .AG Frankfurt am Main PR 1000 .Ust-Id-Nr.: DE 20 64 54 351 Informationen zu den zuständigen Rechtsanwaltskammern, Steuerberaterkammern und der Wirtschaftsprüferkammer und den jeweils einschlägigen berufsrechtlichen Regelungen unter www.brak.de, www.bstbk.de, www.wpk.de oder www.lawsociety.co.uk. Back to reason – German administrative court rejects BaFin's 2 approach to licensing December 2005 Why is this important? linked to the performance of other which invested its capital in financial assets. instruments. In its decision, the relevant In the last two years, the BaFin's broad court held that this business model could interpretation of the Banking Act (and in The BaFin never published any circular, be treated as licensable investment fund particular of section 1 para. 1 sentence 2 regulation or other regulatory paper ex- business within the meaning of section 1 no. 4) has led to considerable uncertainty plaining its views on this topic in detail, para. 1 sentence 2 no. 6 of the Banking about the scope of the licensing but it did publish on its website several Act. requirements under that Act. This has press releases in relation to administra- become an impediment with respect to a tive orders prohibiting the activities of The Frankfurt Administrative Court's new number of types of transaction in which certain market participants (exclusively decision departs from its previous special purpose companies are used to grey capital market players offering interpretations, as to the scope of the invest in assets, such as CDOs,2 instruments to retail investors).3 In these definition of both financial commission repackagings and other structured cases, the BaFin asserted that investors agency business under section 1 para. 1 finance transactions. The Administrative had indirectly invested in financial sentence 2 no. 4 of the KWG and Court's new decision could in the future instruments bought by their counter- investment fund business under section help to resolve this uncertainty if it is parties and that this was sufficient for the 1 para. 1 sentence 2 no. 6 of the KWG. affirmed by the higher courts. counterparty's business to qualify as regulated financial commission agency Why is the new judgment Background business carried on for the account of right? the investors. Until recently, the general view was that Financial commission agency business an entity did not require a licence under This new policy was - in our view, rightly the Banking Act to invest for its own – criticised4 as not being consistent with Section 1 para. 1 sentence 2 of the account in financial instruments (i.e. the statute. However, the Frankfurt Banking Act provides an exhaustive securities, money market instruments, Administrative Court5 and the Higher definition of what constitutes licensable forex or derivatives) or to issue its own Administrative Court of Hesse6 partially banking business, which includes the bonds, debentures, certificates or other confirmed the BaFin's view in a series of purchase and sale of financial instru- securities, even if the payout on those decisions. ments in one's own name for the securities was linked to the performance account of others (i.e. financial commis- of other instruments or assets held by the Nevertheless, the scope of application of sion agency business, also referred to as issuer.