What are the high risk businesses

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The Shielding Act requires large banks and banking groups to use a risk analysis to determine which particularly risky businesses they are conducting. You must end such transactions or separate them from the deposit business and other areas worthy of protection (see info box “A Brief History of the Shielding Act”). When separating, they must transfer the business to an economically, organizationally and legally independent financial trading institution. The advantage: The risk then lies in the separate institute - without the risk of infecting the healthy parts of the banking group.

The prohibitions under Section 3 (2) of the German Banking Act (KWG) include proprietary transactions, credit and guarantee transactions with certain hedge funds and European and foreign alternative investment funds (AIF) as well as high-frequency trading with the exception of market-making (see BaFinJournal January 2019).

At a glance: a brief history of the Shielding Act

With the financial crisis of 2007/2008, the too-big-to-fail problem came into focus. Behind this is the dilemma that banks that are large, complex and networked with other market participants, or whose functions are very important for the financial market, cannot simply leave the market in the event of a crisis. Because the failure of such a bank endangers financial stability. During the financial crisis, some institutes had to be rescued using state funds. This put a strain on the taxpayer and distorted competition.

The European Commission therefore set up a group of experts in 2012 under the leadership of the Finnish Central Bank President Erkki Liikanen (Liikanen Group). She came to the conclusion that banks should separate certain high-risk transactions, in particular from their deposit business - the birth of various separate banking regulations in Europe (see info box “International banking regulations”).

The German legislator took up the recommendations of the Liikanen Group and passed the Shielding Act, which came into force on January 14, 2014. With it, the Banking Act (KWG) also changed.

scope

Section 3 (2) KWG covers large credit institutions that are subject to the European Capital Requirements Regulation (CRR), as well as companies in groups with CRR companies if they exceed certain thresholds (see information box "Thresholds"). For smaller credit institutions that operate the above-mentioned transactions below the threshold values, their prohibition or the obligation to separate does not apply.

At a glance: threshold values

Credit institutions can qualify for the separate banking regime in two ways:

  • either through international accounting if certain balance sheet items defined in Section 3 (2) sentence 2 no. 1 of the German Banking Act (KWG) exceed the absolute threshold of 100 billion euros or if the balance sheet total has reached 90 billion euros in the past three financial years and the in Legally defined balance sheet items exceed at least 20 percent of the balance sheet total (relative threshold value),
  • or via national accounting in accordance with the Commercial Code (HGB) if your trading portfolio and liquidity reserve exceed EUR 100 billion (absolute threshold) or total assets of at least EUR 90 billion have been reached in the past three financial years and trading portfolio and liquidity reserve 20 percent of the last Exceed total assets (relative threshold).

As far as BaFin knows, ten institutes currently exceed the threshold values ​​mentioned and are therefore subject to the Shielding Act. The institutes have to determine for themselves whether they meet the criteria. There is currently no obligation to report to the supervisory authority. The Federal Council has had a legislative proposal from the federal government since August 2020. Before the law can be passed in parliament, the Federal Council gives its opinion. The draft stipulates that institutions must notify the supervisory authority if they exceed or fall below the threshold values. That would further increase transparency, especially with regard to the supervisory authorities.

Regardless of the threshold values, BaFin can order any institution under its supervision that it cease or transfer particularly risky transactions in addition to the transactions specified in the law. Such individual authorization comes into question if the transactions endanger the solvency of the credit institution and can also affect market making. Anyone who continues to pursue prohibited business can face imprisonment or a fine.

From shielding law to interpretation aid

After the Shielding Act came into force, BaFin published the first version of its interpretative guide in December 2016. It thus offered those responsible in the institutes, beyond the wording of the law, clues on how to identify and deal with prohibited transactions - an important aspect against the background of criminal liability. In addition, the law enforcement authorities were also able to orientate themselves on the explanations.

Numerous other questions have arisen since it was first published. BaFin therefore published an updated version of the interpretation guide with the Deutsche Bundesbank on August 6, 2020 after prior consultation.

At a glance: international separate banking regulations

In addition to the German shielding act, there are a number of other separate banking regulations - for example the Dodd-Frank Act with the Volcker Rule in the USA and the Financial Services Act in Great Britain, which was based on a proposal by the Independent Commission on Banking and chaired by the well-known economist Sir John Vickers based.

Within the EU, for example, there are separate banking regulations in France and Belgium. In contrast, the EU Commission's draft regulation for a structural reform of the banking system with separate banking regulations for the entire EU banking sector was rejected at EU level.

Important changes in the second version

In terms of content, the changes affect, for example, the scope of an exception that was already developed in the original version, according to which fully secured credit and guarantee business with hedge funds and AIFs is still permitted - provided that the collateral is of sufficient quality. In addition, the interpretative aid answers the question under which circumstances indirect lending and guarantee business with hedge funds and AIFs is also covered by the prohibition of Section 3 (2) sentence 2 KWG - for example in connection with special purpose vehicles that are not hedge funds or AIFs themselves But has used hedge funds or AIFs and has significant control over them.

With regard to the term hedge fund and AIF, the updated interpretation guide now makes it clear that the prohibition also includes loan and guarantee transactions with open domestic special AIFs if the investment conditions do not exclude the use of leverage to a considerable extent.

New structure

BaFin and the Bundesbank have given the interpretation aid a modular form because it is easier for users to orientate themselves and because it allows later additions.

In view of the punitive reinforcement and the legal risks for the institute and its employees, BaFin appeals to the banks to establish effective compliance processes that contribute in particular to the identification of prohibited transactions. In addition to ongoing business, this also applies to the new product process.

Authors

Max Sussbauer
Nina Linder
BaFin keynote address for the restructuring of banks

Note

The article reflects the status quo at the time of publication in the BaFinJournal and is not updated retrospectively. Please note the general terms of use.

Further information

BaFinJournal 09/2020 (Download)

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