1ST QUARTER EDITION 2010

BaFinQuarterly

Current regulationThe new Remuneration Ordinance forInstitutionspage 8

InternationalIASB Issues Exposure Draft onHedge Accountingpage 21

Current regulationThe Investor Protection andFunctionality Improvement Actpage 15

Issue

Gabriele Hahn: Interview with BaFin’s new Chief Executive Director of Insurance Supervision page 24

Current regulationMaRisk: Further revision to takeaccount of international standardspage 3

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Foreword

What are the challenges facing insurance supervisionat BaFin? What approach is BaFin taking on the issueof low interest rates? And what is its position on theconcerns of small and medium-sized insurance com-panies, who fear that the future European regulatoryframework, Solvency II, will demand too much ofthem? BaFinQuarterly spoke about these matterswith Gabriele Hahn, the new Chief Executive Directorof Insurance Supervision. The interview may befound on page 24.

The fifth quantitative impact study on Solvency II,QIS 5, has been carried out at the request of theEuropean Commission to test how insurers in theEuropean Economic Area are coping with therequirements of Solvency II. BaFin published theresults for the German insurance market on 21March. They revealed that German insurers consid-ered Solvency II’s standard formula to be too com-plex and thought that it should be made more prac-ticable. It was also shown that because of the long-term nature of their business and the assumption ofinterest rate guarantees, the own funds position ofGerman life insurers is extremely sensitive to smallchanges in the yield curve. BaFin is advocating thatthe Solvency II draft be reworked accordingly. Formore on this subject, see page 19.

The financial crisis exposed weaknesses in banks’risk management. For that reason numerous regula-tory steps have been taken in this area as well, atboth the global and European level. BaFin has incor-porated these steps in its revised version of the“Minimum Requirements for Risk Management”(Mindestanforderungen an das Risikomanagement –MaRisk), which were published in December 2010.An article on this subject appears on page 3.

A further consequence of the financial crisis is the“Act relating to Strengthening Investor Protectionand Improving the Functionality of the CapitalMarket” (Gesetz zur Stärkung des Anlegerschutzesund Verbesserung der Funktionsfähigkeit desKapitalmarkts – AnsFuG), which was promulgated inthe Federal Law Gazette (Bundesgesetzblatt) in April.The Act is intended to strengthen confidence in theintegrity and functionality of the capital market by,for instance, seeking to ensure greater market trans-parency and providing better protection for retailinvestors. To find out what changes the Act willintroduce – in the Securities Trading Act (Wert-papierhandelsgesetz), for example – see page 15.

Anja Engelland, Deputy Head of Press and PublicRelations

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from the more superordinate principles of riskmanagement (high level principles for riskmanagement) over requirements on the quality andquantity of liquidity buffers to more specific riskmanagement subjects such as dealing with riskconcentrations or performing meaningful stresstests.

Of course, the subjects for this are not chosen atrandom but instead reflect the weaknesses in riskmanagement that have emerged with manyinstitutions during the financial crisis. Although insome cases these were finalised and published onlylate in the summer of 2010, the CEBS hadcommitted itself to very ambitious implementationdeadlines – these guidelines were to be adopted intonational supervisory practice already by the end of2010. Moreover, CEBS, departing from past practice,intends to conduct an implementation study oneyear after the implementation date. In this context,it is to be reviewed to what extent the content ofthe respective CEBS guidelines has found its way notonly into national regulations and supervisoryprocesses but also into industry practice.Accordingly, the objective of greater convergenceand harmonisation of European supervisory practicewill likely enjoy even greater emphasis than hasalready been the case in the past.

Adjustment of Minimum Requirements for RiskManagement (MaRisk)

It became clear already early on that the new CEBSGuidelines on Risk Management, given their depth ofdetail, would have an impact on nationalrequirements. BaFin therefore offered theassociations of the banking industry early 2010 theprospect of a further revision of the MaRiskrequirements which, based on section 25a of theGerman Banking Act (Kreditwesengesetz – KWG),represent the qualitative framework for bank-internalrisk management. According to the first draft of 9July 2010 and a subsequent meeting of the MaRiskexpert committee in October 2010, BaFin lastly, on15 December 2010, submitted the final version.

Current regulation

SUPERVISORY PRACTICE

MaRisk: Further revision to takeaccount of international standards

Markus Hofer, BaFin

With its Minimum Requirements for RiskManagement (Mindestanforderungen an dasRisikomanagement – MaRisk, available in Germanonly) published in August 2009, BaFin has, for thetime being, completed the regulatory steps in thearea of risk management that were triggered by thefinancial crisis. These first initiatives had beenstarted by the Financial Stability Board (FSB) with itsReport on Enhancing Market and InstitutionalResilience (also referred to as the Draghi Reportafter the name of the FSB’s chairman), resulting infollow-up work at the EU level. However, anyonewho thought that this already concluded the mostimportant regulatory steps in the wake of the crisisand that things for now would return to calm shouldthink again. Since then, the international communityof states not only has subjected the BaselFramework on Banking Regulation and, thus, aboveall the existing international capital and liquidityregime to a fundamental overhaul and published thenew framework under the name of Basel III. Also inthe area of risk management, work on improvedsupervisory standards has been stepped upconsiderably over the past 18 months. In addition tothe Basel Committee on Banking Supervision, theCommittee of European Banking Supervisors (CEBS)– since 1 January 2011: the European BankingAuthority (EBA) – has been a driving force in thisarea.

The range of issues addressed as part of suchconvergence work is multifaceted and has sinceculminated in numerous guidelines. These range

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Initially, the salient points naturally focused onsubjects of international debate such as riskconcentrations, stress tests and liquidity buffers.Above and beyond that, BaFin also took the furtherrevision as an opportunity to allow the experiencegathered in supervisory and auditing practice toculminate in adjustments and additions where theneed for such improvements had become apparent.This notably affected the subjects of risk-bearingcapacity concepts and strategies. The adjustments inthe MaRisk requirements were rounded off byfurther specific additions.

Inventory of risks and risk-bearing capacity

Initially, BaFin focused adjustments on a few pointsrelating to the concept of risk-bearing capacity.These were based above all on experience gained forsupervisory practice. To enable a structuredexamination of significant risks, the revised versionof MaRisk clarifies that the overall risk profile has tobe prepared as part of an inventory of risks.Essentially, this does not entail anything that isreally new: as in the past, institutions are requiredto prepare an overall risk profile based on theanalysis of the economic, legal and politicalenvironment and the risks resulting therefrom.However, what this does make clear is that merelydefining the risks listed in MaRisk without thinkingthese through does not suffice when it comes toidentifying the material risks that make up thestarting point for the institute’s internal concept forrisk-bearing capacity. That institutions for thispurpose may not exclusively base this concept onformal legal models or the current impacts onaccounting underscores the aim of getting them tokeep an eye on the economic substance of their ownactivities. Of course, formal legal arrangements andtheir representation in accounting are indeedsignificant factors when it comes to identifying risksand therefore should not be disregarded; however,taking these aspects as the exclusive basis carriesthe risk of certain risks (such as reputational risks orrisks arising from off-balance sheet structures, forexample) being disregarded.

Also fed by experience from supervisory practice,requirements to take account of diversificationeffects in banks’ concepts for risk-bearing capacityare set out for the first time. Here BaFin, in view ofthe assumptions made by some banks, sees theneed for action since, despite the absent orinsufficient data basis, these assumptions were quiteprogressive for some institutions, leading to (insome cases considerable) savings in internal capital.Determining diversification effects spanning all typesof risk is anything but trivial, but so far no generallyaccepted procedures have been developed to asufficient extent for such determination. This is allthe more reason to take a conservative approach todetermining such effects given that the financialmarkets crisis has shown how quickly diversificationcan literally “vanish” in situations of spiralling crises.Against this background and given the stillcontinuing international debate on the recognition ofdiversification effects, BaFin has set outrequirements which put a focus on a determinationof these effects that must be sufficientlyconservative. What is decisive is that the data usedfor this represent the institution’s individual businessand risk structure. Moreover, it is also important toensure that the effects also prove sufficiently stablein times of economic downturns and upturns (as wellas in market conditions that are unfavourable for theinstitution). It is the responsibility of the institutionsto show that the effects included are stable andwere determined conservatively, and that the dataapply to the institution’s individual circumstances. Ofcourse, this clearly cannot take the form ofirrefutable proof; that said, this does not release theinstitution from its obligation to be capable offurnishing this proof in a manner that is at leastplausibly comprehensible, also when risk models areused as part of so-called pooling solutions (e.g. inthe case of cooperative solutions).

Strategies

BaFin has taken up the subject of strategies onceagain as part of the revision of MaRisk, since in thepast the impression sometimes has arisen that inpractice the requirements of Module 4.2 in somecases were only implemented on paper. There weredifferent kinds of weaknesses: in some casessignificant influencing factors, whether internal orexternal, were not taken into account sufficiently inthe determination; in others the strategic aims wereextremely vague with the result that targetfulfilment could not be verified. Also the sometimesabsent consistency between the business and riskstrategy provided an incentive to review therequirements critically. As a logical consequence, the

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changes in this area therefore focus on theconsistent strategy planning process. In particular itis now clarified that the aims must be worded insuch a way as to enable meaningful verification oftarget fulfilment. In that sense, the main interesthere is in the necessity of a target/performancecomparison, which however does not mean thatobjectives that by nature are more qualitative mustbe forced into the mould of quantitative schemes orkey ratios (e.g. customer satisfaction). By contrast,fears of practitioners that negative deviations fromtargets per se will be stigmatised or even sanctionedin future (whether by the supervisory authority orthe supervisory body) are unfounded. Given thatultimately there will always be at least someplanning uncertainty, it will never be possible tocompletely avoid negative deviations from targets.On the other hand they are even useful indicators ofwhere corrective measures have to be taken, and forthis reason make an important contribution tocorporate governance. And of course this can onlysucceed if the degree of target fulfilment is verifiableat all.

Discussion in the expert committee has moreovermade clear that, in terms of supervisoryrequirements, the differentiation of strategicplanning and targets from the planning and targetsat the operative level apparently have sometimesgiven rise to difficulties. Of course, strategicplanning is something that takes place at a muchhigher level of abstraction than operative planning,which is often expressed in specific key ratios anddetailed systems of limits. In order to avoiddifferentiation difficulties in future, BaFin has shownthat the strategic objectives represent the coreelements of operative planning and that therefore asufficiently clear wording of the strategic objectivesmust ensure that they are plausibly incorporatedinto operative planning.

Risk concentrations

The subject of risk concentrations is currently beinglent considerable weight in the internationaldiscussion. It was no coincidence that the DraghiReport from 2008 already pointed out that it wasexactly the dependencies and concentrations thatwere not recognised that played a considerable rolein triggering the financial markets crisis. People liketo refer to this problem as the silo problem: aparticular characteristic of this is the isolatedmanagement of specific risk types which then, as itwere, form “silos”. Frequently, no communicationtakes place with units responsible for themanagement of other risks. The result of this is a

failure to examine what interdependencies mayexist, e.g. as a result of the simultaneous influenceof risk drivers on several types of risks or as a resultof interdependencies between different risk driverseach having an isolated impact on only certain risks.

BaFin had already attached considerable importanceto the subject of risk concentrations with the lastamendment of MaRisk. The adjustments made atthat time have now been supplemented once again,especially with a view to highlighting to a greaterextent the overarching aspect of risk concentrationsin that they span the different types of risks. TheMaRisk requirements thus to a greater extent reflectthe corresponding international requirements. Interms of its scope alone, the need for adjustment –also due to already existing requirements –remained within limits. First of all, the additionsprovide clarification that risk concentrations are notconfined to risk positions as against specificcounterparties but also cover what are referred to asintra-risk concentrations (concentrations within onerisk type) and inter-risk concentrations(concentrations spanning risk types). Moreover, thefocus of interest is on adequately reflecting such riskconcentrations in the risk management andcontrolling processes. To this end, institutions mayavail themselves of different methods; bothquantitative instruments (such as limit systems ortraffic light systems) and qualitative instruments(such as regular risk analyses) may be used here. Inthis regard it is essentially irrelevant whether riskconcentrations are interpreted as a separate risktype or perceived as a component of significant risksand thus monitored and controlled. It is, and willcontinue to be possible to apply both approaches,although in practice the last variant is oftenpreferred. This incidentally also means that riskconcentrations, though taken into account for risk-bearing capacity, do not have to be addressed inisolation from risk-taking potential. Moreover, itpresumably has to be assumed that institutions, toidentify risk concentrations spanning different risktypes, will increasingly have to resort to the use ofcorresponding stress tests.

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Stress tests

Genuine amendments within the MaRisk context arefound in the new Module AT 4.3.3 in which therequirements of the stress tests are pooled. Inaddition to a few other aspects designed to furtherimprove the quality of institution-internal stress testprogrammes (addressing risk concentrations anddiversification effects or analysing the impact of aserious economic downturn), the necessity ofperforming so-called inverse stress tests isemphasised for the first time. Inverse stress tests,unlike “normal” stress tests, do not assume anunderlying scenario and examine the impacts ofsuch scenario; instead, the impacts (or outcome) arepredefined (in this case: business model proves tobe no longer viable), with the scenario leading tosuch outcome being looked for.Currently such inverse stress tests are very rarelyfound in practice. Moreover, the meaningfulness ofsuch stress tests is quite controversial in practice.From a supervisory viewpoint, however, they canmake a helpful contribution to answering thequestion as to the scenarios under which aninstitution’s viability is threatened. Of particularinterest is the question of what interaction of riskdrivers is capable of posing a threat to the businessmodel. With this approach institutions can gainanother, undistorted view of their own risk situationand the risk drivers that are capable of posing aparticular threat to their own business activities.Moreover, inverse stress tests, by providing anadditional point of reference, make it possible tobetter gauge how far the institution is “from thebrink”. As a kind of by-product, this instrument canalso be used to examine whether regular stress testsare sufficiently severe and thus goal-orientedenough.

Without question, little experience in practice has sofar been made with this type of stress tests. In theletter regarding the final version, BaFin has assuredinstitutions that it will closely watch developments in

this field and initially not apply excessively highstandards to the implementation of these stresstests. By way of introduction to this subject, inversestress tests that in principle have been performedchiefly as qualitative tests (in the form of acorresponding analysis documented in writing) maybe viewed as sufficient. However, large institutionsare expected to perform supplementary quantitativeanalyses. The interval of such tests may initially belimited to at least once per year.

Liquidity buffers

It quickly became clear that the dramatic liquidityshortages seen at the peak of the financial marketcrisis, which required a massive intervention on thepart of central banks and nearly led to the collapseof the financial system, had to have consequencesfor the institutions’ liquidity risk management. Ittherefore came as little surprise that the revision ofinternational provisions in this field was one of thefirst steps towards adjusting the supervisory regime.Work was quickly taken up at the European level aswell. The objective quickly became clear: in future itmust be ensured that institutions, even in very tightliquidity situations, are capable of themselvesprocuring on the private markets the liquidity theyneed within a very short-term period, without havingto rely on interventions by a central bank. Thesituation during the financial market crisis, when thecentral banks for all intents and purposes were the“lenders of first resort”, must not repeat itself.

For this purpose, the European banking supervisoryauthorities agreed on the new guidelines requiringinstitutions to keep available highly liquid,recoverable liquidity buffers that may be sold onprivate markets within a very short-term period,thus ensuring liquidity supply both in the very shortterm (one week) and in the longer term (at leastone month). The institutions must determine thesize of such buffers under their own responsibilitybased on the stress tests performed by them.However, CEBS in this area has set out certainaspects that have to be observed when defining thefeatures of the respective stress scenarios to beused as a basis. This relates not only to the type ofthe scenarios (assessment of both ideosyncratic andmarket-wide causes of a liquidity shortage) but alsoto the aspects for which reasonable assumptions areto be made (e.g. no extension of unsecuredinstitutional funding, general drop in the prices ofmarketable assets). All these aspects have also beenadopted in the MaRisk requirements and pooled in anew Module BTR 3.2. The emphasis on recoverability

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moreover means that shares and other assetsexhibiting a certain volatility in terms of their marketprices are not eligible as liquidity buffers. Althoughthis has sometimes been criticised in theconsultation on MaRisk, it being pointed out that insuch situations marketability takes precedence overrecoverability, the emphasis on recoverability stemsfrom the consequence that institutions encounteringliquidity shortages due to ideosyncratic causesusually also exhibit difficulties in terms of solvency.In this regard they are usually also unable to sustainmajor impairments on realisation of assets.

Essentially, the requirements as result from theCEBS guidelines are tailored to those institutionswhich are chiefly funded via the capital market. Theguidelines in this connection refer to “money centrebanks”. BaFin has taken account of this fundamentalconcept by limiting the new requirements forliquidity buffers to capital-market orientedinstitutions (i.e. institutions having issued securitiestraded on a stock exchange).

Outlook

In the area of risk management, the further revisionof the MaRisk requirements and the resultingadoption of international standards into nationalsupervisory practice marks the conclusion of themost important work for the time being. It remainsto be hoped that international institutions will firstwait and see whether the medicine prescribed to thebanks in the form of more stringent regulation willtake effect also for their purposes. At any rate thereis probably no doubt that banks’ risk managementalso in future will remain an important area ofactivity of international regulators. Theestablishment of a European supervisory authorityfor banking, the European Banking Authority (EBA),may even mark the beginning of a new era in thisregard. Sooner or later, though, the EBA willprobably exercise its right to issue binding anddirectly applicable supervisory standards, also in thearea of risk management. It will be interesting tosee whether in doing so it will confine itself only tospecific fields or will seek to create a comprehensiveframework in the form of a comprehensiveguidebook for the area of risk management – andthus a kind of EU MaRisk. Regardless of theapproach chosen by the EBA: decisive regulatorydecisions, also as regards risk management, arelikely in future to be taken in London. For Germansupervisors this can only mean taking an evenstronger part in the international discussion andplaying a decisive role in helping to shape suchdiscussions.

"Duetsche Anstalt fürFinanzdienstleistungsaufsicht" and“Financial Services RegulatoryAuthority of Frankfurt” are notGerman supervisory authoritiesFor some time now, a "Duetsche Anstalt fürFinanzdienstleistungsaufsicht (DAFin)" and a“Financial Services Regulatory Authority of Frankfurt(FSRAF)” have been presenting themselves on theirown websites, www.dafin.org and www.fsraf.org, asthe financial supervisory authority for Germany.BaFin wishes to point out that no supervisoryauthority with the name "DAFin" or “FSRAF” exists inthe Federal Republic of Germany. The authorisationand supervision of credit, financial services andpayment services institutions are conductedexclusively by BaFin (the Federal FinancialSupervisory Authority) and the German Bundesbank;BaFin is exclusively responsible for private insurancecompanies. In recent months, there has been anincreasing incidence of websites appearing whichpurport to be the official website of a nationalsupervisory authority. For example, in October 2010BaFin drew attention on its website to the fact thatthe so-called Frankfurt Financial SupervisoryAuthority (FFSA) is not a German supervisoryauthority.

www.bafin.de

Supervisory authorities modernisereporting requirements for bankingsupervision

With a view to strengthening preventive supervisionin Germany, BaFin and the Deutsche Bundesbankare modernising reporting requirements under bank-ing supervision. The requirements are being revisedin response to experiences from the financial mar-kets crisis as well as several initiatives still underway internationally requiring an adjustment to theinformation basis in banking supervision. On 24February 2011, BaFin submitted a first draft for pub-lic consultation. Statements and comments may besubmitted in writing to BaFin and the DeutscheBundesbank by 23 May 2011. BaFin and theDeutsche Bundesbank are convinced that implemen-

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tation of the concept will result in a lasting improve-ment in supervision efficiency and performance,broadening the range of analytical instruments avail-able to banking supervisors at the microprudentiallevel while strengthening the macroprudential ana-lytical capacity of the Deutsche Bundesbank.

www.bafin.de

SUPERVISORY LAW

The new Remuneration Ordinancefor Institutions

On 13 October 2010 the Remuneration Ordinance forInstitutions (Instituts-Vergütungsverordnung –InstitutsVergV)1 entered into force. It transposedinto German law at an early stage the requirementsof decisive international regulatory initiatives forinstitutions to establish orderly remunerationsystems.

The new requirements are based on variouscriticisms made with regard to remunerationsystems of banks in the past.2 The criticism that byfar has attracted the most public attention in thisarea (i.e. the mere level of executive pay) happensto be the most problematic when it comes to

justifying provisions under banking supervisorylegislation. What argues against granting anemployee an attractive (variable) remuneration ifthat employee performs good work, if the institutionachieves sustained financial success, if suchremuneration payments do not put at risk theinstitution’s sufficient capital and liquidity base and ifthe remuneration system does not provide for anyharmful incentives? Admittedly, those are a lot of“if’s”, but it becomes clear that remunerationschemes can only be evaluated from a bankingsupervision perspective within the context of theinstitution’s specific situation. Both bankingsupervision law and banking supervision can be nosubstitute for a necessary political and ethicaldiscussion on remuneration levels.

It is only on the basis of the legislative mandate setout in section 6 (2) of the German Banking Act(Kreditwesengesetz – KWG) that the mere level ofremuneration can become relevant. According tothis, BaFin is required to counteract undesirabledevelopments in the banking and financial servicessector which may endanger the safety of the assetsentrusted to institutions, impair the proper conductof banking business or provision of financial servicesor lead to serious disadvantages for the economy asa whole. This would be the case, for instance, whereremuneration payments jeopardise an institution’sadequate capital base or its liquidity.3 This lendscredibility to the criticism that remunerations,particularly of the variable kind, were paid outduring the financial crisis despite institutions’financial distress (and that even though institutionsin some cases had even claimed state assistance).This was demonstrated very graphically, for instance,by the New York Attorney-General Andrew M. Cuomoin the case of some large US banks.4 There is thestrong impression that, where an institution’seconomic development is so clearly ignored in thearea of bonus payments, the concept ofsustainability cannot have mattered at all.

Following a survey of the Institute of InternationalFinance, the financial industry ultimately itself cameto realise that such misguided remuneration systemswere one of the factors that triggered the financial

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Arne Buscher, BaFin

1 Ordinance on the Supervisory Requirements for Institutions’Remuneration Systems (Remuneration Ordinance for Institutions )of 6 October 2010, Federal Law Gazette I 2010, 1374.2 With regard to the criticisms, see also Institute of InternationalFinance (IIF), “Compensation in Wholesale Banking 2010: Progressin Implementing Global Standards” from September 2010, p. 12 etseq.3 Section 45 (2) sentence 1 no. 6 in conjunction with subsection (1)sentence 3 of the KWG takes up this concept of ensuring solvency.4 Andrew M. Cuomo, Attorney General State of New York, report“No Rhyme or Reason: The `Heads I Win, Tails you loose` BankBonus Culture” of 30 July 2009.

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crisis because they were all too focused on chalkingup short-term success without giving sufficiently dueregard to sustainability factors such as risks and riskperiods.5

I. International remuneration requirements

Several international regulatory initiatives at oncetook up these points of criticism and worked outrequirements providing a draft model for thenational requirements of the InstitutsVergV. Ofparticular relevance are the works of the FinancialStability Board (FSB); it developed the principles forsound remuneration practices6 and specificstandards building up on these7, which in turn wereapproved by the group of the most importantindustrialised and developing countries (G20) attheir September 2009 summit in Pittsburgh.8 Toprovide a “level playing field” for institutions andfinancial centres, it must be ensured that the FSBrequirements are actually applied convergently atleast amongst the G20 countries. The requisite onusto implement them is to be created by peer reviewsof the FSB, one of which was already conducted.9

This report shows Germany to be among thosecountries having taken the lead in transposing theFSB requirements. The next FSB peer review isplanned for the second quarter of 2011.10

The subject has also been broached at the Europeanlevel. Already in April 2009 the EuropeanCommission published recommendations forremuneration policy in the financial services sector.11

At the same time, the Committee of EuropeanBanking Supervisors (CEBS) has drafted the firstremuneration principles.12 Of decisive significance,though, was the amendment to Directives2006/48/EC and 2006/49/EC of 14 December 2010as regards capital requirements for the trading bookand for re-securitisations, and the supervisoryreview of remuneration policies (Capital

Requirements Directive III – CRD III).13 CRD IIImoreover authorised the CEBS to develop guidelineson the remuneration requirements of CRD III (CEBSGuidelines). These were published on 10 December2010.14 The CEBS Guidelines are intended topromote the greatest possible uniformity intransposition of directive requirements into nationaljurisdictions and their implementation within theinstitutions. Transposition of the Europeanrequirements will also be followed up by thesuccessor organisation of the CEBS, the EuropeanBanking Authority (EBA), in the form of peerreviews. The InstitutsVergV already takes account ofthe requirements of the CRD III and the CEBSGuidelines.

II. Banking supervision provisions onremuneration systems

In the area of banking supervision legislation,remuneration rules have been created in numerousfields.

In this context those institutions that have receivedor will receive state assistance are subject to somespecial statutory rules on remuneration. In the eventof competing provisions, these rules prevail over thestatutory remuneration rules of the KWG and theInstitutsVergV as lex specialis.

With the newly created Restructuring Act(Restrukturierungsgesetz)15, the Financial MarketStabilisation Fund Act (Finanzmarktstabilisierungs-fondsgesetz – FMStFG)16 has now been broadenedby rules providing for restrictions on bothremuneration of members of the institution’s bodiesand senior management and on remuneration ofemployees. Pursuant to section 10 (2a) of theFMStFG, remuneration of the members of theinstitution’s bodies and employees of companies inwhich the Financial Market Stabilisation Fund holds adirect or indirect equity interest of at least 75% andwhich claim the recapitalisation measures pursuantto section 7 FMStFG may not exceed €500,000 peryear. In such cases, variable remuneration is notpermitted.

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5 IIF, “Compensation in Financial Services Industry: Progress andthe Agenda for Change”, March 2009, p. 2.6 FSB, “Principles for Sound Compensation Practices” of 2 April2009.7 FSB, “Principles for Sound Compensation Practices –Implementation Standards” of 25 September 2009.8 G20, “Leaders’ Statement: The Pittsburgh Summit September 24-25 2009“, Strengthening the International Financial RegulatorySystem, item 13.9 FSB, “Thematic Review on Compensation: Peer Review Report”of 30 March 2010.10 FSB, “Thematic Review on Compensation: Peer Review Report”of 30 March 2010, p. 3.11 Commission Recommendation of 30 April 2009 on remunerati-on policies in the financial services sector (2009/384/EC).12 CEBS, “High-level principles for Remuneration Policies” of 20April 2009.

13 Directive 2010/76/EU; OJ L 329/3 of 14 December 2010, pp. 3-35.14 CEBS, “Guidelines on Remuneration Policies and Practices” of10 December 2010.15 Act on the restructuring and orderly liquidation of credit institu-tions, on the establishment of a restructuring fund for credit insti-tutions and on the extension of the limitation period for D&O liabi-lity of 9 December 2010, Federal Law Gazette I 2010, 1900.16 Act Establishing a Financial Market Stabilisation Fund(Finanzmarktstabilisierungsfondsgesetz - FMStFG) of 17 October2008, Federal Gazette I 2008, 1982.

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For companies in which the equity interest thresholdof 75% is not reached, the remuneration pursuant tosection 10 (2b) of the FMStFG as a rule mustlikewise not exceed €500,000. Variableremunerations are permitted, but only if the sum ofvariable and fixed remuneration does not exceed the€500,000 limit. That said, such cap may beexceeded provided that the company has repaid atleast half of the recapitalisation funds received, orprovided that interest is paid on the capital inflowreceived at the full rate.

Similar provisions are defined by the RestructuringAct for the new Restructuring Fund Act(Restrukturierungsfondsgesetz – RStruktFG).Pursuant to section 4 (3) to (5) of the RStruktFG,the provisions applying to companies that will berecipients of the restructuring measures of theRestructuring Fund are identical in their substance tothose of the FMStFG.

The possibilities of intervention pursuant to section45 of the KWG, under which payment of variableremuneration may be prohibited or at leastrestricted in cases where an institution’s sufficientcapital or liquidity base are at risk, was alsobroadened by the Restructuring Act. Up to now,remuneration claims affected by such prohibition orrestriction were not extinguished but accumulated,with the result that they could be asserted again intheir entirety once the prohibition by BaFin waslifted. In addition to the prohibition on disbursement,BaFin in certain cases has ordering power subject tothe conditions of section 45 (5) sentences 5 and 6 ofthe KWG and by virtue of which such remunerationclaims are extinguished. This will apply, for example,when the institution receives benefits from theRestructuring Fund or the Financial MarketStabilisation Fund. The objective of such benefits isto stabilise distressed institutions on a sustainablebasis. However, following the end of the acute crisisthese funds are not allowed to be used to settle anyremuneration claims having accrued.

Lastly, the InstitutsVergV has its statutory point ofreference in section 25a (1) sentence 3 no. 4 andsubsection (5) of the KWG according to whichremuneration rules, as part of risk management, area component of institutions’ proper businessorganisation.

III. Requirements of the InstitutsVergV17

1. Scope of application

Pursuant to section 1 (1) of the InstitutsVergV, theInstitutsVergV is directed to institutions as definedin the KWG. Pursuant to section 1 (1b) of the KWG,institutions include credit institutions and financialservices institutions. Moreover, the InstitutsVergVmust be observed by all legally dependent branchesof companies domiciled abroad within the meaningof section 53 (1) of the KWG. Given the principle ofhome country supervision, the InstitutsVergV doesnot apply to branches of companies domiciled inanother state of the European Economic Area(section 53b of the KWG). However, these branchesmust also observe the requirements of the CRD IIIand the CEBS Guidelines through the legaljurisdiction of the respective Member States inwhich the company is domiciled.

When implementing the international remunerationrequirements in Germany, it was important tomaintain the right balance through proportionateprovisions so as to take account of theheterogeneous structure of institutions oftencharacterised by conservative business models. Byway of illustration it may be pointed out that inGermany at the end of 2009 there were a total of2,008 institutions, of which 204 private commercialbanks (Kreditbanken), 441 institutions from theGerman savings banks (Sparkassen) sector and1,208 institutions from the German co-operativebanks (Genossenschaftbanken) sector. Besides this,Germany has hardly witnessed the remunerationexcesses like those seen in other financial centres.And even if isolated negative examples can be citedwith German institutions, these were not foundwith the small, often regionally based institutionswhich for the most part engage in retail businessand smaller to medium corporate client business. Ifthese small institutions also had to fulfil the samestringent criteria as large banks, it would almost belike handing a dust pan not only to the bulls butalso the mice after the herd has stampededthrough the china shop.

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17 With regard to the specific requirements of the InstitutsVergV, seealso Arne Martin Buscher, “Neue bankaufsichtsrechtlicheVergütungsanforderungen für Institute”, Hamburg 2011.

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For this reason the InstitutsVergV makes adistinction between the requirements applying to allinstitutions and the remuneration systems of thesenior management and employees (sections 3, 4and 7 of the InstitutsVergV), on the one hand, andsignificantly more demanding requirements (sections5, 6 and 8 of the InstitutsVergV) that are relevantonly for “major institutions” and the remunerationschemes of their senior managers as well as certainemployees, on the other. Also within such generaland special requirements, it is possible to apply therules proportionally so as to take account of thespecial characteristics and the activities of theindividual employees that are specific to theinstitution in question.

The question of when an institution is to be qualifiedas “major” will depend on its total assets on the onehand, and a risk analysis which the institution isrequired to perform itself, on the other.

This risk analysis is relevant for all institutionswhose total assets on the respective balance sheetdates for the last three completed financial yearsreached or exceeded an average of 10 billion euros.The risk analysis shall take particular account of theinstitution’s size, its remuneration structure and the nature, scope, complexity, risk content andinternational scale of the business activitiesconducted. In this regard, particular significance willbe attached to an institution’s business activities andnot so much to how it is “packaged”. If, for example,a development institution engages in transactionswith credit derivatives or similar on a large scaleand exhibits the requisite total assets, thisinstitution will be classified as “major” even though

it (also) has a public developmentmandate. The risk analysis must bedocumented in writing. The analysismust be plausible, comprehensive andcomprehensible to third parties. If therisk analysis should be implausible, thusmaking it possible for the institution to(deliberately) avoid being classified as amajor institution, the entire range ofbanking supervisory measures availablefor contraventions of section 25a KWGwill apply.

2. General requirements

The general requirements apply to allinstitutions and employees as well assenior managers. Also within thesegeneral requirements, though, the

proportionality notion of section 25a (1) sentence 4of the KWG will apply according to which thestructure of risk management will depend on thenature, scale, complexity and risk content of theinstitution’s business activity. Smaller institutionswith comparatively conservative business models areof course not required to apply the same standardsas, for instance, large banks that operateinternationally. In the following, only a few keygeneral requirements will be singled out.

Arguably the most important general requirement isthat pursuant to section 3 (1) sentence 3 of theInstitutsVergV the remuneration systems must be inkeeping with the attainment of the objectives setout in the institution’s strategies. By strategies,particularly a sustainable business strategy and therisk strategy consistent with the same within themeaning of AT 4.2 of the Minimum Requirements forRisk Management (MaRisk) are meant. Gearing theremuneration systems to the institution’s strategies

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is a logical necessity because remuneration systems,at least constructively, are also an instrument ofcorporate management. This characteristic has notalways been reflected in the past. Manyremuneration systems gave the impression of beingonly concerned with keeping hot talents loyal to theinstitution. In order to ensure an attractiveremuneration level, it was not uncommon in the pastfor remuneration-relevant targets to be defined thatwere easy to achieve and did not fit the targets setout in the company’s strategies. If even these oftenlittle ambitious remuneration-relevant targets werenot achieved, the practice in some isolated caseswas to nonetheless grant variable remuneration byreference, for instance, to exogenous effects. Thepurpose pursued with gearing the remunerationsystems to the institution’s strategies is to helpensure that the remuneration-relevant targets aresufficiently ambitious and that the remunerationsystems can make an effective contribution towardsachievement of the targets formulated in thecorporate strategies. This underscores the risk-controlling function of the remuneration systems andwith them the variable remuneration components.

Particularly with regard to the revamp of theremuneration systems currently under way,supervisory and administrative boards should form apicture of the draft work being done on theremuneration systems at an early stage. Misguidedremuneration systems can do harm not only to theinstitution but also (given the public interest) to thereputation of those having noddedthrough such systems. To make iteasier for supervisory andadministrative boards to perform thiscontrol, the senior managers arerequired to inform the administrative orsupervisory body about the structure ofthe remuneration systems of thecompany at least once a year pursuantto section 3 (10) of the InstitutsVergVso that the latter can make its ownassessment of its adequacy.

Lastly, section 7 of the InstitutsVergVprovides for disclosure requirements for allinstitutions in respect of which information regardingthe structure of their remuneration system is ofutmost importance since this is the only way thatthe quality of the remuneration system can reallybecome comprehensible to third parties. The level ofdetail of the information to be published depends onthe size and remuneration structure of the institutionas well as the nature, scope, risk content andinternational scale of its business activities. In thecase of small institutions whose total assets are, for

instance, less than 10 billion euros, a few basicstatements will suffice as far as the presentation andstructure of the remuneration systems areconcerned. By contrast, particularly “majorinstitutions” are required to ensure a level of detailregarding their information whereby an outsideobserver is able to understand in substance thecompliance of the remuneration system with therequirements of this Ordinance.

3. Special requirements for major institutions

When an institution is classified as a “majorinstitution”, that means that the institution isrequired to identify those employees whose activitiespursuant to section 5 (1) sentence 1 of theInstitutsVergV have a material impact on theinstitution’s overall risk profile.18 Specifically, theseemployees and all senior managers of majorinstitutions are then subject to the demandingrequirements of section 5 (2) to (4) and section 8(3) of the InstitutsVergV. The institution is requiredto identify these employees itself by performing arisk analysis under its own responsibility. The criteriathat may be used for such analysis may include,among other things, the nature of the businessactivity (e.g. investment banking), the businessvolume, the level of risks and an organisationalunit’s revenue. An employee’s activity (for exampleas a trader), position and level of remuneration todate, as well as a highly competitive labour-marketsituation may also be eligible as criteria.

For senior managers as well as identified employeesof major institutions, section 5 (2) of theInstitutsVergV defines special rules that go wellbeyond the general requirements.

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18 The phrase still used in the repealed BaFin Circular 22/2009 of21 December 2009 referred to employees who “can establish highrisk positions”. The purpose of changing the text in theInstitutsVergV to refer to employees who “have a material impacton the overall risk profile” is merely to bring the language in linewith the CRD III. In terms of content, this does not result in anychange. In particular, there is no intention to narrow the group ofemployees to be identified.

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An important requirement (and one that is alsochallenging in terms of its implementation) is to takeaccount of risks and their terms as well as capitaland liquidity costs. This may be done first of all exante by using, e.g., risk-adjusted performanceparameters instead of short-term earnings figures todetermine performance relevant for remunerationand by choosing assessment periods coveringseveral years.

Risks can also be taken account of ex post in thedisbursement process. In this regard, theInstitutsVergV in some places contains detailedprovisions which are based on the equally preciselydetailed international requirements, especially theCRD III. For example, longer disbursement andretention periods with the possibility of a malus arerequired, it is being decisive that the malus is notbased on alibi criteria not realistically likely to occur.A malus also has to be applied in the event ofadverse economic developments of the institution(or even only one of its organisational units). Inaddition, part of the variable remuneration has tocomprise equity-based remuneration instrumentsbased on the sustainable development of theinstitution’s value. This refers above all to shares orinstruments with reference to a share price, such asstock appriciation rights (Wertsteigerungsrechte) aswell as, where applicable, hybrid capital or similar inthose institutions which do not have any capitalavailable as a remuneration instrument. Theseremuneration instruments must be subject to aretention period during which disposal of theremuneration components is not allowed. The chartbelow provides an overview of the interaction of theex post provisions, namely deferral requirements,equity-based instruments, malus provision andretention periods.

Major institutions are moreover required to establisha remuneration committee pursuant to section 6 ofthe InstitutsVergV. Non-major institutions, too,should consider implementing such remunerationcommittee. The task of the remuneration committeepursuant to section 6 (1) of the InstitutsVergV is tomonitor the appropriateness of the remunerationsystems. The remuneration committee may also beused to structure and further develop theremuneration systems. In addition to employeesfrom the human resources department, themembers of the remuneration committee must alsoinclude employees from organisational unitsresponsible for originating transactions as well ascontrol units, e.g. from the front office, trading, backoffice, risk controlling, compliance function orinternal auditing). By integrating the humanresources department with an institution’s otherunits, both the quality and employees’ acceptance ofthe remuneration can be improved. Any deficits inthe remuneration can be identified by the committeeearly on, thus making it possible to nip in the budany adverse developments.

In addition to the general publication requirements,major institutions must comply with further detaileddisclosure requirements pursuant to section 8 of theInstitutsVergV. These relate to the remunerationcommittee as well as aggregated disclosures on theremuneration of senior managers and thoseemployees identified whose activities have a materialimpact on the overall risk profile.

4. Special provisions for groups

Pursuant to section 9 InstitutsVergV, a superordinateenterprise (or the superordinate financialconglomerate enterprise) of a group of institutions, a

financial holding group or a financialconglomerate is responsible forcompliance with the requirements of theInstitutsVergV also at the group level.

For this it is necessary for thesuperordinate enterprise to implement agroup-wide remuneration strategysatisfying the provisions of theInstitutsVergV. The reach of such group-wide strategy extends to the entiregroup, with the result that institutions ofthe group domiciled abroad (includingnon-European countries) are required tocomply with the requirements of theInstitutsVergV through the group-wideremuneration strategy. For this purposethe superordinate enterprise must also at

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least ensure that subordinated enterprises for whichother special remuneration requirements undersupervisory law apply comply with their specialrequirements under supervisory law concerningremuneration systems. For example, if thesuperordinate enterprise is an institution and thesubordinated enterprise is an insurance undertaking,the superordinate institution must ensure that theinsurance undertaking complies with therequirements of the Remuneration Ordinance for theInsurance Industry (Versicherungs-Vergütungs-verordnung – VersVergV).19 The same applies in thecase of an asset management company (Kapital-anlagegesellschaft) for which remunerationrequirements were created in AT 7.1 item 4 et seq.of the Minimum Requirements for the RiskManagement of Investment Companies (Mindest-anforderungen für das Risikomanagement fürInvestmentgesellschaften – InvMaRisk).20 It is thusnot the case that, based on the group requirementsof the InstitutsVergV, the provisions applying toinstitutions are simply slipped over enterprises ofdifferent classes for which remuneration provisionsunder supervisory law already exist. Enterprises ofthe group which are not themselves affected byremuneration provisions under special law but whoseemployees are directly involved in services for theinstitution for the purpose of engaging in bankingtransactions or providing financial services will beaffected by the requirements of the InstitutsVergVthrough the broad definition of employees providedfor in section 2 no. 6 of the InstitutsVergV.

IV. Conclusion

The InstitutsVergV is based on the internationalremuneration requirements developed at the level ofthe G20 and the European Union. It is decisive for allmajor financial centres to effectively implement atleast the globally applicable requirements of the FSB.This particularly applies to financial centres that havewitnessed exorbitant remuneration levels in the past.But in the emerging markets of Asia or SouthAmerica, too, where new oases of remunerationthreaten to arise, the lessons of past mistakes shouldbe learned. That means not letting up oninternational pressure for developing adequatenational remuneration requirements as well as puttingthese into practice. In addition to the FSB’s peerreviews, the Basel Committee on Banking

Supervision might, for instance, incorporate theremuneration requirements into the Core Principlesfor Effective Banking Supervision of October 2006.Compliance with these principles in the individualcountries could then be verified by the InternationalMonetary Fund.

It also remains to be seen whether and to whatextent remuneration requirements under bankingsupervision legislation and especially publicationrequirements will influence other areas of legislation.For all the emotions that this subject inevitably stirsup, it should always be kept in mind that the questionof wherefore a variable remuneration is paid is moreimportant than the question of how high it is.

www.eur-lex.europa.eu » Directive2006/48/EC

www.eur-lex.europa.eu » Directive2006/49/EC

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19 Ordinance on the Supervisory Requirementsfor Remuneration Systems in the InsuranceIndustry (Versicherungs-Vergütungsverordnung– VersVergV) of 6 October 2010, Federal LawGazette I p. 1379.20 BaFin Circular 5/2010 (WA) of 30 June 2010 onthe Minimum Requirements for the RiskManagement of Investment Companies –InvMaRisk.

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The Investor Protection andFunctionality Improvement Act

The “Act relating to Strengthening InvestorProtection and Improving the Functionality of theCapital Market” (Gesetz zur Stärkung des Anlegerschutzes und Verbesserung der Funktionsfähigkeitdes Kapitalmarkts – AnsFuG) had already arousedwidespread interest during the legislative process –in the financial industry and among trade unions andconsumer protection organisations. The Bill wasapproved by the Bundestag on 11 February 2011(Bundestag printed paper 17/4710) and was alsopassed by the Bundesrat without objection on18 March 2011 (Bundesrat printed paper 101/11).Following its signing by the Bundespräsident, the Actwas promulgated in the Federal Law Gazette(Bundesgesetzblatt) on 7 April 2011 (BGBl. I 2011,pp. 538 et seqq.). Some of the new provisionscreated by the Act came into effect immediatelyupon promulgation, while others will come into effectup to 18 months after promulgation.

The regulatory fields covered by this omnibus Actare as broadly diversified as the interest in it. Thenew Act contains fairly minor amendments to theFinancial-Market Stabilisation Acceleration Act(Finanzmarktstabilisierungsbeschleunigungsgesetz)and the Restructuring Fund Act (Restrukturierungs-fondsgesetz) and it includes in particularamendments and additions to the Securities TradingAct (Wertpapierhandelsgesetz – WpHG), theSecurities Acquisition and Takeover Act (Wertpapier-erwerbs- und Übernahmegesetz – WpÜG) and theInvestment Act (Investmentgesetz – InvG) as wellas their accompanying regulations.

Changes to the Securities Trading Act andSecurities Acquisition and Takeover Act

The amendments to the Securities Trading Act andcorresponding consequential amendments to the

Securities Acquisition and Takeover Act are a corefeature of the new Act. In broad terms, they may bedivided into three sets of provisions: increasedtransparency for financial instruments that have to besettled in cash – otherwise known as cash-settledinstruments; the introduction of a product informationsheet; and notification of staff and staff qualifications.

Increased transparency for cash-settledinstruments

Prominent securities transactions in listed companieshave in the past drawn the attention of the public tofinancial instruments that have to be settled in cash –otherwise known as cash-settled instruments. Suchinstruments, which include contracts for difference,swaps, call options as well as baskets or indices, haveuntil now not been covered by the voting rightsnotification requirements of Part 5 of the SecuritiesTrading Act, the purpose of which is that the capitalmarket should be informed of holders of majorholdings in listed companies. In addition to changes indirectly held voting rights, parties subject to thenotification requirement had up to now only neededto report changes in respect of financial instrumentsthat entitle the holder to unilaterally acquire, under alegally binding agreement, shares of an issuer thatcarry voting rights and have already been issued. Thenew section 25a of the Securities Trading Act createdby the new Act now extends the notificationrequirements to all financial instruments and otherinstruments which enable their holder either in fact orbased on an economic view to acquire such shares.This is meant to prevent stealth takeovers of listedcompanies by investors trying to circumvent theholdings transparency rules.

In addition to the newly created notificationrequirement, the new Act also creates legal certaintyby extending section 25 of the Securities Trading Actin the revised version to “other instruments”. For upto now the wording of this provision covered onlyfinancial instruments, which created regulatoryloopholes and scope for circumventing the rules.Other instruments are deemed to be all agreementsthat confer a right to acquire shares which carryvoting rights without falling within the definition offinancial instrument of section 2 (2b) of the SecuritiesTrading Act. These include in particular the lender’sright to recall the securities in a securities loan andthe repurchase agreement in a repo.

Product information sheet

At the heart of the second set of provisions lies theintroduction of an information sheet, with whichclients must be provided when they are being given

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investment advice. According to the newlyintroduced section 31 (3a) of the Securities TradingAct, the information sheet must be easy tounderstand and must not contain inaccuracies or bemisleading. Clients must be provided with a copywhen they are being given investment advice ingood time before a financial instruments transactionis concluded, and in fact for every financialinstrument that clients are recommended to buy. Ifthe purchase of certain investment fund units isbeing recommended, the information sheet isreplaced by the “key investor information”prescribed for these under the EU UCITS IV Directive(JO L 302 of 17 November 2009, pp. 32-96) and EUImplementing Regulation 583/2010 (JO 176 of10 July 2010, pp. 1-15).

The specific requirements laid down for theinformation sheet in Germany are spelled out indetail in the Investment Services Conduct ofBusiness and Organisation Regulation (Wertpapier-dienstleistungs-Verhaltens- und Organisations-verordnung – WpDVerOV). The information sheet isintended to provide clients in future with all theinformation they need to be able to assess and alsoto compare financial instruments. In order thatclients should not be inundated with information butshould also be able to assimilate information on thekey features of the financial instrument, thelegislation has limited the scope of the informationsheet. For non-complex financial instruments theinformation sheet may not exceed two pages of A4and for complex financial instruments three pages ofA4; information sheets may not be longer than this.The key information on the financial instrument inquestion must be set out on these two / three pagesmaximum in a clear and easily understandable way.The information must allow the client in particular toassess the nature of the financial instrument, how itworks, the risks involved, the prospects of thecapital being repaid and income under variousmarket conditions and the costs associated with theinvestment and to compare it to other financialinstruments.

If an investment services enterprise fails to providethe client with the information sheet or the “keyinvestor information” as prescribed, it is liable to afine of up to €50,000 – apart from the fact that theclient might be unhappy and switch to a competitor.That will be the case if the information sheet or thekey investor information is not provided or if it isinaccurate, incomplete or not provided in good time.

In principle, the obligation to provide the client withthe information sheet applies from 1 July 2011.

There is a transitional arrangement for EUinvestment units: for them, the obligation in thebeginning only applies provided key investorinformation is produced and published in accordancewith the legal provisions of the respective homecountry, but it will apply in any case by no later than1 July 2012.

Notification of staff and staff qualifications

The financial industry as a whole shares the viewthat qualified staff are the basis for successful andcustomised (investment) services. However, as faras investment advice is concerned, the financialcrisis has caused uncertainty among many clients onthis point as well. The new Act is intended tostrengthen supervision also on this point and to helpto solve problems such as the very differentqualifications of staff providing advice or thedetrimental influence of sales interests, pressure andinducements. For that reason, according to thegrounds stated for the Act, pursuant to section 34dof the Securities Trading Act BaFin is in future to benotified of staff to be engaged in providinginvestment advice, as sales representatives and ascompliance officers.

“Staff engaged in providing investment advice” isthe formal designation of those persons providingclients with investment advice on behalf of theinvestment services enterprise – colloquially referredto as “investment advisers” or “client advisers”.Sales representatives, on the other hand, may befound at many hierarchy levels within an institution.They may possibly be members of the Board ofManagement responsible for sales, setting group-wide sales targets, area managers implementing thetargets for the branches under them or branchmanagers monitoring the performance of investmentadvisers with regard to the sales targets cascadeddown to their branches. As these illustrativeexamples show, such persons have the capacity toinfluence investment advice processes in differentways and to different degrees. To a certain extent,institutions’ compliance officers perform an in housequality assurance function in that they are to help toensure that institutions and their staff act inaccordance with the law.

In future, institutions will have to notify BaFin ofcompliance officers, sales representatives and“investment advisers” before they are allowed tostart work. It is a prerequisite that they meet thestatutory qualification requirements and possess thenecessary reliability. In the case of investmentadvisers, institutions will also have to notify BaFin of

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the sales representative that is responsible for theadviser and report all complaints henceforth lodgedagainst the adviser on account of the investmentadvice provided. If an institution reports acomplaint, it will also have to specify the branch inwhich this adviser is employed. Further details onprofessional qualifications and reliability are set outin the Securities Trading Act Staff NotificationRegulation (WpHG-Mitarbeiteranzeigeverordnung),which spells out in more detail the particulars of theelectronic notification procedure.

The institution is the guarantor of, and responsiblefor, compliance with the statutory requirements. If,however, BaFin becomes aware that a member ofstaff does not satisfy the requirements at all, or nolonger satisfies them, it can prohibit the undertakingfrom employing this member of staff in the activityin question. Similarly, BaFin can reprimand both theinstitution and the particular member of staff if he orshe is in breach of those provisions (of Part 6) of theSecurities Trading Act that have to be observed inperforming the notifiable activity. As a last resort,BaFin can ultimately even ban an institution fromemploying a member of staff in the notifiable activityfor up to two years. Furthermore, BaFin may publishunappealable orders of this kind on its website,without, however, disclosing the name of themember of staff concerned.

In the main, the new provisions of section 34d ofthe Securities Trading Act will not come into effectuntil 18 months after the promulgation of the newAct (see section 9 (4) of the new Act). Theinstitutions subject to the notification requirementtherefore have sufficient time to adapt to the newrequirements and – if necessary – train staff so thatthey can satisfy the statutory requirements whenthe provisions come into force. Furthermore, the Actprovides for another transitional period of sixmonths for staff who are entrusted with a notifiableactivity at the time the new provisions come intoforce but who do not (yet) meet the statutoryrequirements. These members of staff are allowed tobe employed on this activity for a further sixmonths. Thereafter they must either satisfy thestatutory conditions and be notified to BaFin or theymay no longer be entrusted with such an activityonce this transitional period has expired.

Changes to the Investment Act

Almost exclusively, the amendment of theInvestment Act (Investmentgesetz – InvG) changesonly provisions relating to open-ended real estatefunds. The long-term investment of these funds in

real estate, combined with the current promise tofund investors that they will nonetheless be able towithdraw funds paid into any such fund at any time,caused a mismatch of maturities, according to thepresentation of the problem prefixed to the FederalGovernment Bill (Bundestag printed paper 17/3628).This impaired the stability of the product, the paperwent on to say, and could have a negative impact oninvestment performance, especially for privateinvestors. The system had functioned in the pastsince investors wanting to sell had always beenmatched by an adequate number of new investors.Changed investor and marketing behaviour on theone hand and increasingly volatile valuations on thereal estate market on the other had resulted,especially in the financial crisis, in frequent andsometimes repeated suspensions of redemptions ofreal estate fund units.

As a reaction to these developments, the Actprovides, in particular, for changes in the valuationprocedure for properties held directly and indirectlyby funds, a reduction in their scope for borrowing,restrictions on the ability to give precedence to largeinvestors in the redemption of fund units and clearerrules for further action by an asset managementcompany in the event of a (temporary) suspensionof the redemption of units.

The changes come into effect once the fund rules ofthe open-ended real estate funds have beenamended by the respective asset managementcompanies managing them (section 145 (4 6) of theInvestment Act (revised version)). In principle thenew Act gives the asset management companies adeadline for this of 31 December 2012.

In detail:

Minimum holding period and notice period

In future, pursuant to section 80c (3) sentence 1 ofthe Investment Act (revised version), investors willas a matter of general principle not be able toredeem units in open-ended real estate funds untilthe end of a two-year minimum holding period. Insuch cases a twelve-month redemption notice periodapplies, which starts with the giving of anirrevocable notice of redemption to the assetmanagement company by the investor (section 80c(4) sentence 1 of the Investment Act (revisedversion)). The minimum holding period is meant tomitigate the disadvantages arising for remaininginvestors if units are bought and then sold againwithin a relatively short period of time and it isintended to make investors more aware of the

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longer-term character of investing in real estate,albeit only indirectly. Investors have to demonstratethat they fulfil the minimum holding periodrequirement for the number of units in question thatthey would like to redeem. For investors who boughtunits in open-ended real estate funds before thefund rules of the open-ended real estate fundconcerned were amended to take into account theprovisions of the new Act, by operation of law theminimum holding period for these units is deemed tohave already been met. Private investors are,however, likely to be hardly affected by theserestrictions, since they apply only for redemptions ofunits in excess of €30,000 in a calendar half year.

The minimum holding period and notice period alsohave to be observed in the case of investments inreal estate funds of funds (section 83 (2) of theInvestment Act (revised version)), i.e. mixed fundswhich are entitled to invest more than 50% of theirassets in open-ended real estate funds.

Tying of issue and redemption dates to thevaluation cycle

In future, the valuation cycle for properties helddirectly and indirectly through an investment in realestate companies will be determined in accordancewith the dates provided for by the assetmanagement company for issues and redemption ofopen-ended real estate fund units (sections 79 (1)and 80c (2) of the Investment Act (revisedversion)). If the asset management company wantsto stick to the existing annual valuation cycle, theissue and redemption of units will in future belimited to one date a year. Correspondingly, if unitsare to be issued and redeemed on a half-yearlybasis, the valuation cycle will have to switch to ahalf-yearly basis. The Act demands that assetsshould be valued no more frequently than once aquarter, even if the asset management companyprovides, in its fund rules, for more than four datesfor the issue and redemption of units. This will alsoapply if the asset management company intends tostick to its existing daily issue and redemption ofunits.

Rotation of real estate valuers

In the light of recent developments in open-endedreal estate funds, according to the exposition in thereport of the Finance Committee of the Bundestag(Finanzausschuss) it was considered essential totighten the rules intended to ensure theindependence of real estate valuers. Under the newrules, a valuer must now cease working on an assetmanagement company’s valuation committee after

five years at the latest (section 77 (2) sentence 4 ofthe Investment Act (revised version)) and may beginto work again as such for this asset managementcompany no earlier than two years later (section 77(2) sentence 5 of the Investment Act (revisedversion)). The initial appointment will in future befor only two years and not for five years as hitherto(section 77 (2) sentence 3 of the Investment Act(revised version)). Appointments are now allowed tobe extended by one year each time up to amaximum of three times, but as is the case atpresent, this option is lost if the valuer’s incomefrom his work for the asset management companyexceeds 30 percent of his total income.

New rules governing the suspension ofredemptions

Up to now asset management companies have beenable to suspend the redemption of units until theend of a period to be specified in the fund rules ifthere is insufficient liquidity to service investors’redemption requests (section 81 of the InvestmentAct). Redemptions can be refused up to a maximumof one year from presentation of the unit; this one-year period can be extended to two years by thefund rules. Pursuant to section 81 of the InvestmentAct (revised version), the redemption of units maybe suspended for up to 30 months uninterrupted.After six months the asset management company isobliged to create liquidity by (also) selling assets.After one year, notwithstanding section 82 (1)sentence 1 of the Investment Act, the proceeds ofsuch sales may be up to 10 percent below marketvalue (section 81 (2) of the Investment Act (revisedversion)). After two years the shortfall may be up to20 percent below the market value (section 81 (3)of the Investment Act (revised version)).

Furthermore, section 81b of the Investment Act(revised version) will enable asset managementcompanies in future to obtain investors’ consent tosell certain assets, even if this were to be “not onreasonable terms”. Here the Act provides for aprocedure akin to that of the Debt Security Act(Schuldverschreibungsgesetz), which gives the assetmanagement company greater scope for action whileexcluding liability risks as much as possible.

If even after 30 months of uninterrupted suspensionof redemptions there are still not enough liquidassets to resume redemptions, the assetmanagement company’s right to manage the open-ended real estate fund lapses (section 81 (4)sentence 1 of the Investment Act (revised version)).In this case the right to manage the fund passes byoperation of law directly to the custodian bank.

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Requirements for the winding-up of open-ended real estate funds

With section 81a of the Investment Act (revisedversion), the Act makes it clear that an assetmanagement company can base a suspension of theredemption of units on section 37 (2) sentence 1 ofthe Investment Act if it terminates its managementof an open-ended real estate fund; in this case, theissue of units must also be suspended. In this waythe asset management company will be able tosecure the winding-up of an open-ended real estatefund. Accordingly, section 81a (2) of the InvestmentAct (revised version) stipulates that until itsmanagement right lapses – i.e. during the term ofthe notice period – the asset management company,in coordination with the custodian bank, is entitledand obliged to (continue to) sell the fund’s assets.

Pursuant to section 81a (4) of the Investment Act(revised version), in coordination with the custodianbank, payments have to be made to investors on ahalf-yearly basis from the sale proceeds. This meansthat the asset management company will thusalready be making distributions of assets if liquidassets are not needed to service any paymentobligations the open-ended real estate fund mighthave or are not needed to manage the fund. In thisway the company will best serve the interest ofinvestors in as rapid as possible a distribution of theliquidation proceeds.

Reduction in maximum borrowing limit

As a reaction to recent developments in the open-ended real estate funds segment, the FinanceCommittee of the Bundestag (Finanzausschuss)considered it necessary to reduce the maximum debtfinancing ratio of these funds from the present 50percent to 30 percent (section 80a sentence 1 of theInvestment Act (revised version)). According to thereport of the Finance Committee of the Bundestag(Finanzausschuss), it is hoped that this will lead to asignificant increase in stability (with regard to thevolatility of investment performance). In order toallow sufficient time to bring actual debt financingratios into line with the new requirements, there is atransition period of up to 31 December 2014(section 145 (5) of the Investment Act (revisedversion)). Special funds (Spezialfonds), however, arenot affected by this change (section 91 (4) of theInvestment Act (revised version)).

International

REPORTS

Solvency II: BaFin publishesnational report on QIS 5

On 21 March 2011, BaFin published the results forthe German market (available in German only) ofthe fifth Quantitative Impact Study (QIS 5). One ofthe findings amongst German insurers from theQIS 5 assessment of the proposed new Europeanregime was that the standard formula underSolvency II is too complex from a German point ofview and should have been made more practicable.The study also showed that, owing to the long-termnature of the life insurance business and theassumption applicability of interest rate guarantees,the own funds position of German life insurers isextremely sensitive to small changes in the yieldcurve.

QIS 5 was conducted under the aegis of theEuropean Insurance and Occupational PensionsAuthority (EIOPA) in all member states of theEuropean Economic Area at the behest of theEuropean Commission. European insuranceundertakings tested out various aspects of theproposed Solvency II regime in its current form.BaFin conducted the German part of the study fromAugust to November 2010 (BaFinJournal 8/2010). Atotal of 251 German insurance undertakings and 26German groups took part.

On 14 March, EIOPA published a report on theresults of QIS 5 which took into account thefeedback from all thirty countries in the EuropeanEconomic Area. BaFin's national report essentiallysets out the results of QIS 5 for the Germaninsurance market and is thus complementssupplementary to the EIOPA report. At Europeanlevel, BaFin will be striving to ensure at Europeanlevel that the findings from the study are taken onboard in the discussions shaping Solvency II andthat the draft regime is improved.

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EBA publishes details of 2011 EU-wide stress test

On 18 March 2011, the European Banking Authority(EBA) published details of this year’s stress test forleading European banks on its website. The 2011EU-wide stress test assumes two basic scenarios: a“baseline scenario” and an “adverse macro-economicscenario”. The baseline scenario is based on theautumn economic forecast of the EuropeanCommission and includes the continuing recoverytrend in the EU. The adverse scenario differs fromthe baseline scenario in that the overall deteriorationof the GDP over a two-year period for exampleamounts to four percentage points in the 2011stress test compared to three percentage points inthe 2010 EU-wide stress test. The stress test alsotakes into account higher refinancing costs insituations of stress, which affects profitability andcapital. Furthermore, stricter assumptions apply forthe performance of an institution’s business in acrisis situation: such performance is assumed to becontinuous and no changes of the business modelare permitted (except in the event of a publiclyannounced and legally binding restructuring of theinstitution).

On 8 April 2011, EBA published details on thedefinition of capital to be used in the 2011 EU-widestress test. EBA adopted a benchmark of Core Tier 1(CT1) against which to assess banks results. TheCT1 benchmark will be set at 5% of risk weightedassets.

www.bafin.de

Basel III – Changes in the area ofcounterparty credit risk

Dr. Hansjörg Schmidt, BaFin

In December 2009 the Basel Committee on BankingSupervision, in response to the financial crisis and inpreparation of the Basel III Package, published theconsultation paper 164 (CP 164) "Strengthening theresilience of the banking sector".

A fair part of the paper deals with counterparty risk(sections 112 to 177). Counterparty risk involvesrisks arising from the possible default of

counterparties in the case of derivatives as well assecurities repurchase and securities lendingtransactions. The competent subgroup of the BaselCommittee, the "Risk Management & ModelingGroup“, had previously determined as part of itsanalysis mandate that capital charges in the pasthad not always been adequate for this riskcategory. In this connection, the subgroupexamined a wide range of different aspects relatingto this risk category. For some items, Basel IIIrepresents a considerable advance compared withthe consultation paper CP 164 from December2009.

The following paper explains the changes that BaselIII will bring about for capital charges in the area ofcounterparty risk. Following the customarypreliminary EU procedure, the changes areexpected to be implemented into nationallegislation in the course of 2012. Special deviationsfrom the original proposals of the consultationpaper (CP 164) will also be highlighted.

By way of analogy to the procedure for stressedrisk measures in the area of market risk, derivativeexposures are also subject to a calibration based ontime sequences of market data from stress periods,e.g. the peak of the a financial crisis. Onemotivation for this is the observation made duringthe past crisis that defaults and deteriorations incredit rating can take place particularly in times ofmajor derivative exposures (wrong-way risk).Market data and credit parameters may bothperform unfavourably at the same time. That canalso be seen at the individual transaction level, asshown by the following example: a put optionmoves into the money exactly when the underlyingsecurity falls. If this security is a share and if thecounterparty of the option is precisely the companycorresponding to this share, the holder of the putoption also suffers the biggest loss on the option inthe event of such party’s default. Under Basel III,regulators in such cases expect explicit, whereappropriate subsequent corrections to regular(automated) exposure calculation.

Another observation made during 2008/2009 wasthat entire groups of institutions became distressedpractically simultaneously. Particularly in times ofcrisis there appears to be a greater defaultcorrelation. In the case of institutions applying theinternal rating approach, Basel II provides aparameter for this ("R") in paragraph 272, whichunder Basel III is 25% higher versus Basel II forlarge banks having total assets of more than 100billion US dollars.

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In the area of collateralised, bilateral over-the-counter (OTC) margined trading, time intervals ofseveral days (depending on re-margining intervalsand products) – within which participants maywithdraw from the agreement in a credit event or inthe case of failure to furnish collateral – determinethe relevant risk horizon. In many cases this“margin period of risk” proved too short in the pastcrisis because in times of reduced liquidity moretime is needed to close out derivative contracts. Thisholds for securities repurchase and lendingtransactions either, if the security in question ishardly tradable any more. In future Basel III, withthe more frequent use of longer risk horizons, willrequire a more market liquidity-adequatedetermination of collateralised exposures. It will alsobetter reflect the versatility of collateral agreementsin terms of the type of re-margining thresholdscompared with Basel II.

It does not come as any surprise that for validation(backtesting, i.e. backward comparisons of exposureforecasts with subsequent realisations) as well as forthe requirements for stress testing, a higher qualitystandard is being required post-crisis. Particularly forthe backtesting of counterparty exposures, aseparate accompanying "Guidance" prepared withthe intense collaboration of BaFin was published on10 December 2010.

Compared with the previous year’s proposal in CP164, there were major changes in the area of creditvaluation adjustments (CVAs). These had risensignificantly during the crisis and led to considerablevaluation losses on derivative positions. This refersto the influence of the counterparty’s credit rating onthe fair valuation of a derivative that is otherwisevalued using default-free interest rate curves.However, this CVA is a portfolio value, with theportfolio being the enforcable netting agreement(positive and negative market values netted in theevent of insolvency). CVA is booked under its ownitem, separate from the derivatives, and is thereforenot as obviously visible as the (otherwise similar)price discount on a corporate bond. Such bondsvalued at "sovereign" interest rates would be worth,say, 100, but because of the so-called credit spreadsis traded at e.g. only 90. As with bonds, creditspreads are significant drivers of risk. The approachtaken by a zero-coupon bond under CP 164 has nowbeen refined in the advanced CVA capital charge tothe structure of a coupon bond, i.e. expected lossesare viewed over the entire time axis and not just atmaturity of the derivative contracts. This couponbond forms a hypothetical position giving rise tomarket risk calculated in internal models. Forinstitutions that are no model banks, a standardised

method was developed with the collaboration ofBaFin that is likewise based on credit spread levelsand volatilities (fixed by regulators) but that doesnot require any fine-tuning of risk drivers nor timeresolution of exposure components. In addition, CVAalso deals with the capital charge for default risks(credit risk standard approach or based on internalrating) and in this regard exposure at default minusCVA better represents the expected replacementcosts. The final calibration of the standardisedmethod will take place in the first quarter of 2011.

The last significant change compared with CP 164relates to the measurement of exposures to centralcounterparties (CCPs). Systematic risks are reducedby a greater integration of exchanges and clearinghouses into what is then an increasingly transparentnetwork of derivative transaction relationships.Methods for exposures and thereupon capital chargerules were developed and adapted that the memberof a clearing house applies for customers and theexchange. Again with the close involvement ofBaFin, a risk-sensitive method has been developedto cover the risk and subsequent capital chargerelated to the member’s default fund contribution. Itmodels the "cascade" of losses in the event ofdefault of one or more clearing members. In thiscontext, the co-operation with subgroups of the BISCommittee on Payment and Settlement Systems(CPSS) and the International Organization ofSecurities Commissions (IOSCO) proved veryfruitful. The parameters of this capital calculation willlikewise be calibrated at the beginning of 2011 aspart of a quantitative impact study.

IASB Issues Exposure Draft on HedgeAccounting

The InternationalAccounting StandardsBoard (IASB) issued anexposure draft (ED) of astandard governinghedge accounting inDecember 2010, initiatingPhase 3 of the ongoingproject to revise IAS 39Financial Instruments:Recognition andMeasurement. The IASB’sgoal is to completely

revise IAS 39 – a standard that is important not onlyfor banks – by the end of 2011 and to replace it byIFRS 9 effective 1 January 2013.

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Dr. Frank-Thomas Gräfe, BaFin

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IFRS 9 issued in three phases

In contrast to the Financial Accounting StandardsBoard (FASB), the United States standard-setter,which is also in the process of revising its ownstandard on financial instruments accounting, theIASB has opted for a three-phase revision of IAS 39.This approach met with widespread support becauseaccounting for financial instruments is viewed aswithout doubt one of the most complex issues infinancial accounting and reporting. Splitting thecomprehensive project into several phases that areaccompanied by a public consultation processtherefore appeared to be a logical move.

The three phases of the IFRS 9 project:

However, this approach has proven to beproblematic in practice: although there aresignificant overlaps between issues addressed by theindividual phases, the interactions between thephases themselves cannot be assessed. This is oneof the reasons why the EU decided after completionof Phase 1 in November 2009 not to take anydecision on endorsing IFRS 9 until all three phaseshave been completed.

This means that early adoption in the EU ofindividual phases that have already been completedis not possible. From a regulatory perspective, this isa welcome development, especially because theoriginal three phases have now, technicallyspeaking, evolved into five phases – which is thesecond problem affecting the IASB’s approach to thisproject. Phase 1 (Classification and Measurement)only resulted in requirements governing financialassets; financial liabilities were not incorporated untillater, in Phase 1b (Fair Value Option for FinancialLiabilities). The IASB is currently redeliberating therequirements governing impairment of financialinstruments measured at amortised cost. And thehedge accounting exposure draft that has now finallybeen issued still does not address macro (portfolio)hedge accounting, an issue that the IASB will revisit

once the hedge accounting standard has beenfinalised.

Despite this, the IASB is still clinging to its timelineof finalising IFRS 9 by June 2011. In view of the factthat only one phase has been finally completed –and this phase also contains a requirement that hascome in for widespread criticism – this timetable canbe termed highly ambitious. We must thereforeassume that the IASB will probably be kept busy bythis project well beyond this summer. For thisreason, a requirement to apply IFRS 9 for periodsbeginning on or after 1 January 2013 is lookingincreasingly unlikely.

Hedge accounting: Accounting follows riskmanagement

The extremely demanding requirements for applyinghedge accounting under IAS 39 are a majorcontributory factor to the complexity of financialinstruments accounting, which is why they havecome in for regular criticism in the past.

The new exposure draft is supposed to change allthis: the underlying approach in the ED is toharmonise hedge accounting with risk managementto a much greater extent in the future. This isdesigned in particular to make it easier for reportingentities to assess hedge effectiveness. The currentrules contain very strict quantitative criteria – acorridor of 80 to 125% is prescribed for hedgeeffectiveness – whereas the ED will also allow aqualitative assessment. A hedging relationship thatmeets the entity’s risk management objectives willbe eligible for hedge accounting.

There is no obligation to apply hedge accounting.However, if an entity accounts for its riskmanagement activities using hedge accounting, itmust also recognise all changes in these activities inthe financial statements. This means that if ahedging relationship ceases to meet the objective ofthe hedge effectiveness strategy, but the riskmanagement strategy remains the same, thehedging relationship must be adjusted(“rebalanced”). Rebalancing is also possible if hedgeineffectiveness is only expected in the future.Another innovation in this context is that hedgeeffectiveness need only be demonstratedprospectively, whereas IAS 39 also required aretrospective test of hedge effectiveness. As before,the ineffective portion of a hedging relationship isrecognised in profit or loss.

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Phase Project name Date of adoption Status

1 Classificationand Measurement

November 2009 Finalised

2 Impairment September 2010 Request for views

3 HedgeAccounting

June 2011 ED

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Another factor that will align hedge accounting moreclosely with risk management is the proposal topermit risk components of “non-financial instruments”as eligible hedged items in the future. In addition,entities will be allowed to recognise aggregatedexposures containing derivatives as hedged items.This is not possible under the existing IAS 39, asderivatives do not qualify in principle as hedgeditems.

In addition, another revision that governs accountingfor options whose intrinsic value and time value havebeen separated aligns hedge accounting more closelywith current practice. If the intrinsic value of anoption is designated as a hedging instrument, theoption’s time value (premium) is no longer recognisedimmediately in profit or loss. Rather, the amounts arerecognised initially in other comprehensive income(OCI) and subsequently – for transaction-basedhedges – reclassified from OCI to profit or loss, or –for time period-related hedges – amortised to profitor loss over the term of the hedging relationship. Thisreduces volatility in the income statement, which iswhy this revision – despite its high level of detailedcomplexity – is very welcome.

No hedges of OCI instruments allowed

As the exposure draft currently stands, hedgeaccounting may not be applied in the future tohedged items designated as at fair value throughother comprehensive income (FVTOCI). The reasongiven by the IASB for this prohibition is that, underIFRS 9, gains or losses on the disposal of theseinstruments may no longer be recycled to profit orloss.

BaFin continues to take a highly critical stance onthese requirements and is urging the issue of OCIinstruments recycling to be revisited in the commentletters on the exposure draft. There can only be asystematic link between risk management andaccounting if hedged equity instruments in theFVTOCI category are also eligible for hedgeaccounting – yet another argument for allowingequity instruments measured through OCI to berecycled.

Fair value hedges converge with cash flowhedges

To reduce complexity and ensure that financialstatement presentation is as consistent as possible,the IASB had originally planned to merge therequirements governing cash flow hedge accountingfully with those for fair value hedge accounting.However, the Board distanced itself from this concept

during the course of the project, in particularbecause it would have led to artificial volatility inequity.

Nevertheless, there will be substantial similaritiesbetween both types of recognised hedge in thefuture. Similar to cash flow hedge accounting, gainsor losses for fair value hedges – on both the hedgeditem and the hedging instrument – will berecognised in OCI under IFRS 9. The carryingamount of the hedged item will not be adjusted;instead, gains or losses will be presented in aseparate line item in the statement of financialposition. Because this line item will be presenteddirectly below the corresponding assets or liabilities,this means that – in theory – several of these lineitems will appear in the statement of financialposition. It remains to be seen how this will look inpractice.

Conclusion: a step in the right direction

To date, the IASB has carved out requirements formacro (portfolio) hedge accounting from the currentexposure draft and plans issuing these in thesummer. Because macro hedge accounting plays anot insignificant role, especially at credit andfinancial services institutions, no conclusiveassessment of the ED is possible at the presenttime. However, it is already clear that thewidespread criticism aimed at IAS 39 has resurfacedfor the IFRS 9 exposure draft. It needs to bestressed in this context in particular that the morepronounced alignment of hedge accountingrequirements with risk management will enable arational link between these two elements.

A significant weakness is the decision not to allowequity instruments classified as at fair value throughother comprehensive income to qualify as hedginginstruments for hedge accounting purposes. Thisshows again that the rigid requirements of IFRS 9preventing gains or losses on these instrumentsfrom being recognised in profit or loss, even on theirdisposal, do not reflect the economic reality of profitor loss recognition. The German supervisor is notthe only constituent who believes that this issuemust be remedied as a matter of urgency.

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Ms Hahn, what prompted you to move toBaFin?

After ten years at the Federal Finance Office andsubsequently at its successor, the Federal CentralTax Office, I really wanted to do something verydifferent, something entirely new. It’s not as if Ididn’t enjoy working there, but what reallyexcited me about BaFin is the internationaldimension.

To which you’re no stranger.

That’s right. At the Federal Finance Ministry, Iheaded a department dealing with VATharmonisation in the European Union. That wasduring one of the German presidencies.International harmonisation is a very interestingissue – and a very important one, too. Ofcourse, the same applies to insurancesupervision and financial supervision in general.We need harmonised European and globalstandards in financial supervision, and this issomething I’d like to contribute to.

So you’re looking forward to your new job?

Definitely!

What’s your first impression?

My first impression is that the workingatmosphere here at BaFin is very collaborative,and I very much enjoy working together with mynew colleagues. The atmosphere is very openhere and people are willing to engage. These areextremely pleasant conditions to work in – andvery fruitful ones, too. We have important,challenging tasks to master, and the best way todo this successfully is if we’re all pulling together.

One of these challenging tasks goes by thename of “Solvency II”. Small and medium-sized insurance companies in particular areconcerned that the future Europeanregulatory framework will demand too muchfrom them. What’s your position on this?

I will continue the line that BaFin has taken inthe past. In the context of Solvency II, BaFin hasalways championed the interests of small andmedium-sized companies. It has argued that theintroduction of Solvency II should not lead to anyshake-up in the market. The Federal FinanceMinistry and the German Insurance Association(GDV) also share this fundamental line. And theEuropean Commission supports it, too.

To avoid overburdening small and medium-sizedinsurers, BaFin has always urged the effectiveimplementation of the principle of proportionalitywhen it comes to elaborating the detailedprovisions of Solvency II, and is proactivelyhelping to shape the new rules. This will play akey role, for instance in the further developmentof the supervisory guidance and technicalstandards on Solvency II. We believe thatsimplifications are possible there, as well aselsewhere.

We will be organising another BaFin informationevent for small and medium-sized insurancecompanies, similar to the one last year. It isplanned to be held on 7 June. We want to givethe companies another opportunity to find outmore about Solvency II at first hand and indiscussions with BaFin representatives andexternal experts.

Solvency II isn’t the only challenge facinginsurance supervision.

Definitely. The low interest rate phase is anothermajor issue that is keeping us busy. Because of

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Issue

INTERVIEW

Gabriele Hahn isBaFin’s new ChiefExecutive Director ofInsurance Supervision.She started working atBaFin in February.BaFinQuarterly spoketo the formerPresident of theFederal Central TaxOffice (BZSt) aboutthe reasons for hermove and the chal-lenges facing insur-ance supervisiontoday.

Gabriele Hahn, Chief Executive

Director of Insurance Supervision

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the financial crisis, capital market rates havebeen very low for quite some time now. Whetheror not the recent decision of the ECB to raiserates moderately signals an end to this phase isanybody’s guess. BaFin must be prepared forboth possible outcomes, the return to highermarket interest rates or a further continuation ofthe low interest rate phase. The low interest rateenvironment is hitting the life insurersparticularly hard – as institutional investors, they are heavily dependent on financial markettrends. A life insurer enters into what aregenerally long-term return commitments to itscustomers that it has to keep. To be able to fulfilthese contractual obligations on a sustainablebasis, it has to acquire capital investments thatoffer sufficient security and at the same timegenerate an adequate yield. This isn’t easy wheninterest rates are low. This is also thebackground to the recent decision by the FederalFinance Ministry (BMF) to cut the maximumtechnical interest rate to 1.75 percent forinsurance contracts with a guaranteed returnsigned after 1 January 2012.

What approach is the insurance supervisortaking to the issue of low interest rates?

BaFin is monitoring the economic position of theGerman life insurers very closely and carefully toidentify adverse developments and trends forthose companies’ risk-bearing capacity and theinterests of the policyholders at an early stage.To do this, we are increasingly using risk-basedsupervisory instruments such as the BaFin stresstest and specially designed projection modelsthat simulate the effects of stable and adversecapital market trends on the economic positionof the companies. For 2011, we are alsoplanning once again to collect data on the lifeinsurers’ ability to meet their interest rateguarantees in the long term. We are in closecontact with the industry and the BMF regardingpotential additional measures to enhance the lifeinsurers’ risk-bearing capacity.

What changes do you want to make toinsurance supervision at BaFin?

I’d like to start by stressing that I’ve taken overan extremely well-functioning supervisory pillar.And one of the reasons for this – but by nomeans the only one – is certainly that theatmosphere here is extremely collaborative, as Isaid earlier. This excellent teamwork combines

with effectiveness and efficiency and the strongdesire of the staff members to do justice to theirtremendous responsibility. So there’s no reasonto turn everything upside down along the lines of“It’s my turn now, and I’m going to doeverything differently and better”. But we can’trest on our laurels even at this high level. Wemust continuously examine whether we can workeven more effectively, even more efficiently. Andwe will always do what needs to be done to stayabreast of the latest developments. After all, thefinancial markets are in constant flux.

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17.-21.04. IOSCO, Cape town

28.04. Joint Committee, London

11.05. ESRB ATC, Frankfurt

25.05. ESMA Board of Supervisors, Paris

07.-08.06. IOPS Technical und Executive

Committee Meetings, Mexico

08.-09.06. EBA Board of Supervisors, London

15.-17.06. IAIS Triannual Meeting, Macau

21.06. JCFC, London

22.06. ESRB General Board, Frankfurt

23.-24.06. BCBS, Basel

28.-29.06. Joint Forum, Madrid

30.06.-01.07. EIOPA Board of Supervisors, Prague

Agenda

DIARY

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PublisherFederal Financial Supervisory Authority (BaFin)Press and Public Relations DepartmentGraurheindorfer Straße 108, 53117 BonnLurgiallee 12, 60439 Frankfurt, Germany

Editorial Office and LayoutBaFin, Press and Public Relations DepartmentGeorg-von-Boeselager-Str. 25, 53117 BonnE-Mail: journal@bafin.de

ContactAnja Engelland, Fon: +49 228 - 4108 3304 Sven Gebauer, Fon: +49 228 - 4108 1385

Imprint

PhotosOwn pictures; photothek (Ute Grabowsky); felinda,Orlando Florin Rosu, Spectral-Design, Popsy, Foto-Ruhrgebiet, ALAIN VERMEULEN, kormanngraphics/www.fotolia.de

Journal-DesignAGENTUR DISCODOENERBüro für Design und KommunikationPeter Lederle und Peter Palec GbRStiftstraße 1, 70173 Stuttgart

SubscriptionBaFinQuarterly is published every three months onthe BaFin homepage. To be informed by e-mailabout the publication of the latest edition, pleasesubscribe to BaFin’s Newsletter, which can be foundat www.bafin.de » Newsletter.

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