Following a nine-month monitoring period, the German Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht - Bafin) has decided not to prohibit the distribution of credit-linked notes (CLN) to retail investors. The German watchdog 'monitored the issuance and distribution of these products intensively' until the end of September 2017, and established that the 'voluntary commitment' made by the German Banking Industry Committee (DK) and the German Derivatives Association (DDV) was 'broadly adhered to and protected retail investors sufficiently'.
"The way that credit-linked notes have developed shows that Bafin can significantly improve investor protection without introducing a prohibition," said Bafin's chief executive director, Elisabeth Roegele (pictured), in light of the results of the investigation. Between January and September 2017, the regulator monitored a total of 106 newly issued CLNs from a number of issuers, and concluded that the voluntary commitment made by the structured products industry was being adhered to and that further supervisory restrictions were 'therefore not necessary at the present time'.
The background to this is that the supervisor has checked both the issuance and the distribution of these products and has determined that the voluntary commitment of the German derivatives industry is being kept, according to Lars Brandau, managing director at the DDV. "Thus, there is no question that retail investors are sufficiently protected. Basically, self-regulation is always preferable to legal regulation. In this case, supervision/regulator and industry have found an amicable solution in the interests of investor protection."
With respect to the principles regarding the issuance of CLNs, Bafin carried out checks on securities prospectuses and product information sheets and inspected advertising and information material as well as product descriptions on the issuers' websites. In addition, the German regulator implemented on-site inspections to ascertain whether the principles regarding distribution were being observed, and also evaluated investment advice minutes, among other things.
According to the regulator's findings, there were 'contraventions in isolated cases', which 'were not of a systemic nature, but rather due to individual wrongdoing'.
Brandau said that the DDV has been "extremely active" in standardisation measures and product clarification since it was founded almost ten years ago. "Apart from the product classification and the derivatives codex, the DDV offers assistance in many ways," said Brandau. "In particular, these include, first and foremost, the focal points of content that are resolved within the industry, and then the broad communication to all relevant stakeholders."
According to Brandau, retail investors receive comprehensive statistics, book material, brochures, explanatory films, and "can also take a certificate online course or attend one of the numerous events"."Education and investor protection are elementary components of the work of the DDV," said Brandau, adding that the association's committees and working groups have "adequately discussed and harmonised" the regulatory requirements and "are currently in the active implementation phase".
"The DDV has created a transposition guide for its members and sponsoring members for both the Mifid 2/Mifir and the Priips requirements, which the issuers can use to orient themselves," said Brandau.
Bafin announced a prohibition of the marketing, distribution and sale of certificates linked to creditworthiness risks to retail clients and gave those in the certificates industry the opportunity to state their position, at the end of July 2016, due to investor protection concerns. The regulator had launched an investigation earlier in March to establish the suitability of CLN sales to German retail investors.
In response, in mid-December 2016 the DK and the DDV announced a voluntary commitment to implement 10 principles for the issuance and distribution of CLNs. The principles established a commitment for improved advice about risks, increase quality control for the selection of the reference entity and restrict the distribution of CLNs to investors with a higher risk appetite, which resulted on Bafin deferring the planned prohibition.
'Now that its intensive monitoring phase has been concluded, Bafin has made a final decision not to introduce a prohibition, but will continue to review adherence to the voluntary commitment as part of its market and product supervision,' stated the regulator.
Credit has been the fastest growing asset class in the German structured products retail market since 2010, overtaking commodities, hybrid and interest rates structures in 2012, according to SRP data. In 2015, sales of CLNs stood at €1.59bn and represented 7.89% of the German market's structured products sales and is the fifth most utilised asset class in the market after equity, FX rates, commodities and interest rates. Currently, over €5.6bn are invested in CLNs, according to the DDV's April report.
In 2016, over 357 CLNs worth €1.2bn were marketed in Germany down from 513/ €1.85bn in 2015. Despite self-regulatory efforts the issuance of CLNs has dropped significantly in 2017 with only 37 CLNs issued year to date worth €84m. There are no CLNs open for subscription in Germany's retail market, according to SRP data.
Additional reporting Suzanna Moni
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