BaFin’s draft Circular Letter is based on the fundamentals of Section 25a (1) of the German Banking Act (Kreditwesengesetz, KWG) (Special organisational duties; authority to issue orders) and Section 22 (1) of the German Payment Services Supervisory Act (Gesetz über die Beaufsichtigung von Zahlungsdiensten, ZAG) (Non-cash payments; special organisational duties of payment institutions and e-money institutions as well as safeguards against money laundering and terrorist financing) and aims to prescribe the requirements for monitoring, distributing and controlling the development of financial products.
With the planned circular letter, BaFin will implement the EBA Guidelines EBA/GL/2015/18 which were published in 2015 and have been effective since 3 January 2017. Use of this new regulation would be mandatory for all credit institutions. In particular, it affects everyday market products such as payment accounts, consumer credit, home loans and deposit products (so-called “mass retail products”). It will apply to future, purchased, as well as to already-existing, products. The “New Product Process” (NPP) from (Germany's) Minimum Requirements in Risk Management (MaRisk) also applies analogously.
In future, institutions will have to determine the relevant target market concerned for each financial product. The target market is to be defined based on the consumer’s required level of knowledge, understanding, potential creditworthiness and financial standing, as well as the respective product’s inherent risk. The developed products must, in turn, be consistent with the consumer group’s interests, objectives and characteristics. Even if the individual consumer tallies with the defined target market, the institution remains obliged to offer tailored advice prior to contractual conclusion. It should be possible for the consumer to decide “with reasonable effort” on which of the offered products to choose.
Another aspect of the regulation is that the financial products as well as the target market must be permanently monitored to ensure that the consumers’ interests, objectives and characteristics are still considered. This monitoring should allow recognition of whether the identified target market was correctly defined and, if this is no longer the case, that countermeasures possibly be instigated by, amongst others, dropping the original sales channel for the product concerned.
To prevent risks, appropriate sales safeguards must be implemented for the respective products and integrated into the existing compliance and risk-controlling mechanisms. The Circular Letter additionally obliges the institutions to document all processes – from a product’s development through to its monitoring.
In future, the institutions’ sales units will have to select sales channels which are suitable for the target market concerned, and ensure that the financial products are exclusively distributed in the specified target market.
The institutions must provide their distributors with all the financial products’ specifications, details, characteristics and risks, and the identified target markets, as well as information on pricing and fees. The distributors, in turn, must gather all the information on the compliant distribution of the financial products and their suitability for the identified target market to enable the institution to execute its duty to monitor its financial products.
DK’s position statement on the draft Circular Letter
In its capacity as the lobby group for Germany’s credit institutions, die Deutsche Kreditwirtschaft criticised in its 31 August 2017 statement various aspects of the Circular Letter, as well as the EBA’s attempt, per se, to regulate further activities in the credit industry. Amongst others, it referred to its position statement on the EBA Guidelines published back in 2015 that “less-complex retail products which have been established on the market for decades” do not “need such comprehensive monitoring and documentation”, and that rulebooks already exist for the sale of these products. The “New Product Process” from MaRisk is cited as an example.
It also states that the regulatory measures of BaFin’s draft Circular Letter extend far beyond the EBA’s requirements and could thus place German institutions at a competitive disadvantage.
In its position statement, DK points out to BaFin that, in particular, in the draft Circular Letter, the definition of the sales channels does not distinguish between online and branch-office business; this is of fundamental importance because contracts are often concluded without consulting in the already-prevalent online business, but this would now be required under the BaFin draft. Also absent is the clarification of proportionality, as required in EBA Guideline 1, No 1.5. It is also not evident from the draft Circular Letter specifically which payment services would be affected, but welcomes the fact that basis accounts would be exempted.
DK demands better dovetailing with already-existing regulations to avoid redundancies and inconsistencies. It also reminds BaFin that, since publication of the EBA Guidelines in July 2015, other regulatory measures have already been – or are currently being – implemented which overlap with the underlying contents of the draft Circular Letter, and that these must be taken into account. In this context, it explicitly mentions credit products in the area of real estate loans where regulation is still outstanding, and recommends particularly that these products be excluded entirely from the draft Circular Letter.
DK is also doubtful about the cost-benefit ratio of the measures in the draft Circular Letter which will result from the additional effort for new / additional test runs and the technical changes and implementations needed for them.
Final Circular Letter not yet in sight
With its draft Circular Letter, BaFin is tardily fulfilling its duty from EBA Guideline EBA/GL/2015/18 to regulate credit institutions’ development and sales processes. Banks which offer classical payment products and services and are already under enormous competitive pressure would have to expect additional costs in light of existing and ongoing regulatory processes. These would impact, in particular, the labour-intensive areas of controlling and documentation. Budgeting for appropriate capacities and resources for this over the mid-term would be advisable. Other costs can also be expected in the areas of media presence and communication channels, where advertising brochures and websites may have to be updated. And last but not least, a review of the current sales channels, and possibly also sales-staff training in the new regulations, should also be considered.
It is expected that BaFin will tweak some of its demands in the Draft, because overlaps with the MaRisk New Product Process are indisputable. A precise reconciliation / demarcation of the two regulations would be necessary here, especially to avoid additional costs caused by redundant documentation, risk controlling and test runs. The principle of proportionality mentioned and prescribed both in EBA Guideline 1, No 1.5 and Guideline 9, No 9.1 has not been adequately considered in the draft Circular Letter. This would have to be better addressed in BaFin’s final Circular Letter.
Despite the amendments to be expected to the draft, the new regulation will essentially apply to all market players, and they will have to prepare themselves for it. When BaFin releases its final Circular Letter, however, is not yet foreseeable.