Its a tough job, but someone has to do it
How do you regulate a market just enough to protect investors, but not so much as to stifle innovation and inflict unnecessary costs? Regulation can be a thankless task, and when you hear about it, it usually means something has gone wrong. IFR took some time out of its schedule to catch up with BaFin, one of Europe’s preeminent regulators.
How would you characterise BaFin’s regulatory philosophy? As Germany's integrated financial supervisor, our principal task is the supervision of credit institutions and financial services providers (banking supervision), insurance undertakings (insurance supervision) and securities trading (securities supervision). We believe our view of the whole financial system - with all its interdependencies and relationships – allows us to better identify risks and can limit them. We believe in a principles based regulation and our degree of involvement depends on the risk associated with a bank or insurance company.
Markets are changing rapidly, so we seek to maintain a dialogue with the companies we regulate, their customers, academics, other supervisory authorities in Germany and other countries and international organisations.
What are the latest figures for how many institutions of various types BaFin oversees?
As of January 2008 BaFin supervises around 2,080 banks, 720 financial services institutions, 630 insurance undertakings, 26 pension funds, 6,000 investment funds and 78 investment companies.
How do BaFin and the Deutsche Bundesbank divide the regulatory process between them? In the case of the exchanges, what is BaFin responsible for and what falls under the Lander?
The co-operation in the field of banking supervision was just recently newly agreed on in the new Supervisory Guideline. In regards of ongoing supervision BaFin is in charge of all sovereign actions whereas Bundesbank is in charge of the preceding investigation, for example in forms of on-sight inspections. The institutional supervision of exchanges is in the hands of the Länder whereas the market supervision – the rules concerning ad-hoc disclosure, insider trading, market manipulation, director's dealings or other transparency requirements – is the responsibility of BaFin.
Senior management of banks are subjected to a “fit and proper” assessment to determine their suitability. Please elaborate on that.
The so called "fit and proper" assessment of a prospective manager consists in particular of an assessment of his trustworthiness and an assessment of his professional qualifications. His trustworthiness is determined with reference to a centrally held government register, where criminal records are recorded for an appropriate length of time. There are no set guidelines for the experience required by managers before they can be determined suitable for a senior role at a bank. We can be flexible, but want to see a number of years experience in an area relevant to the role the manager will be taking on, but at a more junior level.
What proportion of the banking supervision department’s resources are put aside for authorisation and what proportion to ongoing supervision?
As ongoing supervision follows from authorisation both are taken care of in the particular operative department and section, a clear proportion cannot be given. It would be fair to say, however, that there is preponderance in the field of ongoing supervision.
What are the greatest challenges currently facing financial regulators?
The internationalisation of the financial market and its products is a great challenge for all supervisors, as shown by the recent market turbulence.
More cooperation between financial regulators is necessary, but BaFin believes there are already good standards in this respect. For example, within Europe there is the Committee for Banking Supervision, the Committee of European Banking Supervisors and the Committee of European Securities Regulators, all comprising staff from the national regulators. Internationally there is the Bank for International Settlements, the Financial Stability Forum and the International Organization of Securities Commissions.
Just recently a group of senior financial supervisors from five countries issued a report that assesses a range of risk management practices among a sample of major global financial services organizations. BaFin was a member of this group.
But the fact there is a considerable amount of cooperation already does not mean we should not look to improve.
How does the regulator ensure it effectively monitors market activity?
BaFin monitors the risks of undertakings and institutions with reference to the audit report on the annual financial statements, with further reference to notices and reports issued by the supervised company. If more detailed information is required, BaFin may conduct its own inspections of companies, or hold meetings relating to supervision. In obtaining this information, the use of any instrument that may hamper supervision of the undertaking is strictly controlled by the supervisor according to the undertaking’s activities and level of risk. BaFin has developed a model of risk classification, which it uses for the companies and institutions it supervises (see graphic). In 2005, BaFin began to classify the companies and institutions being supervised using a 12-position risk matrix. The horizontal axis of the risk matrix shows the quality of the supervised company, on a four-level scale. The vertical axis indicates the company’s relevance to the system, previously also referred to as impact, on a three-level scale, with the assessment made by the competent supervisory department. The “quality” axis takes account of both qualitative and quantitative elements. Qualitative elements include, for instance, the findings of the annual financial statements or on-site inspections, while quantitative elements include key figures from solvency supervision. The system relevance of a supervised company or institution is determined primarily from its relative size compared with its peers, and from its market share if the relevant market is of significance for the economy as a whole.
What is BaFin’s role in overseeing the dissemination of information from issuers to the market?
The Transparency Directive Implementation Act (Transparenzrichtlinie-Umsetzungsgesetz – TUG) came into force on 20 January 2007, implementing the provisions of the Transparency Directive into German law. It is intended to improve transparency on the European capital markets and to harmonise the corresponding regulations at a Europe-wide level, to enhance both investor protection and market efficiency. Investors are to be provided with accurate, comprehensive and timely information about security issuers, as well as on major shareholdings.
It is not an entirely new act but amends existing legislation. Its main goals are to deliver: higher transparency with respect to holdings of shares, with respect to changes regarding notification and disclosure requirements; improved accounting transparency; provision of required information for the exercise of rights attached to securities; introduction of the home country principle, with the scope of application new provisions based on the domicile of a security issuer, not on where it is listed; and the prompt provision of key capital market information to BaFin.
With regards to financial reporting, BaFin has the power to force companies to publish their detected mistakes.
As the markets become more complex is the problem of fraud getting harder to manage?
Yes. The problem of fraud is a difficult one to summarise. It is not helpful to overstate the problems associated with fraud. It is not such a problem, for example, that BaFin has a department specifically dedicated to it. It is not an everyday problem so much as an exceptional problem. It is currently at the fore in peoples’ minds because of what happened at SG but problems on that scale are in fact very rare – though it is fair to say there is a greater frequency of smaller problems associated with fraud.
It is true that fraud is harder to manage when it involves the highly complex securities increasingly common today. But BaFin, as well as other national regulators, have the tools to manage the problem, for example in our enforcement of risk management practises in German institutions.
How many investigations is BaFin likely to be conducting into market abuses at any one time? And what are these investigations concerning?
The figures for 2007 are not available. In 2006, the authority conducted 1,250 analyses, compared with 1,450 in 2005, due in part to the new approach adopted by the supervisor in its insider analysis, which is now more heavily risk-oriented, focusing on particularly insider-relevant backgrounds. The number of ad hoc disclosures, on the basis of which BaFin conducts a number of analyses of possible insider actions and market manipulation, also fell slightly in 2006 compared to the previous year. Reports submitted by investors, in contrast, almost doubled. Most reports concerned the raw materials and solar power sectors, relating primarily to low-liquidity financial instruments traded in the OTC market.
In 84 cases, the analysis revealed evidence pointing to insider trading (52 cases) or market manipulation (32). In these cases, BaFin initiated formal investigations. Despite the fall in the overall number of cases, the number of positive analyses was almost the same as during the previous year. The vast proportion of positive insider analyses (87%) related, as in previous years, to insolvencies, interim results and, above all, M&A activity (46%).
How does a regulator compete in employing top talent when financial institutions are able to pay such large salaries? With this in mind, how does the regulator keep pace with the constant innovation in finance, for example in the latest exotic derivatives?
Mainly BaFin employees are civil servants. In exceptional cases BaFin can also pay non-tariff salaries in order to employ individual experts.
How concerned is BaFin about the prospects for regulatory arbitrage from institutions domiciled offshore but active in the German market?
Offshore institutions require a licence by BaFin if they actively target the German market, and they must have a branch in Germany.