Client Publication March 2004

German License Requirement for Cross-Border Banking and

In September 2003, the German Federal Financial “target-oriented” way to offer banking2 or financial Supervisory Authority (Bundesanstalt für Finanz- services3 repeatedly and on a commercial basis to dienstleistungsaufsicht—BaFin) issued a circular persons having their residence in Germany. regarding the license requirement for individuals as The new license requirement does not apply to well as enterprises intending to offer banking or and broker-dealers located in a member state of the financial services in Germany. In particular, the BaFin European Union or the European Economic Area for addressed the rendering of banking and financial those services which benefit from the so-called services on a cross-border basis. The following European passport. summarizes the BaFin’s view as expressed in the circular and describes the current administrative praxis. Solicitation of Clients in Germany Introduction The Circular distinguishes between offering services in a “directed” or “target-oriented way”—that require Any persons or enterprise wishing to engage in a license—and providing services passively, i.e., on banking business or financial services business in the initiative of German residents—that do not require Germany on a commercial basis or on a scale that a license. It stands to reason that this distinction may requires a commercially organized business operation be difficult to apply, but in general a foreign must obtain a license from the BaFin. institution which does not solicit clients in Germany Before September 2003, no license was required for an may, without being licensed, offer banking or enterprise domiciled in a foreign country providing financial services to German residents. banking services or financial services to customers in In order to be able to rely on this “unsolicited Germany from abroad, e.g., by mail, e-mail or telephone. transaction exemption”, it is advisable that the foreign Note that in Germany broker-dealer services are institution documents that a transaction was solely considered to be banking services or financial services. based on the customer’s initiative. It is advisable to Now the BaFin changed its view with regard to cross- rely on the unsolicited transaction exemption only in border banking and financial services activities. isolated instances; reliance in a multitude of According to the circular issued on September 16, transactions would arouse the suspicion of the BaFin. 2003 (the “Circular”)1, the license requirement for Furthermore, a general solicitation effort by the banking and financial services is already triggered if foreign institution would destroy the exemption. the service provider has his place of business abroad but solicits clients in Germany. According to the BaFin, the service provider solicits clients in 2 According to § 1(1) of the German Banking Act, inter alia, the Germany if it turns to the domestic market in a following activities are considered banking activities: (1) deposit business, (2) lending business, (3) discount business, (4) brokerage business whereby the broker acts in its own name 1 but for the account of others, (5) custody business, (6) It should be noted that the Circular is not a binding regulation. investment fund business, (7) guarantee business, (8) giro Rather, it states the BaFin’s view with regard to cross-border business, (9) underwriting business, and (10) E-money business. banking and financial services activities and is intended to give interpretative guidance. However, although the courts are not 3 The following services are, inter alia, considered financial bound by the Circular, it gives an accurate view of the present services within the meaning of § 1(1a) of the German Banking administrative practice. Moreover, the Federal Ministry of Act: (1) investment opportunity brokerage, (2) brokerage is planning to amend § 32 (1) of the German Banking business whereby the broker acts as disclosed agent, Act and to clarify that banking and financial services are (3) portfolio management, (4) dealing, (5) non-EEA deposit provided “domestically” already where the services provider brokerage, (6) money transmitter business, and (7) card solicits clients which are residing in Germany. business. 2

It is important to note that the Circular does not contain triggered. The test is whether the initiative was taken a “sophisticated investor” exemption. Providing cross- by the foreign institution or by the German issuer. border services to a sophisticated institution is treated It must be emphasized that underwriting of financial the same way as providing services to a retail customer. instruments, the activities of a member of a selling group and best efforts underwriting are all banking or Relevant Cases Causing a License financial services under the German Banking Act. Requirement However, institutional investors or major customers The Circular discusses several typical fact situations usually initiate the underwriting relationship and, which can be summarized as follows: therefore, in practice an underwriter may be able to rely on the unsolicited transaction exemption. Lending business/lending syndicate. If the foreign institution solicits clients in Germany to offer Non-EEA deposit brokerage. If a customer repeatedly and on a commercial basis, the license domiciled in Germany approaches a German deposit requirement is triggered. Only if pre-existing customer broker that refers such customer to a deposit relationships are continued, or the agreement is institution domiciled in a country that is not a member based on the customers’ initiative, is a license not state of the EU or the European Economic Area, such foreign institution, in general, may rely on the required. Initiative of the customer is more likely in 4 cases of large commercial customers or institutional unsolicited transaction exemption. investors. However, it is important to note that, if a However, if the contractual relationship (e.g., master service provider wants to rely on the exemption for pre- or cooperation agreements) or the actual conduct of existing customer relationships, according to the BaFin the business relationship between the foreign these relationships must have been established with the institution and the domestic broker suggests that the service provider itself and not with an affiliate. If, e.g., a foreign institution uses the domestic broker as a German-licensed subsidiary of a U.S. has a pre- distribution network, the foreign (non-EEA) deposit existing relationship with a customer, the German institution is subject to the license requirement. subsidiary may not transfer this client to its U.S. parent. Money transmission services. Foreign institutions Generally, these standards also apply to the underwriting frequently open correspondent accounts with German of loans by lending syndicates. In practice, however, the credit institutions in order to process money transfers establishment of a syndicate is often based on a so-called with German customers through these accounts. “beauty contest” initiated by the borrower during which German transferors and transferees are able to place or several banks compete for the mandate with proposals receive payments by using such domestic accounts. tailor-made for the borrower. A syndicate is generally From the participants’ point of view, it makes no formed only after the borrower has further specified its difference whether the account transactions are initiated conditions. According to the Circular, such a procedure from Germany or from abroad. Thus, in the Circular the does not require a license. BaFin expressed the view that the opening of a In this context it is important to note that purchasing loans correspondence or interbank account for the purpose of is not a banking or financial activity but rather is transacting money transmission services with German considered an activity of a so-called financial enterprise customers triggers the license requirement. (Finanzunternehmen). A company engaging in such kind Visits to potential customers. Any foreign institution of activity is in general not obliged to obtain a banking which acquires new customers in Germany for license. Thus, a foreign company may acquire loans from banking and/or financial services by visiting potential a German bank without being licensed. However, if the customers is required to obtain a banking license. German bank sets up a , the customers uses Only if the customer requested such visit, as is often only a part of the credit and the German bank then sells the case with institutional investors, is the license the loan to a foreign institution, this foreign institution requirement not triggered. In the latter case the might be required to obtain a banking license. According foreign institution may rely on the unsolicited to the BaFin, only if the foreign institution does not have transaction exemption. any discretion with regard to honoring the draw will the license requirement not apply. Mail, Fax/E-mail. Where a foreign institution approaches potential customers in Germany directly Underwriting. In case of a securities underwriting by mail, fax or e-mail, offering them banking and/or agreement, the question is how the agreement was financial services, a banking license is required. Only concluded. If the foreign institution had previously targeted the German market for the purpose of offering 4 However, the German broker needs a license according to its services in Germany, the license requirement is § 1(1a)(no. 5) of the German Banking Act. 3 if such foreign institution continues to provide its In this context it should be noted that a disclaimer is only existing customers with information about its one of many different indicators. Further evidence of products in connection with an already existing whether an internet offer is targeting German residents business relationship, may such institution rely on the is, e.g., the domain name, language, product description, unsolicited transaction exemption. Furthermore, the financial or other country-specific customer information, unsolicited transaction exemption applies if the legal conditions, price information and methods of customer approaches the foreign institution on its own payment as well as the naming of German contacts. In initiative. It is advisable to document that the particular, the fact that the banking and/or financial transaction was based on the customers’ initiative. services offered are actually being sold to customers domiciled in Germany is viewed by the BaFin as an Distribution through licensed institutions. If a foreign indication that the products are being offered specifically institution acquires new customers by utilizing a to the German market. This seems to make it German institution as a distribution network, the impossible to sell banking and/or financial services to foreign institution is required to obtain a license for the German customers via the internet without a German banking and/or financial services offered to German banking license. customers. This is even the case if the German institution has a license to engage itself in the activity. Advertising. In order to determine whether a banking license is required for advertisement, the BaFin looks at For instance, where a German institution advises its the content of the advertisement rather than on its nature clients regarding its products but the client wishes to or circulation. Advertisements that contain statements obtain a special product or financial service (e.g., about a specific service should no longer be placed Mezzanine-Finance) that is only offered by a foreign without a license to conduct such business. Only entity (e.g., by the institution’s subsidiary located in advertisements of a general nature are permitted without the United States), the foreign entity is required to a license. For instance, a general advertisement obtain a banking license in order to provide such regarding an institution, which, e.g., merely advertises a financial service. However, if in such a case the name or improves a brand image, does not target the German institution not only mentions its foreign German market for the purpose of offering specific subsidiary but also competitors who could provide the banking and financial services. However, where an service, the license requirement would not apply. The advertisement relates to the conclusion of contracts BaFin is of the view that in the latter case there is no concerning specific products or names specific services solicitation by the foreign entity. offered by the foreign institution, e.g., “XY Bank—top According to the BaFin, the “solicitation test” is conditions for deposits”, a banking license is required. already met if the contractual obligations (e.g., master It is not always possible to make a clear-cut distinction or cooperation agreements) or the actual conduct of the in individual cases. However, the foreign institution business relationship between the foreign institution often follows up the advertising campaign by taking and the domestic institution (e.g., banks, portfolio further steps to actually provide the advertised services managers, or brokers) indicate that the foreign to potential customers who have been solicited institution uses the German institution as a distribution by the advertising. The BaFin takes all the facts and network. In particular, this is the case if a commission circumstances into account when determining whether is paid for the solicitation of customers, or the banking the customers approached the foreign entity on their and/or financial services of the foreign institution are own initiative, i.e., whether the transaction is covered offered to the customers. by the unsolicited transaction exemption. Internet offers. With regard to offers of banking and/or financial services via the internet, the test is License Requirement whether the services offered are focused on the German market. If an entity specifically targets the In general, according to the Circular, foreign German market by providing special information or institutions now are required to obtain a license in order by actively conducting advertising through the to offer on a cross-border basis banking or financial internet for the purpose of offering its banking and/or services to customers in Germany where they cannot financial services to German residents, a banking rely on the unsolicited transaction exemption. license is required. The focus of a website is not to be The license referred to in the Circular is the regular determined on the basis of its technical accessibility banking license pursuant to § 32 of the German Banking but on the basis of the website’s content or the online Act. It should be noted that a banking license can be activities in light of all facts and circumstances. applied for selected banking and financial services. 4

Non-EEA institutions that intend to offer banking and financial services institutions, including investment financial services products in Germany have to establish companies, insurance companies as well as certain a German subsidiary or branch in order to obtain the major corporations. Exemptions may also be granted license required. It should be noted that such subsidiary where a foreign entity is a member of a group of an or branch then may outsource certain activities to its institution licensed in Germany. In particular, an foreign parent. On the basis of an agency contract exemption may be granted where a German licensed concluded with the German subsidiary or branch, the institution transfers customers to its foreign banking products may therefore continue to be provided parent/subsidiary/affiliate. However, an exemption by the foreign parent, which conducts the business for will only be granted if the entity is effectively the customer in the name of and for the account of the supervised in its home country by the competent German subsidiary or branch. However, in case of a authority according to international standards, and the German branch or subsidiary, the transaction conducted competent authority of the home state cooperates with under the license must be booked at the German entity the BaFin. Furthermore, the applicant must submit a and the accounts and portfolios opened in connection certificate from the authority of the home country with the business must be held by such entity. which confirms that the foreign institution has a license Moreover, the German subsidiary or branch may not be in its home country, that the intended cross-border a mere “shell” company. activities do not raise any supervisory concerns and that any future concerns will be reported to the BaFin. Exemptions from the License Moreover, the foreign institution must nominate an Requirement authorized agent for service of process in Germany. Pursuant to § 2(4) of the German Banking Act, foreign Legal Consequences of Acting without a entities may be eligible for exemptions from the license Required License requirement.5 An exemption may be granted by the BaFin on a case-by-case review if “the enterprise does According to § 54(1)(no. 2) of the German Banking not require supervision, given the nature of the Act, a person who is conducting a banking or business it conducts”. Such an exemption from the financial service business without a license may be license requirement can only be considered for limited punished with imprisonment up to three years or with business operations and in principle is only granted to a fine. In case of a company, the responsible officer entities that the BaFin can assume will not require may be punished. Moreover, according to § 37(1) of additional supervision in Germany due to the effective the German Banking Act, the BaFin may order the supervision in their home country. Foreign institutions immediate discontinuation of the business as well as may be exempted for transactions involving interbank its liquidation. In addition, it may publish its business and transactions with institutional investors intervention against such types of business. The such as the German federal government, the states, purpose behind this is to prevent potential customers local authorities and their institutions, credit and and business partners from concluding further business with the foreign institution concerned. 5 Any exemption granted by the BaFin is subject to fees, which amount to approximately € 5000.

This memorandum is intended only as a general discussion of these issues. It should not be regarded as legal advice. We would be pleased to provide additional details or advice about specific situations if desired. For more information on the topics covered in this issue, please contact:

Dr. Michael Gruson Dr. Rainer Schmitz New York Frankfurt (+1 212) 848 8060 (+49 (0) 69) 9711 1687 [email protected] [email protected]

www.shearman.com

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