Liability and enforcement
Territorial scope of regulations
What is the territorial scope of the laws and regulations governing listed, cleared and uncleared equity derivatives transactions?
The laws and regulations governing listed, cleared and uncleared equity derivatives transactions do not have a uniform territorial scope. Whether the relevant German or European legislation applies to cross-border transactions in which non-German or non-EU parties participate hinges on criteria differing depending on the legislative objective of the relevant law. For example, financial licence requirements under the Banking Act apply if the provider of the financial services is providing the services through a physical presence in Germany or – even in the absence of a place of business in Germany – targets the German market to offer its services repeatedly and on a commercial basis to companies or persons having their registered office or ordinary residence in Germany. Licence requirements for proprietary trading activities generally also apply if the trading activities are conducted as a participant of a regulated market or a multilateral trading facility or via direct electronic access to a trading venue. In contrast, the Short Selling Regulation applies irrespective of where and by whom the relevant financial instrument is traded, to all financial instruments admitted to trading on a trading venue in the EU. Some legislation (eg, Regulation (EU) 648/2012 on OTC derivatives, central counterparties and trade repositories (EMIR)) addresses the direct, substantial and foreseeable effect in the EU or whether the purpose of the transaction is aimed at evading the obligations under EMIR.
Registration and authorisation requirements
What registration or authorisation requirements apply to market participants that deal or invest in equity derivatives, and what are the implications of registration?
Market participants may require a banking or financial services licence or a ‘European passport’ based on a licence held in another EU/EEA member state, depending on their activities in the equities derivatives market. If a licence has been obtained in Germany, the relevant entity would be subject to ongoing supervision by the Federal Financial Supervisory Authority (BaFin). Where the European passport is used, for mere cross-border services the relevant entity would be mainly supervised by the competent authority of its home member state, but certain German regulatory requirements may still apply.
What reporting requirements apply to market participants that deal or invest in equity derivatives?
The issuer is subject to the reporting obligations applying to share buy-backs if derivatives are used for a share buy-back. In addition, parties to the derivatives transaction may be subject to reporting obligations concerning voting rights notifications and related instruments. This depends very much on the precise structure of the transaction. Any party that holds 3 per cent, 5 per cent, 10 per cent, 15 per cent, 20 per cent, 25 per cent, 30 per cent, 50 per cent or 75 per cent of voting rights of an issuer whose shares are traded on a regulated market must notify this fact. The same thresholds, with the exception of 3 per cent, apply to any party that holds financial instruments in relation to such shares. Even financial instruments without physical settlement will often be covered by this regime.
Counterparties to equity derivatives transactions are subject to the EMIR trade reporting requirements and counterparties to securities financing transactions are obligated under SFTR to report details to every conclusion, modification and termination of recognised securities financing transactions within the working day following the respective event.
Furthermore, investment firms are subject to the transaction reporting requirements under Regulation (EU) No. 600/2014 (MiFIR) and both financial counterparties and non-financial counterparties must comply with the reporting requirements relating to OTC derivative transactions under article 9(1) EMIR.
Since the Sustainable Finance Disclosure Regulation (Regulation (EU) No. 2019/2088, SFDR)) entered into force in March 2021, financial market participants and financial advisers are subject to certain disclosure and reporting requirements relating to sustainability factors and considerations. The SFDR aims to provide a harmonised framework regarding transparency in relation to sustainability risks, the consideration of adverse sustainability impacts in investment processes and the provision of sustainability-related information with respect to financial products.
What legal issues arise in the design and issuance of structured products linked to an unaffiliated third party’s shares or to a basket or index of third-party shares? What additional disclosure and other legal issues arise if the structured product is linked to a proprietary index?
There are no specific legal requirements that apply to this type of product except for the requirements for packaged retail and insurance-based investment products, which in particular include the obligation to prepare a key information document (as set out below).
However, the general regulatory requirements are to be considered. The sale of structured products in Germany, even if sold by the issuer itself, may constitute a licensable activity under the Banking Act or the Investment Firms Act (from June 2021). Further, any public offer of such products or any listing on a regulated market would require that a prospectus be drawn up and approved by BaFin (or notified by another EU/EEA competent authority to BaFin under the European Passport) and such prospectus must, among other things, include disclosure of various information in respect of the underlying and its weighting in the basket, or in respect of any underlying index (including as to whether the index constitutes a benchmark under Regulation (EU) 2016/1011 of 8 June 2016 on indices used as benchmarks in financial instruments and financial contracts or to measure the performance of investment funds and amending Directives 2008/48/EC and 2014/17/EU and Regulation (EU) 596/2014 (the Benchmark Regulation)).
In the case of index-linked products, the issuer may be regarded as an administrator or user of an index depending on whether the index is a proprietary index or provided by a third party. In both cases, additional regulatory requirements under the Benchmark Regulation are triggered, which, in case of the administrator (including third-country administrators whose indices are used in the EU), involves a rather onerous application requirement for authorisation.
Further, the product governance rules of Directive 2014/65/EU (MiFID II), as implemented into the German Securities Trading Act, are to be complied with by a manufacturer and distributor of the structured product (such as the definition of a target market).
Moreover, in case of equity derivative products to be sold to retail investors, product manufacturers need to produce a short disclosure document, the favour ‘key information document’, based on Regulation (EU) No. 1286/2014 of the European Parliament and of the Council on key information documents for packaged retail and insurance-based investment products.
Describe the liability regime related to the issuance of structured products.
The applicable liability regime depends on the type of structured product and in particular whether it is issued in the form of a structured security or not.
The general liability regime may apply in respect of the structured product (ie, an error of the product or the covenants or representations provided by the issuer of the relevant product). This regime is based on the principles related to breach of contract.
A further liability regime exists in respect of wrong or insufficient disclosure as regards the underlying risk or the mechanism of the relevant structured product. This favoured ‘prospectus liability’ may be established on the basis of section 8 et seq of the Securities Prospectus Act (WpPG), if a prospectus under the EU Prospectus Regulation has been drawn up. A similar regime (though typically less relevant for market standard structured products) applies to instruments that are not securities in terms of the EU Prospectus Regulation but for which a prospectus needs to be drawn up under the Investment Code (KAGB). If a relevant disclosure, information or marketing document has not been drawn up under any of these two regimes, an issuer may still be liable for any information provided to investors under the prospectus liability regime established by case law.
Finally, detailed and extensive case law exists in relation to the misselling of structured products in Germany. Sellers of structured products need to comply with the principles established by courts in respect of providing appropriate financial advice to investors.
What registration, disclosure, tax and other legal issues arise when an issuer sells a security that is convertible for shares of the same issuer?
A company requires shareholder approval or authorisation for issuing convertible instruments. Convertibles are treated as a form of securitised equity derivative and are financial instruments for the purposes of MiFID II, the Securities Trading Act, the Banking Act and the Investment Firms Act (from June 2021). As convertible bonds typically are tradable securities, any public offer or listing on a regulated market is subject to the European Prospectus Regulation.
Depending on the details of the documentation, a convertible may be regarded as a financial instrument that needs to be disclosed under the rules described in ‘Reporting obligations’. This depends very much on the precise structure of the transaction. Any party that holds 3 per cent, 5 per cent, 10 per cent, 15 per cent, 20 per cent, 25 per cent, 30 per cent, 50 per cent or 75 per cent of voting rights of an issuer whose shares are traded on a regulated market has to notify this fact. The same thresholds, with the exception of 3 per cent, apply to any party that holds financial instruments in relation to such shares. Even financial instruments without physical settlement will often be covered by this regime. Further, reporting requirements may be triggered under the rules of an exchange where the shares are listed, as well as under MiFIR if the underlying shares are traded on a trading venue, and the issuer or shareholder is a MiFIR investment firm. Moreover, MAR rules on the disclosure of inside information or safe harbour requirements may require adequate publication or reporting by the issuer. Finally, the trade reporting obligations under MiFID/MiFIR may apply.
What registration, disclosure, tax and other legal issues arise when an issuer sells a security that is exchangeable for shares of a third party? Does it matter whether the third party is an affiliate of the issuer?
Exchangeable bonds are regarded as equity derivatives or securities, depending on the scope of the relevant regulations, and no specific rules apply in that respect. They are financial instruments for purposes of MiFID II, the Securities Trading Act, the Banking Act and the Investment Firms Act (as from June 2021). Depending on the details of the documentation, an exchangeable bond may be regarded as a financial instrument that needs to be disclosed, or a relevant trade in such financial instrument may need to be reported, in accordance with the Securities Trading Act, MiFID/MiFIR, and MAR. As exchangeable bonds typically are tradable securities, any public offer or listing on a regulated market is subject to the European Prospectus Regulation.
If the third party is an affiliate of the issuer, the issuer may require shareholder approval or authorisation.
Law stated date
Give the date on which the information above is accurate.
27 April 2020
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