Direct effect doctrine opens Germany to EU firms

The single European passport regime for investment firms is now operating in Germany. Investment firms from member states which have fully implemented both the Investment Services Directive (ISD) and the Capital Adequacy Directive (CAD) are, therefore, free to establish branches in Germany and carry on business without needing to obtain further authorization from competent authorities. In particular, they can now become members of the regulated markets and have access to the national clearance and settlement systems.

The ISD (93/22/EEC) and the CAD (93/6/EEC) had to be implemented in the 15 member states of the EU by December 31 1995. Most of the member states, including Germany, failed to meet the deadline; only the UK, Ireland, Sweden, Belgium and the Netherlands implemented the ISD on time. In February 1996 the European Commission initiated infringement proceedings against Germany, France, Greece and Italy for failure to implement the ISD and CAD. The infringement proceedings against Germany for failure to implement the CAD entered their second phase in September 1996.

In June 1996, the German Federal Ministry of Finance tabled a draft bill for the implementation of several EC Directives, including the ISD and the CAD (the so-called Sixth Amendment to the Banking Laws; see International Financial Law Review, September 1996, page 49). On December 18 1996 a revised draft passed the federal Cabinet. This legislation, however, will not enter into force before August 1 1997.

Meanwhile, the competent German regulators, in particular the Federal Banking Supervisory Office (Bundesaufsichtsamt für das Kreditwesen or BAKred) and the Securities Trading Supervisory Office (Bundesaufsichtsamt für den Wertpapierhandel or BAWe), recognize outwardly-passported investment firms from member states which have fully implemented the ISD and CAD. Thus, passported investment firms can establish branches or provide services across frontiers without being required to obtain further authorization in Germany. However, this administrative practice gives rise to an unequal situation because German companies cannot yet take advantage of the single passport to expand their business.

An investment firm can apply for a passport once it is authorized in the member state in which its head office is situated. The procedure for obtaining a passport is very simple.

To obtain the passport to establish a branch, the investment firm must apply to its competent authority, stating what services it intends to provide in which host member state, outline its proposed programme of operations and provide the names of the persons responsible for the management of the branch. Within three months the competent authority of the home member state must notify the competent authorities of the host member state and inform the investment firm of that notice. After at most two months from the receipt of this information by the host member state regulator, the investment firm will be able to start its passported business in the host member state.

In most countries where the ISD has not yet been implemented, this procedure is not as simple as described here, because there is generally no competent authority with jurisdiction over investment firms in those countries. However, Germany is an exception.

Once the Sixth Amendment to the Banking Laws enters into force, the BAKred and the BAWe will assume jurisdiction over investment firms as competent authorities. However, regardless of Germany's implementation of the ISD, the BAKred and the BAWe already recognize inbound investment firms holding a single passport, provided the home member state has fully implemented the ISD and CAD.

The home member state regulator must report to both authorities simultaneously. The investment firms may then carry on their activities without being required to obtain any further authorization in Germany. In particular, inbound EU investment firms are exempt under the single passport regime from the requirement of obtaining a German banking licence even if their activities would otherwise qualify as banking business under the Banking Act (Kreditwesengesetz). This is important because, of the 'core services' listed in Annex A of the ISD, dealing in securities for clients or executing clients' orders and dealing in securities for own account as a service for third parties (securities business) qualify as banking business.

While domestic firms and branches of foreign (non-EU) investment firms require a banking licence before they can carry on any such business, outwardly-passported EU investment firms consequently do not require such licence if they are authorized for these activities in their home member state.

Under Article 15(1) ISD, the member states must ensure that firms can, either directly or indirectly, become members of or have access to the regulated markets in their host member states. Both the Frankfurt Stock Exchange and the German Forward Exchange acknowledge this obligation and allow branches of outwardly-passported investment firms to become members subject to the same requirements applicable to domestic firms.

While in the past broker/dealers which did not have a banking licence were excluded from participating directly in the domestic clearing and settlement systems (the Kassenvereine), the Deutscher Kassenvereiner AG (DKV) now allows EU investment firms to maintain their own DKV accounts. One of the prerequisites for opening a DKV account is that the company must have access to a settlement account with the relevant state branch of the German Central Bank, the Landeszentralbank. This may be effected either by obtaining a clearing declaration from a clearing member with the DKV or by directly opening a Landeszentralbank account.

Until very recently the Landeszentralbank admitted only credit institutions as account holders. However, following negotiations, the Landeszentralbank of the state of Hesse (whose jurisdiction covers Frankfurt) has adopted a new stance on EU investment firms having a single passport: they now enjoy equal treatment with credit institutions.

Other rules still apply Beyond the scope of prudential supervision by the competent authorities, branches of outwardly-passported investment firms are still subject to all other laws, including the rules of conduct, under which 'in the interest of the general good' they must conduct their business in the host member state. Domestic branches of investment firms engaging in securities business, dealing for their own account or arranging transactions in securities business, or dealing for their own account or arranging transactions in securities or derivatives for customers, qualify as 'securities services companies' under the Securities Trading Act (WpHG). They are therefore required to comply with the following provisions of the WpHG: Reporting requirements under Section 9 WpHG: securities services companies must report to the BAWe every transaction in securities or derivatives which are listed on an organized market in a member state of the EU or EEA, or are included in the OTC market of a domestic stock exchange. Reporting requirements under Section 21 WpHG: shareholders of listed companies must disclose the percentage of their voting rights in an issuer if it reaches, exceeds or falls below certain thresholds due to the acquisition or disposal of securities conferring voting rights. Rules of conduct: securities services companies are subject to certain rules of conduct and requirements as to organization and documents, the concepts of which are broadly similar to the regulations of most EU member states. Insider trading rules: the insider trading rules apply. Other applicable rules include, but are not limited to, money-laundering laws, foreign trade law, reporting requirements on money transfers and the provisions of the German Commercial Code on the registration of the branch with the Commercial Register, on bookkeeping and on reporting.

The new stance adopted by the German regulators is attributable to the fact that the ISD has become directly effective in Germany since the expiry of its implementation deadline on January 1 1996. Under the doctrine of direct effect developed by the European Court of Justice, the provisions of EU Directives will apply, even if not implemented within the prescribed time limit, provided they are unconditional and sufficiently precise (Becker v Finanzamt Münster-Innenstadt, Case 8/81 [1982] ECR 53). If the provisions of a Directive fulfil this test, they become binding on the national courts and the public bodies once the period for implementation has passed. The German regulators have taken the view that the provisions of Articles 14 to 19 inclusive of the ISD, granting freedom of establishment and services, fulfil this test and therefore have direct effect.