To allow certain third-country firms to continue proprietary business (Eigengeschäft) without requiring a licence in Germany, the German legislator has introduced an additional licensing exemption, which came into effect on 26 March 2020.
Section 32(1a), sentence 3, no.4 of the German Banking Act (KWG) exempts 'proprietary business as a member of an exchange or participant in a trading venue that is conducted by a company domiciled in a third country' from having to acquire a licence to conduct proprietary business (the 'proprietary business exemption' or PBE). The PBE does not transpose Directive 2014/65/EU (MiFID II) or other EU-requirements but is an independent German legislative measure.
The PBE adds another layer of complexity to an already opaque dealing-on-own-account regime in Germany.
The differences between proprietary trading and proprietary business
Unlike MiFID II, the KWG distinguishes between two types of dealing on own account: proprietary trading (Eigenhandel) and proprietary business (Eigengeschäft).
Proprietary trading is generally where a firm is dealing on own account with financial instruments as a service for others, including market-making, systematic internalisation and in case of high-frequency trading. Proprietary business, on the other hand, is defined as the ‘purchase and sale of financial instruments for own account which does not constitute proprietary trading’. Proprietary trading and proprietary business are, therefore, mutually exclusive.
The PBE only applies to proprietary business. It therefore does not help firms conducting proprietary trading in Germany.
Licensing requirements for proprietary business
Proprietary business may be licensable under certain circumstances, particularly if it is carried out:
- as a member of or participant in an organised market or multilateral trading facility;
- via a direct electronic access (DEA); or
- in relation to commodity derivatives, emission allowances or derivates thereof.
The PBE widens the scope of licensing exemptions for proprietary business as set out in section 32(1a) sentence 3 of the KWG. Before the PBE came into effect, this part of the KWG already provided for several exemptions to the licensing requirement for proprietary business for hedging purposes or in relation to commodity futures, emission allowances and derivatives thereof.
The PBE can be relied upon until the European Commission has deemed the legal and supervisory regime of the third country in which the undertaking is domiciled as equivalent pursuant article 47 of Regulation (EU) No.600/2014 (MiFIR) and the undertaking has subsequently applied with the European Securities and Market Authority (ESMA) to be entered in ESMA’s register of third-country firms that are allowed to provide investment services or perform investment activities in the EU (article 46 MiFIR) and ESMA has decided on that application.
The PBE only applies to proprietary business via stock exchanges or trading venues. Consequently, the PBE does not apply to any proprietary business with OTC-commodity derivatives, emission allowances or derivates thereof.
The PBE also does not apply to trading via DEA. Therefore, proprietary business with regard to these methods or investments in Germany may continue to qualify as a licensable activity for third-country firms.
The German legislator justifies this distinction by the fact that members and participants of an organised market and multilateral trading facilities are subject to admissions procedures and trading rules, and so are indirectly supervised by the competent authorities.
According to the explanatory memorandum, direct supervision of these undertakings by Germany’s Federal Financial Supervisory Authority (BaFin) is, therefore, not necessary.
Unresolved issues and impact on Brexit preparations
The German proprietary-trading and -business regime has become increasingly complex over the last 10 years – partially driven by the implementation of MiFID II and further legislative initiatives in Germany (such as the German bank separation rules). The maze of licensing requirements and exemptions with regard to proprietary trading and proprietary business is proving to be a challenge for many banks.
The introduction of a new exemption from the licensing requirement, while well intentioned and useful for banks, further adds to the complexity. In particular, the relationship between the PBE and the different circumstances under which a licensing requirement may arise in the first place are unclear.
The PBE may provide a valuable tool for a UK firm when considering how to conduct proprietary business in Germany after the Brexit transition period ends on 31 December 2020. While the exemption is not limited to UK firms, its significance may increase considerably if, on 1 January 2021, the UK becomes a ‘third country’ under the KWG.
Where relevant, UK firms should, therefore, incorporate this exemption into their Brexit preparations. Firms that are domiciled in other third countries that carry out proprietary business may also review their regulatory position under the KWG, in particular whether they benefit from the new PBE.