In a global economy it is essential that each country establish a transparent and efficient regulatory system for financial products. To ensure market stability, governments must also instil a high degree of confidence in the legal system. In relation to over-the-counter derivatives transactions, these goals have not yet been fully achieved in Germany. But with the forthcoming Fourth Financial Markets Enhancement Act (4.Finanzmarktförderungsgesetz) there might be light at the end of the tunnel. In this context, it makes sense to look at a much-needed change in the legal regulation of the so-called Börsentermingeschäfte.
ENFORCEABILITY
Generally, a party to a derivatives contract under German law could attempt to challenge the validity of the agreement by raising a statutory defense: the gaming or betting defense (sec. 762 of the Civil Code, Bürgerliches Gesetzbuch), the margin defense (sec. 764 of the Civil Code), or the futures defense (sec. 52 of the Exchange Act, Börsengesetz). However, there are two ways to possibly avoid the threat of such defenses: (i) the contract in question could qualify as a hedging transaction, or (ii) as a so-called exchange-traded futures agreement (Börsentermingeschäft).
HEDGING
Under the hedging exception, a derivatives transaction is valid, enforceable, and not subject to the gaming, betting or margin defense either if it constitutes a hedge for both parties or if the transaction is a hedge for one party and if this party believes, without negligence, that the transaction constitutes a hedge for the other party as well. The term hedge in this context covers micro-hedging strategies. Whether this exception is also true with respect to macro-hedging strategies is not entirely clear. Modern legal authors tend not to use the term "hedging exception" anymore, but more broadly refer to economically justified transactions.
BÖRSENTERMINGESCHÄFTE
According to the Exchange Act (sec. 53 para. 1) Börsentermingeschäfte are binding on both parties if each party is a merchant, and is either registered or not subject to registration because he/it is a foreign resident or a public law entity, or a professional (defined as a person who, at the time of the transaction or prior thereto, traded in futures commercially or professionally, or is permanently admitted to engage in exchange-trading).
If only one party qualifies under the relevant provision of the Exchange Act, a futures transaction is enforceable only if one party is subject to statutory banking or exchange supervision, be it in Germany or abroad, and informs the other party in writing of the risks inherent in the derivatives transactions in question (standardized information papers which, pursuant to German Supreme Court (Bundesgerichtshof) case law, satisfy the requirements under the Exchange Act and were created by the industry federations of the German banks). This technique of entering a valid agreement is commonly referred to as the "information model" and is subject to strict and ongoing form requirements.
In addition, the transaction in question must qualify as a Börsentermingeschäft. Unfortunately, this term has never been statutorily defined, but is intended to cover new types of transactions and has, thus, to be interpreted in a broad sense. Moreover, the Exchange Act was amended in 1989 to extend the privilege of its sec. 53 to transactions with a similar financial purpose as exchange-traded futures transactions. Therefore, today most types of financial, commodity, energy and credit derivatives, whether stock exchange traded or OTC products, are generally eligible for falling under sec. 53 of the Exchange Act. Despite the vast amount of case law (almost exclusively in the context of warrants) on this matter, there is still some uncertainty as to whether certain OTC derivatives qualify as Börsentermingeschäfte within the meaning of this provision.
RELIEF: THE FOURTH FINANCIAL MARKETS ENHANCEMENT ACT
It is, however, widely expectedor at least hoped--that the forthcoming Fourth Financial Markets Enhancement Act will include the introduction of a statutory definition of Börsentermingeschäfte.
A legislative initiative to define Börsentermingeschäfte in concrete terms would be helpful, not least because the German Supreme Court seems in its more recent judgments to have entirely given up the attempt to bring such transactions within its own traditional definition attempts and now lays emphasis only on the financial purpose necessary for qualification as a Börsentermingeschäft.
The term also requires clarification in light of recent amendments to the Securities Trading Act (Wertpapierhandelsgesetz) and the Banking Act (Kreditwesengesetz), implementing into German law the EC Investment Services Directive (ISD) and the EC Capital Adequacy Directive (CAD), which introduced the distinguishable supervisory law term "derivative," narrowly defined, into the two acts.
The term "Börsentermingeschäft" is not used internationally--it is specific to Germany. Its conceptual scope is controversial, and the continuous development of new types of transactions requires a provision which is as comprehensive as possible. For this reason, it makes sense to find a legal definition which includes existing derivatives and can accommodate new developments.
Moreover, the essential point of a derivative is the dependence of its price upon the development of its underlying(s). Securities, money-market instruments, currencies, units of account, interest rates or other yields as well as commodities, power, and precious metals may all be assets underlying derivatives transactions as defined in, for example, the Securities Trading Act and the Banking Act. In addition, the inclusion of other underlyings such as credit events, weather developments, traffic flows and environmental emissions would be desirable in order to ensure that here too validity defenses are essentially eliminated.
A broad definition of a Börsentermingeschäft would remedy the existing lack of public confidence in the lawespecially with regard to future developmentsand thus would enhance the status of Finanzplatz Deutschland. The German banking associations and the International Swaps and Derivatives Association should be supported by all market participants in their attempts to convince the German legislator to make a broad definition of Börsentermingeschäft a reality as soon as possible.
This week's Learning Curve was written by Peter Scherer,partner, and Gregor P. Ordon. associate at Clifford Chance Pünderin Frankfurt.
