In review: digital markets, funding and payment services in Germany

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Overview

The fintech market in general has demonstrated a remarkable resilience against the challenges caused by the covid-19 pandemic. Agile service providers offering reliable and innovative digital solutions for the financial sector may even be considered as beneficiaries of the crisis. This holds particularly true for solutions for cashless payments or ‘neo-brokering’ (i.e., online brokerage services at low or even nil execution costs).

As a matter of general tendency, the fintech market in Germany has already become relatively consolidated and mature and its influence on the financial sector has been rather revolutionary in nature.2 Although a ‘winner-takes-all’ phenomenon has been observed (attributed to increased competition and high acquisition costs), fintechs are still expected to benefit from new business opportunities.3 It might also be perceived as an indication of a matured market that fintech companies have increasingly been integrated by banks and financial institutions into their value chains.4

These developments, however, do not mean that the German fintech market has become stagnant. The opposite is true. According to a study, in 2021 there were 639 active fintech companies in Germany, out of which 55 per cent were under five years old.5 The highest proportion of young start-ups was identified in the risk and compliance (96 per cent) and decentralised finance (DeFi) (72 per cent) segments.6 As far as financing and capital access for young fintech companies is concerned, financing activity in Germany was on the rise in 2021, with the total number of financing transactions increasing by an average of 6 per cent per quarter, with early-stage financings most frequent in the fields of asset management and investment, credit and factoring, as well as DeFi.7 In addition, the German fintech market has seen significant funding for neo-banks and neo-brokers. Other significant fintech segments include banking, application programming interface banking and personal finance management.8 Thus, even though overall start-up activity in Germany has declined in the past three years (by an average of 1 per cent per quarter),9 new fintech companies are being established and further developments can be expected.

Fintech-related topics have been frequently and intensively discussed in Germany, not only by participants in the financial sector but also by politicians and regulatory authorities. In particular, the question of whether the present legal framework gives sufficient leeway for the application of blockchain-based business models while simultaneously providing a sufficient level of protection for market participants has been the subject matter of these discussions. As a result, an EU-wide framework for cryptoassets and an EU-level sandbox model have been proposed by the European Commission as part of the Digital Finance Package.10

In 2020, the German federal legislator introduced statutory provisions according to which crypto values qualify as financial instruments for financial licensing purposes and crypto custody business became subject to a licence requirement under the German Banking Act (KWG). Further, in 2021 the German securities law was fundamentally changed: the introduction of electronic securities implemented one of the key points of the German government’s blockchain strategy.11 With this step, the German legislator is following the path of other European countries towards securities dematerialisation.12

Further, the German Federal Financial Supervisory Authority (BaFin) has published several statements, explanations and opinions13 on topics such as big data, artificial intelligence (AI) and distributed ledger technologies (DLTs), as well as digitalisation and information security.14 The recent statutory rules on crypto values and the crypto custody business, as well as on blockchain-based dematerialised securities, also indicate that the legislator has realised the need to provide legal certainty for innovative business models and services.

Generally, the German legislator and BaFin apply the technology-neutral principle of ‘same business, same risk, same regulation’.15 This is illustrated by the fact that neither the legislator nor BaFin has promulgated rules that privilege fintech companies compared to traditional players in the financial sector. Therefore, a ‘sandbox’ model that establishes an innovation space where fintech companies may test business models without tight regulation as established in the United Kingdom and in Switzerland has not been introduced in Germany yet.

Hence, BaFin attempts to find a balance between supervisory concerns and the start-up culture that often exists within the fintech sector. As part of its efforts in this regard, BaFin provides fintech companies with information concerning supervisory issues on its website.

There is no special public funding instrument for fintech companies, but the German Ministry of Economics has set up the programme ‘INVEST’ to help start-ups raise venture capital. If business angels purchase shares of newly founded innovative companies and hold them for more than three years, 20 per cent of their original investment will be reimbursed by the state up to a limit of €100,000.16 To qualify for the programme, investors have to spend at least €10,000. Invested capital must not result from a third-party loan to the investor. Furthermore, the business angel has to participate in the new company’s gains and losses. Investors must be natural persons living in the European Economic Area (EEA) or must use special investment companies registered in Germany (e.g., the limited liability company, GmbH).

Generally speaking, German regulatory authorities and the government emphasise that they recognise the potential of fintech for public economic benefit, while the regulation partly still seems rather conservative when the traditional regulatory standards, which stem from the pre-digitalisation era, are applied (although the efforts of BaFin to support fintech companies by offering detailed legal information and by improving the communication channels, as well as recent legislative changes concerning the regulatory requirements for cryptoasset-related services, are evident). The current dynamics in the field of regulating digital finance, blockchain and cryptoassets, both at the EU and a national level, indicates that the legal framework relevant for fintech companies has gained material momentum and may be expected to further evolve quite fast.

The potential of digitalisation has not only been recognised by the participants in the financial industry, but also by central regulators for the purposes of the monetary system. In particular, the Governing Council of the European Central Bank (ECB) has decided to work on the development of a digital euro, which would be an electronic form of a legal tender, introduced for the use by natural persons and firms alongside cash.17 In July 2021, the Governing Council of the ECB decided to launch the investigation phase of the digital euro project, which started in October 2021 and will last two years. It remains to be seen what the outcome of the investigation phase will be and whether the path towards a digital euro will be pursued.18

Regulation

i Licensing and marketing

The general rules apply to licensing and marketing of fintech companies in Germany. Because there is no specific fintech licence available in Germany, the regulation of fintech companies depends ultimately on the business they carry out. This again results from the technology-neutral ‘same business, same risk, same rules’ approach. The entire array of licences and marketing restrictions may therefore become relevant for fintech business models.

In particular, the following types of licences have to be taken into account:

  1. licence pursuant to Section 32(1) of the Banking Act (KWG) for providing banking businesses within the meaning of Section 1(1), sentence 2 of the KWG;
  2. licence pursuant to Section 15(1) of the recently introduced Securities Institutions Act (WpIG) implementing Directive (EU) 2019/2034 on the prudential supervision of investment firms or pursuant to Section 32(1) of the KWG for providing financial services within the meaning of Section 2(2) of the WpIG and Section 1(1a), sentence 2 of the KWG (including, since 1 January 2020, the crypto custody business within the meaning of Section 1(1a), sentence 2, No. 6 of the KWG, which is of particular relevance for fintech companies);
  3. licence pursuant to Section 10(1) of the Payment Services Supervisory Act (ZAG) for providing payment services or pursuant to Section 11 of the ZAG for the issuance of e-money;
  4. licence pursuant to Section 20(1) of the Capital Investment Code (KAGB) or, less burdensome, the mere registration pursuant to Section 44(1) of the KAGB for offering collective asset/funds management;
  5. licence pursuant to Sections 34c, 34d and 34f of the Industrial Code (GewO) for the brokerage of loans, insurance contracts and certain financial products; and
  6. licence pursuant to Section 8(1) of the Insurance Supervisory Act for conducting insurance business.

In addition, the EU-wide Regulation (EU) 2020/1503 on European crowdfunding service providers for business (ECSPR) has applied since November 2021; this requires crowdfunding services providers to obtain authorisation from the national supervisory authority (in Germany, BaFin).

Under German law, a licence requirement is generally triggered if one intends to provide, in Germany, commercially, or on a scale that requires commercially, organised business undertaking one of the services listed in the comprehensive catalogues of regulated activities referred to above. Consequently, it needs to be carefully analysed whether a fintech…



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