New Supervisory Board Rules in Act Strengthening Financial Market Integrity (FISG)

At its meeting on 20 May 2021, the German Bundestag adopted the federal government’s bill on strengthening financial market integrity (Finanzmarktintegritätsstärkungsgesetz – FISG) (Bundestag document 19/26966, in German language) based on the recommendation for a decision and the report of the Finance Committee (Bundestag document 19/29879, in German language). The German Bundesrat approved the Act on 28 May 2021. A consolidated version can be found here (in German language).

Regulatory objectives of the FISG at a glance

There has recently been financial market turbulence due to accounting manipulation and poor accounting control, causing a loss of confidence in the German financial market. Properly functional financial markets are central to the German economy and prosperity in the Federal Republic and the European Union. The objective of the FISG is therefore to restore and strengthen confidence in the German financial market long term.

Alongside reforming the accounting control process, auditing and extending the powers of the Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht – BaFin), the Bundestag has also adopted changes to the corporate governance of listed companies, affecting both the management and the supervisory bodies of companies.

The board of directors of the listed company will henceforth be required to set up an internal control and risk management system that is appropriate and effective given the scope of the business activity and the risk situation of the company (section 91(3) of the Stock Corporation Bill). This requirement will apply from 1 January 2022.

Focus on supervisory board governance

In addition, the changes brought about by the FISG to the Stock Corporation Act and SE Implementing Act impose yet more obligations on the supervisory bodies of public-interest entities. At the same time, supervisory boards are also given new powers. The aim is to further professionalise and reinforce the work of supervisory boards, since strong internal corporate supervisory bodies are essential for good corporate governance.

• In future, the necessary expertise on the supervisory board of capital market-focussed companies will have to be split between two members of the supervisory board.
• The supervisory board must also monitor the quality of the year-end audit.
• Public-interest entities must set up an audit committee, and members of the audit committee have the right to obtain information directly from senior staff. Attendance by the board of directors at meetings of the supervisory board and its committees is also regulated.

This article gives an overview of the new legal provisions for the supervisory board and their initial applicability.

Entities concerned

The amendments apply both to the supervisory board of a public limited company (AG) and of a partnership limited by shares (KGaA), the supervisory board of a two-tier European company (Societas Europaea, SE) and to the administrative board of the one-tier SE.

While the board of directors’ obligation to set up an internal control and risk management system applies only to listed companies, the new legal provisions on the supervisory board apply to public-interest enterprises, in other words to:

• Capital market-focussed companies (section 264d German Commercial Code),
• CRR credit institutions (section 1(3d) sentence 1 German Banking Act), with the exception of those referred to in section 2(1)(1) and (2) German Banking Act and Article 2(5)(5) of Directive 2013/36/EU, and
• Insurance undertakings (Article 2(1) of Directive 91/674/EEC).

Two financial experts required on supervisory board

With the new version of section 100(5) of the German Stock Corporation Act, the FISG promotes and requires progress in the professionalisation of the supervisory board: there are extended personal requirements for membership of the supervisory board. It is no longer enough to have only one member of the supervisory board with expertise in financial reporting or auditing. Instead, in future:

• At least one member of the supervisory board has to have expertise in financial reporting; and
• At least one other member of the supervisory board has to have auditing expertise

Apart from that, the requirement of familiarity with the industry remains unchanged.

In this context, however, the legislature does not attach any new or higher expectations to the concept of expertise:

• As has been the case to date, it is not necessary for the expert members of the supervisory board to be members of an accounting or tax advisory profession. The expertise can also be acquired through appropriate training. Former or current financial directors, as well as longstanding members of audit committees, accounting and financial planning specialists, and analysts or works council members who have trained in the relevant areas due to their work have the necessary technical expertise. The expertise must be maintained on a permanent basis via appropriate training.
• In practice, due to the similarity of the subject matter in both areas, it is not unusual for members of the supervisory board to have expert qualifications in both areas.

It is true that an election decision by the general meeting which fails to comply with the requirements of section 100(5) of the German Stock Corporation Act is not invalid. However, a general meeting decision which results in the composition of the supervisory board not complying with section 100(5) of the German Stock Corporation Act may be challenged.

Audit committee will be compulsory

Until now, setting up an audit committee has been voluntary under the German Stock Corporation Act. However, D.3 of the German Corporate Governance Code (DCGK) already recommends setting up an audit committee, which is why in practice this is an established standard for listed companies. Where such an audit committee had already been set up, at least one member of the audit committee was required to have expertise in the area of financial reporting or auditing.

The revised version of section 107(4) of the Stock Corporation Bill requires the supervisory board of a public-interest entity to set up an audit committee. Setting up an audit committee is intended to ensure the effectiveness and efficiency of the work of the supervisory board. It is clarified that the supervisory board, provided that it consists only of the statutory minimum of three members, is also the audit committee.

Requirements for members of the audit committee

In future, at least one member of the audit committee must have expertise in financial reporting and at least one other member of the audit committee needs to have expertise in statutory auditing.

New tasks for the audit committee

The range of the audit committee’s tasks will also be extended. As in the past, the supervisory board may delegate to the audit committee the monitoring of the financial reporting process, of the effectiveness of the internal control system, of the risk management system and of the internal audit system, as well as the statutory year-end audit. In future, the audit committee will, in addition to considering the selection and independence of the statutory auditors and the additional services provided by the statutory auditors, also consider the quality of the statutory audit (section 107(2) sentence 2 Stock Corporation Bill). The aim is to address potential breaches of duty by the statutory auditor at an early stage and to identify possible shortcomings in the statutory audit.

New right to information for audit committee members

In order to facilitate the work of the audit committee, new rights to information are planned for the members of the audit committee:

• Via the committee chairman, any member of the audit committee may in future request information directly from the heads of the central departments of the company which are responsible in the company for the tasks relating to the audit committee (section 107(4) sentences 4 to 6 Stock Corporation Bill). Any member of the audit committee therefore has the right to information.
• To avoid situations in which several members of the audit committee assert their right to information separately from each other and, for example, approach the head of a central department with a request at the same time, the information must be gathered by the chairman of the audit committee. Thus no individual member gains exclusive knowledge, since it is stipulated that the committee chairman must also communicate the information obtained to all members of the audit committee.
• Information is not collected without the board of directors being informed. The company’s board of directors must be informed without delay by the audit committee chairman about the process of obtaining information.

Change to the board of directors’ opportunity to attend meetings of the supervisory board and its committees

Finally, the financial committee’s recommendation for a decision restricted the opportunity for the board of directors to attend meetings of the supervisory board and its committees:

• If the statutory auditor is involved as an expert in meetings of the supervisory board or its committees, the board of directors will generally not attend those meetings of the supervisory board or its committees.
• This principle can only be disregarded if the supervisory board or committee concerned deems it necessary for the board of directors to attend (section 109(1) sentence 3 Stock Corporation Bill).

The aim of this change is to strengthen the confidential communication of the supervisory board or a committee with the statutory auditor if the supervisory board or committee wishes to share information with them as part of the preparation or conduct of the audit.

Deadlines for implementation

The obligation to set up an audit committee and the audit committee members’ right to information as amended by the FISG will be applicable for the first time from 1 January 2022.

The above amendments to section 100(5) Stock Corporation Bill and section 107(4) sentence 3 Stock Corporation Bill (two financial experts on the supervisory board and the audit committee) apply in principle from 1 July 2021. However, they do not need to be applied as long as all the members of the supervisory board and the audit committee were appointed before 1 July 2021. Members of the supervisory board or audit committee who have already been effectively appointed therefore do not need to be replaced if these requirements are not yet fulfilled. The new rules therefore apply to all supervisory board elections from 1 July 2021 and may therefore become relevant to individual companies at very short notice during this general meeting season.