Financial reporting enforcement in Germany has been reorganised: from the beginning of 2022, BaFin is solely responsible for examining the financial statements of publicly traded companies. The formerly two-stage process – with the German Financial Reporting Enforcement Panel (FREP ) responsible for stage 1 and BaFin for stage 2 (see info box) – has migrated to a single-stage process following the implementation of the Act to Strengthen Financial Market Integrity (Gesetz zur Stärkung der Finanzmarktintegrität – FISG) as at 1 January. The stated goal is to identify indications of accounting errors, and hence also accounting fraud, as early as possible, and to clarify matters that may be relevant under criminal law together with the public prosecutor's office. BaFin President Mark Branson sees the new financial reporting enforcement mechanism as an important tool for revealing vulnerabilities in accounting: “Financial reporting enforcement is not an end to itself. Rather, it strengthens the integrity of the financial markets and thus also benefits investors.”

Going forward, BaFin will conduct both random sampling examinations and ad hoc examinations and will, among other things, publish information about the errors it has identified. In addition, it can publish examination orders and key steps in the process. In addition, BaFin will soon have additional options for exchanging information, for example with the Auditor Oversight Body (Abschlussprüferaufsichtsstelle). This is associated with additional sovereign powers, such as extended rights to obtain information as well as search and seizure rights. Among other things, BaFin will also be entitled to summon and question the executive managers of companies it has examined and their auditors.

New organisational structure

BaFin has adapted its internal structures and processes to match its new responsibilities and established a new directorate for financial reporting enforcement (Directorate BilKo). Internally, Directorate BilKo has already been active since September 2021. On 1 January 2022, it took over full responsibility for financial reporting enforcement. “BaFin has prepared well for its new tasks”, said Dr Thorsten Pötzsch, Chief Executive Director of Securities Supervision at BaFin.

Its functions also include enforcing the pan-EU European Single Electronic Format for reporting financial reporting information (ESEF). International issues related to enforcement also fall within its remit, in particular in cooperation with the European Securities and Markets Authority (ESMA). And last but not least, Directorate BilKo monitors compliance with financial reporting obligations under the Transparency Directive Implementation Act (Transparenzrichtlinie-Umsetzungsgesetz – TUG), to the extent that responsibility in this regard does not lie with the Federal Office of Justice (Bundesamt für Justiz). The Federal Office of Justice is responsible for the disclosure of annual financial information of all issuers whose registered office is in Germany.

The new Directorate BilKo is divided into four divisions. All divisions are responsible for the core tasks of enforcement, random sampling examinations and ad hoc examinations. The other tasks are assigned to individual divisions. BaFin has done this to ensure that there are as few interfaces as possible, but that all divisions can make consistent decisions.

Figure: New organisational structure

© BaFin

It’s the mix that matters!

To be able to continue to benefit from the expertise of FREP’s employees and to combine this knowledge with the supervisory experience of BaFin staff as best as possible to ensure effective and efficient financial reporting enforcement, legislators gave the FREP staff the option of transferring to BaFin. Because of their expertise, they will work in Directorate BilKo. The FISG therefore also amended the Act Establishing the Federal Financial Supervisory Authority (FinDAG). The new section 18b of the FinDAG governs the transfer of the employment relationships of FREP staff to BaFin. Most of the FREP staff moving to BaFin have additional qualifications as German public auditors or comparable foreign qualifications in the field of accounting. For a transitional period of one year, the former FREP staff will have the option to work from Berlin, their current place of employment. As from 1 January 2023, they will become part of Directorate BilKo at the BaFin location in Frankfurt am Main.

There are plans to further strengthen Directorate BilKo through internal and external recruitment. Overall, it will have around 60 staff, which is about twice as many staff as previously at BaFin and FREP together.

More proactive enforcement

BaFin will start by using the procedure previously used by the FREP for random sampling examinations and will systematically expand it in light of the relevant economic risks. In line with the objective of the FISG, BaFin is making enforcement more proactive and is seeking a high level of interaction with the companies it examines. In future, for example, there will also be more on-site examinations if BaFin considers this to be appropriate from supervisory and risk perspectives. If needed, BaFin will also conduct forensic examinations – as already mentioned above.

Another significant innovation is that BaFin is establishing IT-based market monitoring and implementing mostly automated media analysis. The results of this are expected to help to identify companies that need to be examined, and to be able to define the right areas of emphasis for examinations.

Another key source of information for financial reporting enforcement are tips that it receives and acts on, for example from its contact point for whistleblowers and the Market Contact Group. In August 2021, BaFin reorganised its contact point for whistleblowers as part of the modernisation project. The newly created Market Contact Group is part of the contact point for whistleblowers and receives information from the financial industry.

Finally, BaFin will continue to work preventively in the field of financial reporting enforcement and provide accounting guidance like FREP did in the past. Additionally, Directorate BilKo intends to support financial reporting enforcement by means of active communication with stakeholders on the internet, at events and in other forums.

At present, around 540 publicly traded companies are subject to financial reporting enforcement. The new Directorate BilKo will conduct random sampling examinations and ad hoc examinations. The examination teams will be assembled flexibly and tailored to the specific assignment. In-depth cross-divisional exchange within Directorate BilKo will ensure systematic examinations and consistent administrative practice for identifying errors.

Areas of emphasis for examinations in 2022

Active communication with stakeholders also includes publishing areas of emphasis for examinations for the following year early on. BaFin issued a press release on this topic at the end of November (only available in German). According to the press release, Directorate BilKo will focus on reviewing supply chain financing (reverse factoring) in 2021 consolidated financial statements, as this type of corporate finance is being increasingly used. As a direct consequence of the Wirecard case, it also plans to examine, in justified individual cases, whether reported cash and cash equivalents and other assets are actually available. Moreover, BaFin will focus to a greater extent on understandable, verifiable accounting documents.

In its areas of emphasis, BaFin also follows those set by ESMA. At the end of October, ESMA set the following examination priorities for all European enforcers: impacts of the COVID-19 pandemic, climate-related matters and expected credit loss disclosures.