Germany: Sonderfonds Finanzmarktstabilisierung (SoFFin) Guarantee Scheme

The German government passed a package of crisis response measures, which entered into force on October 18, 2008. The backbone of the package was SoFFin, which was permitted to assume guarantees, inject capital, and temporarily acquire assets (FMStFG 2008).

The Financial Market Stabilization Fund Act (Finanzmarktstabilisierungsfondsgesetz, or FMStFG) established the Financial Market Stabilization Fund (Sonderfonds Finanzmarktstabilisierung, or SoFFin) on October 17, 2008. Section 6 of FMStFG specifically authorized SoFFin to provide guarantees (FMStFG 2008).

On October 27, 2008, the European Commission (EC) ruled that guarantees provided by SoFFin were allowed under Article 87(3)(b) of the EC Treaty, which permits state aid to “remedy a serious disturbance in the economy of a Member State” (European Commission 2008b). Following a number of early amendments to the scheme, most of which concerned the recapitalization scheme, the German government re-notified the EC of the scheme and a new decision was announced on December 12, 2008, which replaced the initial approval. The new decision also permitted the guarantees under Article 87(3)(b) (European Commission 2008c). As discussed in more detail below, the need to structure the Guarantee Scheme in such a way as to ensure EC approval significantly influenced the design of certain program features.

According to FMStFG, the total volume of guarantees SoFFin could provide was capped at €400 billion. This amount was specifically separated from the cap for SoFFin’s recapitalization measures and asset purchases, which was set at €80 billion for both measures combined (FMStFG 2008).

The amount of guarantees that could be issued by SoFFin was temporarily reduced to €300 billion in connection with the reauthorization of the scheme in 2012.

SoFFin could issue up to €100 billion in debt to fund itself.

In addition to establishing SoFFin, FMStFG also established the Federal Agency for Financial Market Stabilization (Bundesanstalt für Finanzmarktstabilisierung, or FMSA) to manage SoFFin. When FMStFG was passed, the FMSA was established as a legally dependent institution in Germany’s central bank, Deutsche Bundesbank. In July 2009, the FMSA became an independent institution under the Federal Ministry of Finance (FMSA n.d.). According to the IMF, the FMSA is now an independent organization under the Bundesrepublik Deutschland-Finanzagentur GmbH and under the supervision of the Federal Ministry of Finance (BMF). Decisions are subject to scrutiny by the BMF. The BMF reports the FMSA’s activity to a committee of the German parliament (International Monetary Fund 2011).

FMStFG permitted FMSA and SoFFin to provide guarantees to German financial institutions (including insurance companies and pension funds) and German subsidiaries of foreign financial institutions, and to special purpose vehicles that had assumed the risk positions of an eligible institution (FMStFG 2008). Stolz and Wedow suggest that the ability to transfer securities to a special purpose vehicle (SPV) in exchange for bonds issued by the SPV and guaranteed by SoFFin would allow an institution to hold government-guaranteed bonds instead of volatile assets on its balance sheet, reducing capital requirements. They conclude that this scheme would serve two purposes: providing institutions with collateral that could in turn be used to access central bank liquidity, and freeing up capital (2010).^FNo guarantees were ever provided to special purpose vehicles (Pleister 2011); for more information on the rules governing guarantees to special purpose vehicles, see Stolz and Wedow 2010.

FMStFV, the statute detailing SoFFin, further stipulated that guarantees could only be provided to solvent financial institutions. In practice, the German government restricted participation to institutions with a Tier-1 capital ratio of at least 7%. Exceptions could be made only if the institution in question committed to reaching the 7% threshold within three months (European Commission 2008c).

In order to receive a guarantee through SoFFin, an eligible institution had to request stabilization measures. Section 4 of FMStFG stipulated that there was “no legal entitlement to benefits of the fund,” and that stabilization measures, including guarantees, would only be approved once the Federal Ministry for Finance assessed “the significance of the respective financial-sector enterprise covered by the Stabilization measure to financial-market stability, the urgency and the principle of the most effective and economical deployment of Fund resources possible” (FMStFG 2008).

Under the SoFFin framework, the German government could provide guarantees for new bonds and liabilities, including debt capital and non-Tier 1 and -Tier 2 capital (European Commission 2008c). Covered bonds were also eligible.

When the guarantee scheme began, eligible liabilities were required to have a maturity of 36 months or less (European Commission 2008c). The Financial Markets Stabilization Amendment Act (Finanzmarktstabilisierungsergänzungsgesetz, “FMStErgG”), passed in April 2009, lengthened this maturity limit and allowed SoFFin to guarantee liabilities with a maturity of up to 60 months (FMSA n.d.). According to the amended act, guarantees could be granted for liabilities with a maturity of over 36 months, “only in justified, exceptional cases and for a maximum of one third of the guarantees granted to an enterprise” (FMStFG 2008). The government does not appear to have established minimum maturity requirements for eligible debt.

In connection with the reauthorization of the scheme in 2012, covered bonds with maturities of up to 84 months became eligible.

Program documents do not specify any restrictions on the currencies eligible to participate in the scheme.

Program documents do not specify any limitations on an individual institution’s participation in the scheme.

FMStFG stipulated that a fee would be charged for guarantees, and FMStV enumerated the fee structure, which aligned with recommendations from the European Central Bank issued on October 20, 2008. The base annual fee was 50 basis points; liabilities with a term of over a year were charged a risk premium that corresponded to the participating institution’s CDS spread for senior debt, which cannot be less than the median of the financial institution’s five-year credit default swap spread between January 1, 2007, and August 31, 2008 (European Commission 2008c). In other words, the fees would be calculated as follows:

Fee Payable = Guaranteed Liabilities × (Base Annual Fee + Long Term Maturation Fee)

Participating institutions providing collateral to SoFFin in connection with the issuance of a guarantee could have the base fee reduced from 50 bps to 25 bps.

As conditions improved, Germany increased these fees in order to incentivize banks to scale back and ultimately end their participation in the scheme. Fees were increased by 20 basis points for banks with a rating of A+ or A, 30 basis points for banks rated A-, and 40 basis points for banks rated below A- (European Commission 2010). This met a stipulation by the EC that no extensions to guarantee schemes would be approved beyond June 30, 2010, unless the fees were increased above the 2008 guidelines (Stolz and Wedow 2010).

Guidance issued by the European Commission in October 2008 on the creation of credit guarantee programs called for the inclusion in programs of a set of safeguards “to minimize…distortions and the potential abuse of the preferential situations of beneficiaries brought about by a State guarantee” and “to avoid moral hazard.” This guidance did not specify exactly what safeguards a program should include, but required “an adequate combination” of elements including restrictions on advertising based on the guarantee, balance sheet growth, share buybacks and executive compensation (European Commission 2008a).

By participating in the SoFFin guarantee scheme, institutions agreed to a number of conditions. Every participating institution was required to submit a business model for approval to the German government. Upon review, SoFFin could stipulate that risky lines of business be abandoned or curtailed (European Commission 2008c). In addition, institutions were prohibited from advertising participation in the guarantee scheme in order to avoid distorting competition with other banks (Petrovic and Tutsch 2009).

German authorities abandoned as unnecessary an initial proposal that participants agree to restrictions on balance-sheet growth. Certain other conditions such as restrictions on compensation that applied to SoFFin’s recapitalization scheme did not apply to the guarantee program.

According to FMStFG, guarantees could only be issued until December 31, 2009. However, that end date was conditional on the crisis lasting that long and the German government retained the power to close the issuance window early (European Commission 2008c).

Though the German government was hopeful that improved conditions in the interbank market would render the guarantee scheme unnecessary by the end of 2009, FMStFG recognized that any prolongations of the scheme would need to be approved in accordance with State Aid rules. The EC required that they be notified six months before any extension of the scheme (European Commission 2008c). In fact, the scheme, with amendments, was extended and approved by the EC multiple times before the issuance window closed initially on December 31, 2010.