Definition and Origin of the Term “Discretionary”
The term Discretionary originates from English-speaking law and business spheres and denotes, in a legal context, a scope for decision-making that is granted to a person, institution, or body by virtue of statutory, contractual, or corporate regulations. The adjective “discretionary” is usually translated into German as “ermessensgebunden” (bound by discretion), “wahlfrei” (at one’s choice), or “at one’s own discretion”. The term is especially widely used in Anglo-American legal systems and is applied in various fields of law with different nuances.
Legal Classification of Discretion (“Discretion”)
Scope of Discretion in Public Law
In public law, “discretionary power” refers to a decision-making latitude granted to authorities or administrative bodies when exercising sovereign powers. Statutory provisions that allow for discretion often use terms such as “may,” “can,” or similarly open wording in the legal text. The administration may, within the scope of discretion, taking into account statutory objectives and general principles, make a decision.
Limits of Discretion
However, the range of discretion is not unlimited; it is subject to statutory and constitutional constraints. This particularly includes the prohibition of abuse of discretion, adherence to principles of equal treatment, the prohibition of discrimination, as well as the relationship between discretion and mandatory administrative acts. An arbitrary or irrelevant decision is unlawful.
Types of Discretion
German administrative law distinguishes especially between decision to act discretion (whether a measure is taken) and selection discretion (how a measure is taken). Anglo-American law has comparable distinctions between “discretionary powers” and “mandatory duties.”
Discretionary in Contract and Private Law
In contract law, “discretionary” often refers to provisions that allow a contracting party to take certain actions or make decisions at its own discretion. This may concern options, changes to the contract, termination rights, or performance terms. Here, too, it is fundamental that the scope of discretion is not used to arbitrarily disadvantage the other party but must be exercised in good faith.
Discretionary in Criminal Law
In criminal law, discretion may exist, for example, at the level of investigative and prosecuting authorities. In US law, “prosecutorial discretion” refers to the prosecutor’s decision as to whether and to what extent charges are brought. Courts are also often granted “discretionary powers” in sentencing so that the specific circumstances of the individual case can be appropriately taken into account. Here, compliance with guidelines and fundamental rights must be ensured.
Discretionary in International Law
In international law, “discretionary power” is also significant, for example in the exercise of sanctions or veto rights in international organizations, in the imposition of penalties, or in international treaties that grant states a margin of discretion. Here as well, general principles of the rule of law apply, such as the prohibition of abuse or discrimination.
Discretionary in Case Law
Judicial Review
Judicial reviewability of discretionary decisions is a central aspect of the rule of law. In Germany, judicial control of “discretionary decision-making” takes place in relation to exceeding, failing to exercise, or abusing discretion. Courts examine whether discretion was exercised within statutory limits and whether irrelevant considerations played a role.
Distinction from Mandatory Decisions
Not every statutory latitude implies a scope for discretion. A “mandatory decision” (“non-discretionary”) exists when the legal consequence is triggered absolutely upon fulfillment of all preconditions. The term “discretionary” thus stands in direct contrast to the concept of a mandatory decision.
Practical Examples and Areas of Application
Discretionary Trust in Anglo-American Law
A “Discretionary Trust” is a special type of trust relationship in which the distribution of assets or income from the trust is at the discretion of the trustee. The beneficiaries have no fixed claim but can only hope that the trustee will allocate assets to them.
Discretionary Mandates in Finance
In the financial services sector, a “discretionary mandate” refers to an arrangement where an asset manager is authorized to make investment decisions at their own discretion, without having to obtain consent from the account holder for each transaction. Here, too, discretion must be exercised within the framework of contractual agreements and regulatory requirements.
Limits and Control of Discretionary Powers
The exercise of “discretionary powers” in all legal systems is tied to specific prerequisites and restrictions:
- Compliance with statutory provisions
- Respect for fundamental rights and prohibition of discrimination
- Transparency and verifiability of decision-making
- Judicial review and legal remedies
- Adherence to good faith and the principle of proportionality
Conclusion
The term Discretionary plays a central role in numerous areas of law and refers in each case to a normatively limited scope of decision for authorities, courts, individuals, or institutions. A key prerequisite for the permissibility and effectiveness of discretion is compliance with statutory, constitutional, and contractual boundaries as well as full judicial reviewability at all times. Thus, the rule-of-law framework for “discretionary powers” ensures flexibility, individualized procedural fairness, as well as essential legal certainty and protection against arbitrariness.
Frequently Asked Questions
What legal requirements must be fulfilled for exercising discretionary mandates in Germany?
The exercise of discretionary mandates, i.e. independent asset management based on a margin of discretion, requires a license from the Federal Financial Supervisory Authority (BaFin) in accordance with § 32 of the German Banking Act (KWG). Companies managing portfolios independently must meet strict requirements with regard to their organization, professional qualifications of responsible persons, capital resources, and risk management. Legal requirements in particular include compliance with the German Securities Trading Act (WpHG), implementation of effective control and compliance structures, as well as documentation and disclosure of all business activities. Regulated institutions must ensure that all actions are always in the best interests of the respective client and that clear segregation of client’s assets from the company’s own assets is ensured. Furthermore, there are reporting and notification obligations to supervisory authorities and clients.
How are liability issues regulated in discretionary management?
In discretionary management, the asset manager is obligated to exercise discretion properly and prudently. Legally, it is stipulated that the manager is liable for breaches of duty of care, especially for violations of instructions, investment principles, or other obligations (such as inadequate risk diversification or incorrect selection of investments). Liability covers both contractual and tort claims of the client. However, a certain degree of entrepreneurial risk is excluded from liability, provided that decisions were made within the granted discretion and to the best of the manager’s knowledge and belief. Asset managers are also subject to duties of information and disclosure; violations of these can also result in claims for damages. In addition, discretionary agreements are usually specified through individual contractual clauses.
What information and transparency obligations exist for asset managers in discretionary mandates?
Asset managers are subject to extensive information and transparency obligations. This initially includes the duty to comprehensively inform clients before concluding a contract about the services offered, the cost structure, the investment strategy, and the risks associated with asset management. During the mandate, the manager must report regularly and transparently on all transactions carried out, performance developments, and relevant changes in the asset structure. At the latest at the end of each quarter, a detailed statement (reporting) must be provided. Existing conflicts of interest must be disclosed. In addition, the documentation of all investment activities must be retained for review by clients and supervisory authorities. These obligations arise from the WpHG as well as from implementing regulations and directives (e.g., MiFID II).
To what extent are clients’ rights to issue instructions legally limited or allowed?
Legally, a distinction is made between “full-discretionary” and “part-discretionary” mandates. With a genuine discretionary mandate, the manager has full decision-making authority within the contractual framework—the client cannot issue instructions regarding individual transactions. However, guidelines on investment strategy, risk limits, or exclusion criteria can be contractually agreed upon and are binding on the manager. Part-discretionary models allow for selective instruction rights by the client, with the specific scope and structure required to be clearly defined in the contract. In general, it must always be clearly and transparently delineated from a legal standpoint to what extent the mandate is based on unrestricted decision-making authority or the client retains participation rights.
What role do conflicts of interest and their regulation play?
In discretionary mandates, a wide range of conflicts of interest can arise, especially if the manager also sells its own products or receives third-party commissions. According to § 63 WpHG and the MiFID II requirements, the manager is obliged to identify potential conflicts of interest at an early stage, to document them, and to take suitable organizational measures to avoid or disclose them. Clients must be informed in an understandable manner about existing or potential conflicts of interest. If conflicts of interest cannot be fully excluded, it must be disclosed how they will be managed. Violations may result in regulatory measures and civil liability claims.
How are termination rights and contract termination regulated for discretionary agreements?
The contractual relationship in the context of a discretionary mandate is generally structured as a service contract under §§ 611 et seq. BGB and may be terminated at any time by either party with the agreed or a reasonable period of notice. Often, specific notice periods and procedures are contractually laid out, with overarching statutory provisions prevailing. Upon termination, the asset manager is obliged to promptly and properly end the management mandate, settle any outstanding transactions, and transfer the managed assets to the client or their agent. After termination, post-obligation duties remain, such as handing over documents or a final report.
What requirements apply to data protection and data security in the execution of discretionary mandates?
The processing of personal data in the context of discretionary mandates is subject to the strict requirements of the General Data Protection Regulation (GDPR) and the Federal Data Protection Act (BDSG). Legally, it must be ensured that all client data is kept confidential and only processed for the purposes specified by contract or law. Furthermore, there is an obligation to take appropriate technical and organizational measures to protect data against unauthorized access, loss, or manipulation. Any transfer of data to third parties may only occur in compliance with statutory requirements and, where applicable, with the client’s consent. Breaches may result in significant fines and further regulatory consequences.
