Definition and legal framework of underwriting
Underwriting is a term of central importance in the insurance industry, banking, and the capital market. In a broader sense, underwriting refers to the assumption of financial risks for a fee. In a narrower legal context, underwriting refers to the contractually regulated assumption of risks by one party (underwriter) for another party (issuer, policyholder), often in connection with the placement of securities or the granting of insurance coverage.
Underwriting in insurance law
Basic principle and significance
In the insurance sector, underwriting refers to all processes related to risk assessment and acceptance prior to the conclusion of an insurance contract. The legal basis for this is the German Insurance Contract Act (VVG). In particular, Sections 19 et seq. VVG regulate the pre-contractual disclosure obligations of the policyholder, which are an essential part of the underwriting process.
Risk assessment and disclosure obligations
As part of the underwriting process, the insurer examines whether and on what terms a contract is likely to be concluded. The information provided by the policyholder is decisive. Incomplete or incorrect information may, in accordance with Section 19 VVG, lead to contestation or adjustment of the contract. The decision to accept or reject the risk is the insurer’s responsibility and is based on statutory provisions as well as internal underwriting guidelines.
Prohibition of discrimination and the principle of equal treatment
It is important to observe the prohibition of discrimination in accordance with the General Equal Treatment Act (AGG), especially in the case of personal insurance. Underwriting must not result in unlawful discrimination based on race, ethnicity, sex, or other reasons specified in Section 1 AGG. Violations may result in clauses being void or in claims for damages.
Underwriting in the capital market
Underwriting in security issuances
In capital market law, underwriting describes the obligation of a financial intermediary to purchase securities of an issuer, in whole or in part, and to place them on the market at a defined price. Underwriting is usually based on subscription agreements (underwriting agreements) and is an integral part of issuances, for example, in initial public offerings (IPOs).
Types of capital market underwriting
- Firm commitment underwriting: The underwriter assumes the full placement risk, meaning that any securities not placed are taken into their own portfolio.
- Best efforts underwriting: The underwriter undertakes only to place the securities to the best of their ability; the risk of unsold securities remains largely with the issuer.
- Consortium underwriting: Several institutions share the risk, contractually regulated in a syndicate agreement.
Legal basis and regulatory requirements
The underwriting of securities is regulated by the German Securities Trading Act (WpHG), the Capital Investment Code (KAGB), and the German Banking Act (KWG). Financial service providers require authorization for underwriting under Section 32 KWG. In addition, capital market law transparency and ad-hoc obligations (Sections 33 et seq. WpHG) are of particular significance. In the European context, the provisions of the Market Abuse Regulation (MAR) and guidelines of the European Securities and Markets Authority (ESMA) must also be observed.
Underwriting in banking
Collateralization and creditworthiness assessment
In banking, underwriting serves as a synonym for the assessment of a borrower’s creditworthiness before loans are granted. The requirements for this are governed by the German Civil Code (BGB), the German Banking Act (KWG), and, where applicable, by the Payment Services Supervision Act (ZAG). In the case of securitizations, the rules of Regulation (EU) 2017/2402 (Securitization Regulation) also apply.
Contractual structures of underwriting
Underwriting agreements
Underwriting agreements are civil law contracts that define the terms and conditions of risk assumption, including price, scope, and duration. In corporate law, they are regularly assigned to the law governing contracts for services (§§ 675 et seq. BGB) and may also include supplementary provisions on liability, withdrawal, and special termination rights.
Liability and withdrawal rights
The liability of the underwriter is governed by general civil law provisions, the respective contract, and industry-specific regulations. If the prospectus contains incorrect information, liability claims may arise under the German Securities Prospectus Act (WpPG) or Capital Investor Model Proceeding Act (KapMuG). Withdrawal rights arise from contractual arrangements or in the case of grounds for contestation under §§ 119 et seq. BGB.
Compliance, anti-money laundering, and data protection in underwriting
Anti-money laundering and Know-Your-Customer (KYC)
Underwriting processes are subject to the provisions of the German Anti-Money Laundering Act (GwG). This entails comprehensive identification of contracting parties (KYC checks), the monitoring of suspicious transactions, and the implementation of preventive measures.
Data protection requirements
With the entry into force of the General Data Protection Regulation (GDPR), strict data protection requirements apply to underwriting processes, particularly regarding the processing and storage of sensitive customer data.
Conclusion
Underwriting occupies a central position in numerous areas of business law. The underlying legal norms are diverse and cover insurance law, capital market law, banking, and data protection. Legally compliant underwriting requires compliance with relevant statutory provisions, the correct design of contracts, and adherence to regulatory requirements. Particular attention should be paid to the design of contractual liability provisions, the fulfillment of information and disclosure obligations, and the avoidance of discrimination.
Frequently Asked Questions
What legal obligations does an underwriter have in connection with a securities prospectus?
When securities are issued, an underwriter is subject to particularly extensive legal obligations. According to the Securities Prospectus Act (WpPG) and the EU Prospectus Regulation (Regulation (EU) 2017/1129), the underwriter shares responsibility for the accuracy, completeness, and comprehensibility of the prospectus on which investors base their investment decisions. In addition to thorough content review of the prospectus, the underwriter is particularly subject to a plausibility duty of care (due diligence). This includes the obligation to thoroughly verify the information provided by the issuer, to check for obvious incompleteness or inaccuracies, and, if necessary, to conduct further investigations. Violations of these obligations may give rise to civil liability claims by investors (Section 14 WpPG), provided that a defective prospectus was the basis for the investment decision and the investor suffered a loss.
Is the underwriter subject to special transparency requirements under the underwriting agreement?
Yes, the underwriter is subject to specific transparency and disclosure obligations under the underwriting agreement. The contract between the issuer and the underwriter, usually structured as an underwriting agreement, must clearly and transparently set out all relevant rights and obligations as well as compensation arrangements and liability modalities. In addition, conflicts of interest and compensation structures must be disclosed, especially if the underwriter provides further services for the issuer. For banks acting as underwriters, further anti-money laundering and regulatory transparency obligations under the German Banking Act (KWG), the Anti-Money Laundering Ordinance (GwG), and, if applicable, MiFID II, also apply.
How is the civil liability of an underwriter structured?
The civil liability of an underwriter is primarily based on the Securities Prospectus Act (WpPG) and the general provisions of the German Civil Code (BGB). Pursuant to Section 14 WpPG, the underwriter is liable if he publishes, or causes to be published, a prospectus with or for the issuer, and the prospectus is incorrect or incomplete. The prerequisite is that the investor suffers loss as a result of incorrect or incomplete statements in the prospectus and relied on the prospectus being correct. In addition, the underwriter may also be liable in contract or in tort under §§ 280, 823 BGB for negligent breaches of duty of care. It should be noted that liability is often contractually limited, but such limitations are subject to legal restrictions (in particular, with respect to intent and gross negligence).
Are there regulatory requirements for the organization of the underwriter?
Underwriters that are set up as credit institutions or financial services institutions under the KWG must meet a wide range of organizational requirements. These include, in particular, rules to avoid conflicts of interest, to ensure proper business organization, and to comply with internal control and compliance requirements. Relevant regulatory requirements are set out in the KWG, MiFID II, and the MAR (Market Abuse Regulation). These include, for example, the establishment of control mechanisms to prevent market abuse and insider trading, the design of control and risk management systems, as well as regular compliance and due diligence training for employees.
To what extent does the prohibition on market manipulation (MAR) play a role in underwriting?
The prohibition on market manipulation under the Market Abuse Regulation (MAR) is of central importance for underwriting activities. The underwriter must ensure that its actions do not result in artificial influence on the market price of the issued securities. In particular, creating misleading signals regarding supply, demand, or the price of financial instruments, as well as concealing or disseminating false information, are prohibited. Especially during the placement phase, transactions aimed at supporting prices (stabilization measures) must be disclosed under Article 5 MAR and Commission Delegated Regulation (EU) 2016/1052 and are only permissible under strict conditions. Violations can result in significant fines, reputational loss, and regulatory sanctions.
What role do conflicts of interest play and how should they be dealt with legally?
Conflicts of interest play a significant role in underwriting, as the underwriter is typically obligated to the issuer as contracting party, but must also take into account the interests of investors. Pursuant to Section 80 of the Securities Trading Act (WpHG) and MiFID II, the underwriter must identify, prevent, or, if this is not possible, disclose potential conflicts of interest to the issuer and investors. Effective internal policies for identifying, managing, and disclosing such conflicts must be established. If these obligations are breached, not only regulatory sanctions may be imposed, but also civil law claims for damages can arise for affected investors or issuers.
What reporting and documentation obligations do underwriters have?
Underwriters are obliged to document all significant business transactions, decisions, and communications in connection with the underwriting process without gaps. This includes complete documentation of the due diligence review, communication logs with the issuer and relevant third parties, as well as documentation of all contracts and decisions in connection with the preparation and publication of the prospectus. In addition, there are extensive reporting obligations to the relevant supervisory authorities (e.g., BaFin in Germany) if there are significant indications of market abuse, insider trading, or other legal infringements. Violations of documentation or reporting obligations can result in fines and can also negatively affect the civil or regulatory assessment of business organization.
