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German Banking Law and Practice in International Perspective
 9783110869972, 9783110165739

Table of contents :
List of contributors
Abbreviations
Introduction
Part One: Public Law of Banking and Financial Markets
Chapter One: The Deutsche Bundesbank and its Legal Regime
Chapter Two: The Institutional and Legal Framework for the European Monetary Union (EMU)
Chapter Three: Prudential Supervision of Banks in Germany and in the European Economic Area
Chapter Four: The German System of Securities and Stock Exchanges
Chapter Five: The Internal Market for Banking and Investment Services
Part Two: Bank-Customer Relationship; Credits and Export Financing
Chapter Six: Bank-Customer Relationship in German Law and Practice
Chapter Seven:The Legal Framework for Prices and Charges in Banking Services
Chapter Eight: Consumer Credits and Other Private Credits in German Law and Practice
Chapter Nine: Business Credits and Credit Securities in German Law and Practice
Chapter Ten: Payment Terms: Letters of Credit
Chapter Eleven: The U.N. Convention on Independent Guarantees and the Lex Mercatoria
Part Three: Annex
Banking Act
Securities Act
General Business Conditions
Index

Citation preview

German Banking Law and Practice in International Perspective

1749

1999

German Banking Law and Practice in International Perspective

Edited by

Norbert Horn Professor at the University of Cologne, Germany Law Center for European and International Cooperation (R.I.Z), Cologne

W DE

G 1999 Walter de Gruyter · Berlin · New York

® Printed on acid-free paper which falls within the guidelines of the ANSI to ensure permanence and durability.

Library of Congress — Cataloging-in-Publication Data German banking law and practice in international perspective / edited by Norbert Horn, p. cm. Includes bibliographical references and index. ISBN 3-11-016573-2 (cloth : alk. paper) 1. Banking law — Germany 2. Financial services industry — Law and legislation — Germany. 3. Banks and banking — Germany. 4. Financial services industry — Germany. I. Horn, Norbert. KK2188.G467 1999 346.43'082-dc21 99-43204 CIP

Die Deutsche Bibliothek — Cotaloging-in-Pubiication Data German banking law and practice in international perspective / ed. by Norbert Horn. - Berlin ; New York : de Gruyter, 1999 ISBN 3-11-016573-2

© Copyright 1999 by Walter de Gruyter GmbH & Co. KG, D-10785 Berlin. All rights reserved, including those of translation into foreign languages. No part of this book may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopy, recording, or any information storage and retrieval system, without permission in writing from the publisher. Printing: WB-Druck, Rieden am Forggensee — Binding: Lüderitz & Bauer GmbH, Berlin. — Printed in Germany.

Preface In a time of global banking and financial services, globalized money and capital markets, a look on German banking law and practice might be attractive also for lawyers, bankers and businessmen outside Germany. The articles in this book are designed to cover the subject in a systematic approach. They are written by experts from authorities, banks and universities. The idea to this book was born in a conference on „German and Chinese Banking Law" held in Beijing/China October 6-8, 1997, and co-sponsored by the Law Centre for European and International Cooperation, Cologne (R.I.Z.), and the China University of Political Science and Law, Beijing. Inspired by this conference, the authors wrote their contributions in 1998 with due regard to the comparative and international legal perspective of the subject. A picture of German banking law and practice would be incomplete if it did not introduce to the fact that German banking practice and capital market operations form part of the Euro area and the Common Market. Accordingly, the book contains an article on „The Institutional and Legal Framework for the European Monetary Union" from a German perspective and another one on „The Internal Market for Banking and Investment Services", both written by the editor. Both articles are revised versions of speeches, the first one held at the University of California, Law School, Berkeley and Davis, on October 8-9, 1998; the second article was a contribution to the German Norwegian Lawyers Conference in Munich on October 25, 1998. All contributions were carefully edited by Professor Luke Nottage, Kyushu University, Japan, and Paul Salazar (R.I.Z.), whose endeavours are gratefully recognized. I should like to thank also Dr. Ulrich Wackerbarth (R.I.Z.) for his support in the editorial work. All authors and the editor hope that the book will make a useful contribution to the ongoing global discussion on a harmonized banking and financial law as an important tool for an enhanced international economic and financial cooperation. Cologne, April 1999

Norbert Horn

Survey List of contributors Abbreviations

XIX XXI

Introduction Norbert Horn

1

Part One: Public Law of Banking and Financial Markets

5

Chapter One: The Deutsche Bundesbank and its Legal Regime Bernd Krauskopf

7

Chapter Two: The Institutional and Legal Framework for the European Monetary Union (EMU) Norbert Horn

15

Chapter Three: Prudential Supervision of Banks in Germany and in the European Economic Area Anja Gläser

37

Chapter Four: The German System of Securities and Stock Exchanges Stefanie Tetz

59

Chapter Five: The Internal Market for Banking and Investment Services Norbert Horn

69

VIII

Survey

Part Two: Bank-Customer Relationship; Credits and Export Financing

85

Chapter Six: Bank-Customer Relationship in German Law and Practice Harald Herrmann

87

Chapter Seven: The Legal Framework for Prices and Charges in Banking Services Johannes Köndgen

115

Chapter Eight: Consumer Credits and Other Private Credits in German Law and Practice Martin Henssler

131

Chapter Nine: Business Credits and Credit Securities in German Law and Practice Klaus Christian Hübner

145

Chapter Ten: Payment Terms: Letters of Credit Günther Sattelhak

167

Chapter Eleven: The U.N. Convention on Independent Guarantees and the Lex Mercatoria Norbert Horn

189

Part Three: Annex Banking Act Securities Act General Business Conditions Index

205 207 301 339 355

Table of Contents List of contributors Abbreviations Introduction Norbert Horn I. Market Economy, Banking, and the Law II. The Public Law of Banking HI. The Private Law of Banking IV. International Perspective

XIX XXI 1 1 1 2 3

Part One: Public Law of Banking and Financial Markets

5

Chapter One: The Deutsche Bundesbank and its Legal Regime Bernd Krauskopf

7

I. Introduction II. Organisation of the Deutsche Bundesbank III. Central Bank Functions IV. Objectives of Monetary Policy V. Independence of the Deutsche Bundesbank VI. Cooperation between the Government and the Deutsche Bundesbank VII. Cooperation with the Federal Banking Supervisory Office VIII. Monetary Policy Instruments of the Deutsche Bundesbank IX. Monetary Policy Strategy of the Deutsche Bundesbank X. The Deutsche Bundesbank and the European System of Central Banks

7 7 9 9 10 10 11 11 13 13

Chapter Two: The Institutional and Legal Framework for the European Monetary Union (EMU) Norbert Horn

15

I. The Treaty of Maastricht and Decisions for the EMU 1. The Decisions of 1992 and 1998 2. A Single Currency in 1999 3. The Political Dimension of the EMU

15 15 17 .....18

X

Table of contents

II. The European System of Central Banks 1. The ECB and the ESCB 2. The Monetary Policy of the ESCB III. The Fight for Monetary Stability 1. The Criteria of Convergence 2. The Provisions for Monetary Stability 3. Coordination and Monitoring of National Economic Policies 4. The Stability Pact of Amsterdam IV. The EMU Monetary Area and the Euro Financial Market 1. The Enlarged Euro Monetary Area and its Single Financial Market 2. Supervision of Banks and Financial Services V. The EMU and the Outside World 1. The Euro Exchange Rate Policy of the ECB 2. The New Exchange Rate Mechanism (ERMII) VI. Problems of Transition to EMU 1. National Legislation on the Introduction of the Euro 2. The Principle of Continuity of Contracts a) Lex Monetae and Continuity of Contracts b) Extraterritorial Effects of Lex Monetae c) Adaptation of Contracts? VII. Concluding Remarks

Chapter Three: Prudential Supervision of Banks in Germany and in the European Economic Area Anja Gläser I. Purpose of Prudential Supervision II. Historic Background of Prudential Supervision in Germany III. Position and Organisational Set-up of the FBSO IV. Europe's Impact on German Supervision of Banking V. Banking Groups in Germany 1. Private Commercial Banks 2. Foreign Banks 3. Public Sector Saving Banks and their Central Institutions 4. Credit Co-operatives 5. Building and Loan Associations 6. Mortgage Banks 7. Investment Companies/ Foreign Investment Funds 8. Special-Purpose Credit Institutions under Public Law 9. Providers of Financial Services VI. Legal Framework for Prudential Supervision of Banks in Germany VII. Applications of K WG

21 21 23 25 25 26 27 28 28 28 29 29 29 30 31 31 32 32 33 34 35

37 37 38 41 42 43 43 44 44 44 44 45 45 45 45 45 46

Table of Contents

XI

VIII. Material Provisions of KWG 1. License System 2. Standard Provisions a) Own Funds b) Principles Concerning the Capital and Liquidity of Banks c) Supervision of Credit Business d) Consolidation for Prudential Supervision Purposes IX. Regular Supervision 1. Compulsory Notification 2. Information and Inspection Rights 3. Measures to Cope with Extraordinary Situations X. Contributions, Expenses and Fees of the FBSO

48 48 49 49 51 52 54 55 56 56 57 58

Chapter Four: The German System of Securities and Stock Exchanges Stefanie Tetz

59

I. Introduction II. Regulatory Environment III. Supervision and Rules of Conduct IV. The German Bond Market V. The German Stock Market VI. Stock Exchanges 1. Placement 2. Listing 3. Trading 4. Exchange Market Segments 5. Settlement and Clearing VII. Regulatory Reform VIII. Legal Implications of EURO

59 59 60 61 62 62 63 64 64 65 66 66 67

Chapter Five: The Internal Market for Banking and Investment Services Norbert Horn

69

I. Introduction: EMU and the Various Approaches to Create an Internal Financial Market II. The Integrative Effects of Stage 3 of EMU 1. A Large Transaction Domain 2. A Euro Market for Bonds and Stocks III. Freedom of Payment and Capital Movements in the EU 1. The Liberalization Process 2. Remaining Restrictions: Third Countries

69 70 70 71 72 72 73

XII

Table of contents

IV. A Level Playing Field for Market Operators 1. Financial Services and the Freedom of Establishment and Services under the Treaty 2. Free Movement of Banking Services: the European Passport for Banks 3. Free Movement of Investment Services: the European Passport for Investment Service Providers 4. Further Steps to Harmonize the Laws on Banking and Securities Markets V. Common Rules for Market Operations VI. Remaining Divergencies in the National Laws on Banking and Investment Services 1. Limits to Harmonization 2. National Private Laws VII. Market Integration with Open Boundaries 1. Open Boundaries 2. Enhanced Market Integration

75 75 76 77 79 80 81 81 82 83 83 83

Part Two: Bank-Customer Relationship; Credits and Export Financing

85

Chapter Six: Bank-Customer Relationship in German Law and Practice Harald Herrmann

87

I. Introduction II. Banking Business and Legal Sources of Private Banking 1. Business Types and Customer Relationship 2. Contract Types of the BOB, General Banking Contract and the Law of Adhesion Contracts 3. Quasi Contractual and Tortious Liability III. Banking Contract Law 1. Conclusion of Contract and Pre-Contractual Duties to explain and give information 2. Duties of the Bank a) Obligation to Contract? b) Due Care and Diligence c) Computation of Time for Interest Calculation d) Confidentiality and the Right to Give Information about the Customer 3. Duties of the Customer and Problems of Post-Contractual Securing 4. Variation and Termination of Contracts

87 88 88 89 92 93 93 97 97 98 101 102 103 105

Table of Contents

5. The Applicable Law in Cross-Border Transactions IV. Culpa in Contrahendo and Tortious Liability in Banking Law 1. Investors' Protection and Current Developments of the Suitability Doctrine 2. Special Problems of Discount Banking

Chapter Seven: The Legal Framework for Prices and Charges in Banking Services Johannes Köndgen

XIII

107 109 109 110

115

I. General Foundations 115 1. Why a Legal Framework for Prices? 115 2. A Classification of Bank Charges and their Respective Legal Bases .... 116 3. The Specific Difficulties of Pricing Banking Services: The Quest for Market Failure 117 a) Informational Asymmetries in Fiduciary Transactions 117 b) The Bank-Customer Relation as a Complex Long-Term Contract 118 c) Insufficient Transparency in Price Information 120 II. The Legal Framework for Bank Charges 121 1. Introductory Remarks 121 2. Price Terms in Standard Form Contracts and the Principles of Their Judicial Control 122 a) The Standard Form Contract Terms for Banking Business (1993) 122 b) Principles of Judicial Control of Standard Form Price Terms 123 3. Direct Interference with Primary Price Terms 125 a) Control of Excessive Interest Rates: Usury Laws 125 b) No Compensation for the Performance of Statutory Duties 126 c) Judicial Control of Unilateral Price Determination or Adjustment 126 d) Judicial Control of Expenses Charged to the Customer 127 4. The Law Relating to Price Information 127 a) The Regulation on Price Information of 1985 127 b) Transparency of Price Terms under the Standard Form Contracts Act 128 5. Standard Form Provisions Granting the Authority of Unilateral Price Determination 128

Chapter Eight: Consumer Credits and Other Private Credits in German Law and Practice Martin Henssler I. Introduction II. The Protection of Consumers under the Consumer Credit Act 1. The Goals of the Act

131 131 132 132

XIV

Table of contents

2. The Scope of the Act 3. Consumer Information 4. Protection Against Inconsiderateness 5. Linked Transactions 6. Consumer Protection In Case of Default 7. Credit Brokerage Transactions III. The Termination of Consumer Credits IV. Other Personal Credits 1. Real Estate Loans 2. Credits for Financing Personal Risk Bearing Transactions (Capital Investment Transactions and Speculative Transactions) V. Credit Securities for Personal Credits 1. Guarantees By Private Persons 2. Securing the Credit Through Transfer By Way of Security VI. Summary

Chapter Nine: Business Credits and Credit Securities in German Law and Practice Klaus Christian Hübner I. Introduction II. Business Credits 1. Listed Bonds 2. Investment Credits a) Private Placements b) Special Institutions c) Public and Private Banks 3. Project Finance 4. Leasing 5. Business Credits for Financing Current Assets a) Different Forms b) Commercial Papers c) Supplier Credit d) Export financing e) Forfeiting f) Factoring 6. Trade Tax 7. General Content of Credit Agreements III. Credit Securities 1. Personal Securities a) Guarantee b) Liability as debtors Jointly and Severally

133 133 134 135 135 136 136 137 137 139 140 140 141 142

145 145 147 147 148 148 149 149 151 152 153 153 154 155 155 155 156 156 156 160 160 160 160

Table of Contents

c) Warranty d) Letter of Support for Credit Facilities e) Single-Entity Relationships 2. Impersonal Securities a) Real Estate Liens (Articles 1113 to 1203 BOB) b) Liens on Movable Property and Rights c) Assignment of Ownership d) Assignment of Receivables

XV

161 161 161 162 163 164 164 165

Chapter Ten: Payment Terms: Letters of Credit Günther Sattelhak I.TheUCPSOO 1. History 2. Incorporation into Contracts 3. Established Custom or Usage II. Letters of Credit 1. Definition of L/C 2. Types of L/Cs a) Types of Credit according to Degree of Security b) Types of Credit according to Payment Method III. The Contractual Relationship Between the Various Parties in a Letter of Credit Transaction 1. Contract of Sale and the L/C Clause in the Contract of Sale a) Time for Credit to be Opened b) Revocable and Irrevocable Credits c) Confirmation d) Seller's Remedies e) Incomplete Credit Terms in the L/C Clause 2. The Contract between the Applicant and the Issuing Bank 3. The Contract between the Issuing Bank and the Advising Bank 4. The Contract between the Issuing Bank and the Beneficiary 5. The Contract between the Issuing Bank and the Confirming Bank 6. The Contract between the Issuing Bank and the Negotiating Bank IV. Applicable Law 1. Choice of Law: Construction 2. Applicable Law of Contract of Sale 3. Applicable Law of Contract between Applicant and Issuing Bank 4. Applicable Law of Contract between Beneficiary and Issuing Bank 5. Applicable Law of Relationships between Banks Involved in a Credit V. Autonomy of the Credit

167 167 167 168 168 168 169 169 169 170 172 172 173 173 173 173 173 174 174 174 175 176 176 176 176 177 177 177 177

XVI

Table of contents

1. Article 3 UCP: The Autonomy Principle 2. Article 4 UCP: Dealing in Documents 3. The Fraud Exception 4. Illegality VI. Duties and Responsibilites of Banks Involved in a Credit 1. The Issuing Bank a) Duties to Applicant b) Duties to Beneficiary c) Duties to Confirming /Negotiating Bank d) Acceptance / Rejection of Documents 2. The Advising Bank a) No Payment Liability b) Agency c) Negligence 3. The Confirming Bank a) Separate Undertaking b) Duties to Beneficiary c) Duties to Issuing Bank VII. Presentation of Documents 1. Presentation Period 2. Duty to Examine Documents 3. Discrepancies in Documents 4. Problems on Discrepancies 5. Payment under Reserve / Documentary Collection VIII. Special Forms of Credits 1. Stand-By L/Cs 2. Back-to-Back L/Cs 3. Transferable L/Cs

177 178 178 179 179 179 179 179 180 180 180 180 181 181 181 182 182 182 182 182 183 183 185 185 186 186 186 187

Chapter Eleven: The U.N. Convention on Independent Guarantees and the Lex Mercatoria Norbert Horn

189

I. Introduction: A New Step Towards a Uniform Legal Regime for Bank Guarantees II. The Bank Guarantee as an Instrument to Secure International Commercial Transactions 1. Documentary Letters of Credit (L/Cs) and Bank Guarantees 2. The Independent Guarantee as a Type of Obligation, and Stand- by L/Cs 3. The Risk Covered by the Guarantee or Stand-By L/C 4. Conflicting Interests as to the Protection Against Unfair Calling

189 191 191 192 193 194

Table of Contents

XVII

III. The Efforts to Formulate Uniform Rules for International Guarantees 195 1. Uniform Rules for Contract Guarantees of the ICC 1978 195 2. Uniform Rules for Demand Guarantees, 1991 195 3. Uniform Customs and Practices for Documentary Credits 1993 196 IV. The New U.N. Convention on Independent Guarantees 197 1. The Definition of the Independent Guarantee 197 2. Conditional Guarantees? 198 3. Application of the Convention and of National Laws; Interpretation.... 199 V. Exceptions Under the Convention and the Problem of Unfair Calling 199 1. Exceptions in General 199 2. The Case of Unfair Calling in the U.N. Convention 200 VI. Interim Court Measures 201 VII. Concluding Remarks 202

Part Three: Annex

205

Banking Act Securities Act General Business Conditions Index

207 301 339 355

List of contributors Gläser, Anja

Federal Banking Supervisory Office, Berlin

Henssler, Martin

Dr. jur., Professor, University of Cologne, Cologne

Herrmann, Harald

Dr. jur., Professor, Friedrich-AlexanderUniversity, Erlangen-Nuremberg

Horn, Norbert

Dr. jur., Professor, University of Cologne, Cologne; Law Center for European and International Cooperation (R.I.Z.), Cologne

Hübner, Klaus

Dr. jur., Friedrich-Krupp AG, Essen

Köndgen, Johannes

Dr. jur., Professor, Friedrich-WilhelmsUniversity, Bonn

Krauskopf, Bernd

Deutsche Bundesbank, Frankfurt

Tetz, Stefanie

Dr. jur., Pünder, Volhard, Weber & Axster, Beijing/ Munich/ Frankfurt

Sattelhak, Günther

Dr. jur., Deutsche Bank, Frankfurt

Abbreviations AG AGB AGBG AktG AO Art. BAKred BAWe BB BGB BGB1 BGH BNotO BörsG BVerfG CAD Div. EBRD EC ECB ECT EEA EEC EFTA EGBGB

EIB EMI EMU ESCB EStG EU

Aktiengesellschaft (stock corporation) Allgemeine Geschäftsbedingungen (standard terms, general business conditions) Gesetz über die Allgemeinen Geschäftsbedingungen (standard terms act, standard form contracts act) Aktiengesetz (stock corporation act) Abgabenordnung (tax code) Article Bundesaufsichtsamt für das Kreditwesen (see FSBO) Bundesaufsichtsamt für den Wertpapierhandel (see FASTO) Betriebsberater Bürgerliches Gesetzbuch (civil code) Bundesgesetzblatt (Federal Gazette) Bundesgerichtshof (Federal Supreme Court, Federal Court of Justice) Bundesnotarordnung (federal act on notaries) Börsengesetz (exchange act) Bundesverfassungsgericht (Federal Constitutional Court) EC Capital Adequacy Directive Division, Department European Bank for Reconstruction and Development European Community (see also EEC) European Central Bank Treaty Establishing the European Community European Economic Area European Economic Community (see EC) European Free Trade Association Einfuhrungsgesetz zum Bürgerlichen Gesetzbuch (introductory law of the civil code, contains intertemporal and international choice of law rules) European Investment Bank European Monetary Institute European Monetary Union (Europäische Währungsunion) European System of Central Banks Einkommensteuergesetz (income tax act) European Union

XXII

FASTO FBSO FIBOR GG GmbH GWB HaustürWG

HGB InsO ISO KfW KO KWG LIBOR NJW RG StPO TA UWG VAG VerbrKrG VVG WM WpDRiL WpHG ZIP ZPO ZVG

Abbreviations

Federal Securities Trading Supervisory Office (Bundesaufsichtsamt für den Wertpapierhandel) Federal Banking Supervisory Office (Bundesaufsichtsamt für das Kreditwesen) Frankfurt Interbank Offered Rate Grundgesetz (basic law, constitution) Gesellschaft mit beschränkter Haftung (close corporation) Gesetz gegen Wettbewerbsbeschränkungen (act against restraints of competition (german antitrust law)) Gesetz über den Widerruf von Haustürgeschäften und ähnlichen Geschäften (law regarding revocatin of door-to-door and similar dealings) Handelsgesetzbuch (commercial code) Insolvenzordnung (bankruptcy code (since 1999), see also KO) EC Investments Services Directive Kreditanstalt für Wiederaufbau (Reconstruction Loan Corporation) Konkursordnung (bankruptcy code (until 1998), see also InsO) Kreditwesengesetz (banking act) London Interbank Offered Rate Neue Juristische Wochenschrift Reichsgericht (Supreme Court of the Reich) Strafprozeßordnung (code of criminal procedure) Treaty of Amsterdam Gesetz gegen den unlauteren Wettbewerb (unfair competition act) Versicherungsaufsichtsgesetz (insurance supervisory law) Verbraucherkreditgesetz (consumer credit act) Versicherungsvertragsgesetz (insurance contract act) Wertpapiermitteilungen Wertpapierdienstleistungsrichtlinie (see ISO and WpHG) Wertpapierhandelsgesetz (securities trading act) Zeitschrift für Wirtschaftsrecht Zivilprozeßordnung (code of civil procedure) Zwangsvollstreckungsgesetz (compulsory enforcement act)

Introduction Norbert Horn

I. Market Economy, Banking, and the Law Germany can play its role in world economy as one of the leading industrial States with a strong export position only on the basis of a highly developed and well functioning banking system. Such a banking system is the basis of every market economy. A market economy disposes of an effective capital allocation through the invisible hand of offer and demand, and this mechanism is based on the freedom of the great number of market participants to pursue their business activities exercising personal responsibility, and to make their own decisions on how to borrow money, how to lend money, and how to invest it. In Germany, the freedom of economic activities and private property is protected by the constitution (Art. 2 and 14 Basic Law (Grundgesetz, GG)) and it is also guaranteed by the Treaty on the European Union. Banking law can be defined as all laws regulating the activities of banks. Such laws can either be specifically made for banks alone, or they may regulate all kinds of business activities. The banking laws may be part of public law, or of private law. Public law is (at least in Continental European thinking) the law regulating the activities of the State and of governmental authorities (infra II). Private law is the law that regulates the activities of all citizens such as the law of contracts or company law (infra III). German banking law does not depend on the decisions of the German legislator alone. Germany is a Member of the European Community (and European Union) and banking law has been harmonised to a large extent within the Community. II. The Public Law of Banking Within the area of German public law, the most important laws specifically made for banking activities are (i) the German Federal Bank Law (Bundesbankgesetz), (ii) the Credit Institutions Law (Kreditwesengesetz), and (iii) the Treaty of Maastricht on European Monetary Union. The German Federal Bank Law regulates the activities of the Deutsche Bundesbank, the German Federal Bank. This bank provides liquidity for the banking system and is now integrated into the European System of Central Banks. Fur-

2

Norbert Horn

thermore, the Central Bank has to provide a payment system within Germany and with foreign countries. In its monetary policy, the Central Bank is obliged to support economic growth, to avoid inflation and to cooperate with the Federal Government. In its decisions as to monetary policy, however, the Central Bank is strictly independent. In German legal tradition, this independence of the Central Bank is a corner stone of the Central Bank System, and this principle has been used for building up the European System of Central Banks (infra chapter 1 and chapter 2). The German Law on Credit Institutions (Kreditwesengesetz) establishes a Federal Authority for the prudential supervision of the banks. An enterprise that wishes to start banking business needs a license from this federal authority (infra chapter 3). German financial market and stock exchanges play an important role in the context of globalized financial markets (infra chapter 4). The laws on prudential supervision of banking and investment services have been simplified and harmonised within the European Community, and this will, together with the introduction of the single currency euro, contribute to the establishment of an integrated internal financial market within the Community (chapter 5). III. The Private Law of Banking The business transactions of banks with their private or commercial customers or with other banks are subject to private law. We do not find much specific legislation as to banking activities in this field. The banks simply participate in business life as other merchants and enterprises, and they are subject to the general rules of contract law and tort liability as spelled out in the German Civil Code (Bürgerliches Gesetzbuch; BGB) and Commercial Code (Handelsgesetzbuch; HGB). The majority of banks is organised as companies under the German Company Law. The ownership of those banks is spread among many shareholders. Other bank are organised in the form of co-operatives. Besides, a great number of banks including the saving banks and so-called State banks, historically have developed in the ownership of municipalities and federal states. These so-called public banks, in their business activities, compete with the private banks and are subject to the same general rules of contract law and tort liability as the others. Neither the Civil Code nor the Commercial Code contain specific rules for the highly complex modern business activities of banks. Instead, the courts, when applying the general rules of the Civil and Commercial Codes, have developed many specific rules for contracts concluded by banks and their customers. It is this great number of court decisions and the legal commentaries digesting it that provides legal guidance for banking practice. The banks use general conditions of contract (Allgemeine Geschäftsbedingungen; AGB) in their business transactions and, at least in the great number of their credit and other contracts with customers, standardised form contracts. Both general conditions of contract and form con-

Introduction

3

tracts are subject to the German Law on General Conditions of Contract that tend to protect a customer against surprising and unfair conditions. The main features of the bank/customer relationship and its contractual basis are described below (infra chapter 6) together with the highly important question of prices and charges for banking services (chapter 7). With regard to credits of private customers, the German legislator tends to protect the customer against unclear and one-sided credit conditions through the Consumer Credit Law (Verbraucherkreditgesetz, VerbrKrG), which has been enacted in line with a directive of the European Community (infra chapter 8). To a large extent, business enterprises finance their business transactions through bank credits. Here, the availability of suitable credit securities and the relevant law that regulates them is of great importance (infra chapter 9). IV. International Perspective International perspectives and linkages of German banking law can be observed both in the realm of public banking law and private banking law. With regard to public banking law, Germany is among the first 11 participants of stage 3 of the European Monetary Union (chapter 3). As a Member of the European Community, it participates in the efforts to harmonise the laws and regulations on prudential supervision of banks and other financial service providers and on capital market transactions (infra chapter 5). In the area of private law, we can observe partial harmonisation of law pertaining to consumer protection as the Consumer Credit Law within the European Community (infra chapter 5 and chapter 8). Other developments of harmonisation or even unification of law reach beyond the European Community and can be observed world-wide. Thus, German export business since long has been accustomed to use contractual patterns and clauses that largely follow internationally harmonised or standardised forms, as can be seen in the use of letters of credit (infra chapter 10) and bank guarantees (infra chapter 11).

Part One: Public Law of Banking and Financial Markets

Chapter One The Deutsche Bundesbank and its Legal Regime Bernd Krauskopf

I. Introduction The Central Bank plays an important role in a country's banking system. It supplies central bank money to credit institutions and the economy. In most cases, it has the sole right to issue banknotes with the status of legal tender. In many countries, the central bank also performs banking supervisory functions. The tasks, powers and organisation of central banks can differ very greatly from country to country. As the other chapters of this publication also show, the activities of banks and the banking law of any country depend crucially on the regulatory framework governing economic activities in that country. That is especially true of the legal regime of the central bank. The structure and tasks of a central bank are the result of many previous political and economic decisions. This chapter covers diverse aspects. After outlining the organisation of the Deutsche Bundesbank, I would like to limit myself to a few key points concerning the legal regime of a central bank. What I mean by "legal regime" is its statutory mandate, its relationship with the government, and its set of money policy instruments. I will then conclude with a brief look ahead to the role of the Deutsche Bundesbank in the future European System of Central Banks in a European Monetary Union. II. Organisation of the Deutsche Bundesbank In its present form, the Deutsche Bundesbank was created in 1957. It is a publiclaw corporation based in Frankfurt am Main with a capital base of 290 million Deutsche Mark. The Deutsche Bundesbank is the successor organisation to the Bank Deutscher Länder, which was set up in 1948 (three years after the end of World War II) in connection with the introduction of the Deutsche Mark. The Deutsche Bundesbank's tasks and organisation are regulated in the Bundesbank Act of 1957.

8

Bernd Krauskopf

The Deutsche Bundesbank consists of a Central Office located in Frankfurt am Main and nine regional offices known as Federal State Central Banks. Each State Central Bank is responsible for one or more regional states in Germany. Thus, the Deutsche Bundesbank has a highly decentralised structure. This reflects the federal structure of Germany itself, which consists of sixteen regional states which each have local powers. The supreme decision-making body of the Deutsche Bundesbank is the Central Bank Council. It consists of the President of the Deutsche Bundesbank, the Vice President, the other members of the Board, plus the nine Presidents of the State Central Banks. The Presidents of the State Central Banks are appointed by the German President at the suggestion of the Bundesrat, the Upper House of Parliament in Germany made up of representatives of the regional states. That is another federal element in the structure of the Deutsche Bundesbank. The Board of the Deutsche Bundesbank is headed by the Bundesbank President. The Board has a Vice-President and six other members. The members of the Board are appointed by the German President at the suggestion of the Government. The period of office of the members of the Board consists of a minimum of two years and a maximum of eight years. After having served for eight years, it is possible for them to be reappointed for a second term of office. In principle, they cannot be removed from office before the end of their term. The same applies to the Presidents of the State Central Banks. That is a fundamental aspect of the Bundesbank's independence in terms of its leading personnel. The Central Bank Council decides the Bundesbank's monetary and credit policy. It also issues guidelines on the conduct of the Bank's business and administration. As a rule, it meets one day every two weeks in Frankfurt under the chairmanship of the Bundesbank President or Vice-President. The Central Bank Council reaches its decisions by a simple majority. The Board of the Deutsche Bundesbank runs and manages the Bank and is responsible for implementing the decisions of the Central Bank Council. Certain regional tasks are assigned to the State Central Banks to be performed on their own responsibility. Here are a few figures on the Deutsche Bundesbank: • The Deutsche Bundesbank has a total of 16,300 employees of which around 2,600 work at the Central Office and 13,700 at the State Central Banks. • The Deutsche Bundesbank - or, to be more precise - the State Central Banks maintain 164 branch offices in the major cities. This branch network has a long-standing tradition in the German central banking system. However, for reasons of cost-effectiveness, the Bundesbank is currently being compelled to close smaller offices, so that the number of branch offices will continue to

The Deutsche Bundesbank and its Legal Regime

9

fall. The main tasks of the branch network are the supply of banknotes and coins and the handling of cashless payments.

III. Central Bank Functions The Bundesbank performs a number of typical central bank functions which have evolved over the years. Its monopoly on the issue of banknotes (Art. 14 of the Bundesbank Act) is the cornerstone of the Bundesbank's monetary policy powers and constitutes the real basis for its effective control over the expansion of the entire money stock, including deposit money. The Bundesbank acts as the "banks' bank" by supplying the credit institutions with central bank balances on which they depend for their credit business. Unlike the pre-war Deutsche Reichsbank, the Bundesbank does not engage in direct lending to business and industry. In addition, the Bundesbank is the only holder of official monetary reserves. On August 31, 1997, the Deutsche Bundesbank's monetary reserves amounted to around 114 billion Deutsche Mark. The Deutsche Bundesbank, which is forbidden by the Maastricht Treaty to grant loans to the government, also plays an important role in helping the central Government and the regional state governments to borrow money in the capital market (Art. 20 of the Bundesbank Act). In this context, the Bundesbank mainly performs an advisory, intermediary and coordinating function, for which its knowledge of market conditions makes it especially fitted. For instance, the Bundesbank acts as the fiscal agent for most of the debt instruments issued by the Government. The Deutsche Bundesbank also plays an important role in external monetary relationships. For example, the Bundesbank plays a central part in Germany's operational membership of the IMF. The Bundesbank President traditionally assumes the functions of the German Governor within the IMF. IV. Objectives of Monetary Policy An absolute key element of the legal framework of the Deutsche Bundesbank is the Bundesbank's primary mandate to ensure price stability. According to Art. 3 of the Bundesbank Act, the Bundesbank regulates the amount of money in circulation and of credit supplied to the economy, using the monetary powers conferred on it by the Act, with the aim of safeguarding the currency, and arranges for the execution of domestic and international payments. The aim of safeguarding the currency was regarded, and continues to be regarded, as a mandate to safeguard the value of the currency, i.e. price stability.

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V. Independence of the Deutsche Bundesbank Besides its commitment to maintain price stability, the independence of the Deutsche Bundesbank in relation to the Government is another fundamental element of the legal regime of the Bundesbank. The Bundesbank's relationship with the Government, and hence with the aims of general economic policy, is governed by Art. 12 of the Bundesbank Act. This provision states that the Bundesbank is required to support the general economic policy of the Government, but without prejudice to the performance of its functions. The qualification "without prejudice to the performance of its functions" means that the main aim of the Bundesbank's monetary policy is to safeguard price stability. Only if this objective is not in danger may it also take account in its decisions of general economic policy, which is oriented not only to ensuring monetary stability but also to the goals of full employment and economic growth with balanced public finances. Hence if there is ever a conflict of economic policy objectives, the Bundesbank's top priority is always price stability. In the past four decades the Bundesbank has always made it very clear that it accepts the special responsibility for combating inflation which the law has given to it. Art. 12 of the Bundesbank Act further stipulates that, in exercising the power conferred on it by the Act, the Bundesbank is independent of instructions from the Government. This freedom from government instructions is the key element of the Bundesbank's independence. Independence from government interference makes it much easier for a central bank to implement a monetary policy geared to stability, which is a necessary precondition for sustainable economic growth. Another important aspect of central bank independence is the prohibition of, or at least a limit on, lending to public authorities. As I already mentioned, the Bundesbank is not allowed to lend to public authorities. As I also mentioned earlier, the Bundesbank's independence is strengthened by the fact that the members of the Central Bank Council are appointed for an eight-year term of office and in principle cannot be removed from office except for serious reasons. In the past four decades that has never happened. VI. Cooperation between the Government and the Deutsche Bundesbank However, the independence of the Bundesbank in conducting monetary policy does not mean that there is no cooperation between the Government and the Central Bank. In Art. 13, the Bundesbank Act provides the following institutional framework for cooperation between the Government and the Bundesbank: • The Bank has a duty to advise the Government on monetary policy issues of major importance.

The Deutsche Bundesbank and its Legal Regime

11

• The members of the Government are entitled to attend the meetings of the Central Bank Council. They have no right to vote, but may propose motions. In addition, the Bundesbank's statutes say that the Minister of Economics and the Minister of Finance are to be invited to attend every meeting of the Central Bank Council. • Finally, the Government is obliged to invite the President of the Deutsche Bundesbank io attend its discussions of important policy issues. In addition to the basic standard for cooperation laid down in Arts. 12 and 13, the Bundesbank Act contains a number of rules in matters relating to both operations and staff which give the Government some administrative influence over the Bundesbank outside its key monetary mandate. There are also some rules on interaction outside the Bundesbank Act. The Banking Act, for example, regulates banking supervision. Finally, outside the context of formal cooperation there is an ongoing exchange of views between the Bundesbank and the ministries when new laws are being prepared. VII. Cooperation with the Federal Banking Supervisory Office In Germany, banking supervision is not the responsibility of the Deutsche Bundesbank but of a separate public authority, the Federal Banking Supervisory Office. Banking supervision in Germany and Europe will be explained in the following chapter. The only thing I would like to mention here already about the Bundesbank's role is that, in accordance with Art. 7 of the Banking Act, the Deutsche Bundesbank and the Federal Banking Supervisory Office cooperate closely. VIII. Monetary Policy Instruments of the Deutsche Bundesbank In order to be able to achieve its mandate of maintaining price stability, the Deutsche Bundesbank is armed with a set of monetary policy instruments, in line with the Bundesbank Act, designed to allow it to influence price movements. In view of then" importance, I should explain more about the monetary policy instruments and its monetary policy strategy. The set of monetary policy instruments and the monetary policy of the Deutsche Bundesbank are closely connected with the structure and method of functioning of the German economic system in general, and of the finance system in particular. On the one hand, the underlying conditions in the financial sector define the scope for and the limits to monetary policy action by the central bank. On the other hand, the Bundesbank's statutes and monetary policy define some basic conditions for the functioning and the longer-term development of the financial markets. In the prevailing circumstances in Germany of an open market economy with fully liberalised capital and credit markets, the Bundesbank cannot control price

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movements directly. The starting point of the Bundesbank's monetary policy is its monopoly on the issuance of banknotes. The aim of monetary policy is to influence the decisions on expenditure and prices of the non-banking sector by means of the interest rates it charges for central bank money, especially day-to-day money rates. The Bundesbank's monetary policy actions, directed at the money market, influence commercial banks' lending and deposit rates, capital market rates and exchange rates. From the money market, via a complex transmission process, these impulses affect non-banks' account management and, in the end, influence decisions about expenditure and prices. The Bundesbank Act gives the Bundesbank a wide range of interest rate and liquidity policy instruments with which to perform its monetary policy functions. These enable the Bundesbank to influence interest rate terms and conditions and tensions in the money market in many different ways. First, since the mid-eighties the implementation of monetary policy has centred on open market operations in the form of securities repurchase agreements, or "repos". They are the main channel for providing central bank funds. In these repo transactions the Bundesbank buys securities from credit institutions, subject to the proviso that they will repurchase them at a given date. The legal mandate for repo business is Art. 21 of the Bundesbank Act, together with the general terms and conditions for repo transactions. The Bundesbank conducts repo business with all banks that are subject to minimum reserve regulations. This means that around 3,600 credit institutions have direct access to central bank refinancing. Since December, 1993, repo transactions have been held weekly, and the maturity is usually two weeks. Secondly, one of the traditional refinancing instruments in Germany is billbased lending, so-called rediscount policy (Art. 19, paragraph 1, no.l of the Bundesbank Act). The Bundesbank purchases bills of exchange which satisfy certain requirements of financial soundness. The bills are rediscounted, that is they are bought at a discount. The discount rate that is charged on such business was regarded for a long time as the most important central bank interest rate of all. Since the discount rate has generally been below the overnight market rates for many decades, discount lending constitutes a form of privileged access to central bank money. For that reason, the amount of bills that can be purchased from individual credit institutions is restricted by quota. Thirdly, Lombard credit (Art. 19, paragraph 1, no.3 of the Bundesbank Act) is the Bundesbank's marginal lending facility. With this instrument, the Bundesbank makes interest-bearing loans available to credit institutions against the collateral of certain securities or other financial instruments. These loans are known as lombard loans. The lombard rate acts as a kind of upper limit for the overnight market interest rate as part of flexible money market management. A look at the refinancing structure of banks shows that the share of securities repurchase agreements in overall refinancing is around two thirds, with bill-based lending

The Deutsche Bundesbank and its Legal Regime

13

making up the remaining third. Nowadays, lombard credit accounts for less than 1 per cent. Finally, obligatory minimum reserves (Art. 16 of the Bundesbank Act) were first introduced in Germany in 1948 with the currency reform that created the Deutsche Mark. The legal basis for the present minimum reserve regulations is Art. 16 of the Bundesbank Act. Under that provision the Bundesbank may require credit institutions to hold certain percentages of their liabilities in respect of short and medium-term borrowed funds in the form of non-interest bearing deposits at the Bundesbank. The Bundesbank Act sets the maximum ratios for the minimum reserves. IX. Monetary Policy Strategy of the Deutsche Bundesbank In order to be complete, one must mention the monetary policy strategy which the Bundesbank uses in trying to achieve its final objective of maintaining price stability. Since the mid-seventies, the Bundesbank has oriented its monetary policy decisions to the trend in monetary growth. Each year it announces a monetary target in order to inform the general public, and as an orientation guide for the economic agents concerned. The practice of setting monetary targets is based on the experience that, in the medium term, inflation cannot escalate as long as money balances do not grow excessively. Besides the trend in monetary growth, the Bundesbank considers a whole range of other economic indicators when making monetary policy decisions. From a legal point of view, the Bundesbank is free to choose the monetary policy strategy it considers most suitable in guiding its monetary policy decisions. X. The Deutsche Bundesbank and the European System of Central Banks The Bundesbank will be part of the European System of Central Banks in a future European Monetary Union. In 1992 the member states of the European Community decided to set up a European economic and monetary union in three stages. If the member states have achieved the necessary economic and legal convergence, it is planned that they will join in a monetary union on January 1, 1999. Responsibility for the monetary policy of the participating member states will then be transferred to the Community level. Responsibility for monetary policy will then lie with the European System of Central Banks, consisting of the European Central Bank and the national central banks of the participating member states. Monetary union will fundamentally change the legal regime of the Bundesbank. In future, the Deutsche Bundesbank will no longer operate a monetary policy of its own; but instead will perform its functions in the main as a part of the European System of Central Banks.

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Monetary policy decisions in the monetary union will be taken by the Governing Council of the European Central Bank. It will consist of the President, Vice President and members of the Executive Board of the European Central Bank as well as the Governors of the national central banks of the states participating in the monetary union. The statute of the European System of Central Banks contains a legal regime which essentially corresponds very much to that of the Deutsche Bundesbank. The primary objective of the European System of Central Banks will be to ensure price stability. The ESCB will also support the general economic policies in the Community as long as that does not conflict with the goal of maintaining price stability (Art. 105, paragraph 1 of the ESCB Statute). Art. 107 of the Treaty on European Union guarantees the independence of the European Central Bank and of the national central banks from instructions of European institutions or national governments. On the basis of this treaty, the European System of Central Banks will have a sufficient set of instruments to be able to perform its mandate of ensuring price stability. Open market transactions will be the main monetary policy tool of the ESCB, which will operate within a similar economic policy framework to that of the Deutsche Bundesbank (an open market economy with liberalised capital and credit markets). The work of preparing the set of monetary policy instruments is not yet completed. The European Monetary Institute in Frankfurt am Main, together with the central banks of the European Union, are working at full pressure on the details. The European Monetary Institute is the forerunner of the European Central Bank, which will likewise be located in Frankfurt am Main.

Chapter Two

The Institutional and Legal Framework for the European Monetary Union (EMU) Norbert Horn

I. The Treaty of Maastricht and Decisions for the EMU 1. The Decisions of 1992 and 1998 On February 7, 1992, the heads of state and government of the twelve Member States of the European Economic Community (EEC) convened in Maastricht, Netherlands, to sign the Treaty on the European Union1 for the further development of the EEC, founded in 1957. The core of the Treaty of Maastricht are the provisions on the establishment of a European Economic and Monetary Union. The main goal and the main effect of this union are the introduction of a single European currency, the euro, and the establishment of a common European System of Central Banks (ESCB). Thus, it is justified to speak simply of a "European Monetary Union" (EMU). On May 2, 1998, the heads of state and government of the eleven participating countries (i.e., Germany, France, Austria, the Netherlands, Belgium, Luxembourg, Finland, Ireland, Italy, Spain, and Portugal) decided to enter the third and decisive stage of the EMU, scheduled to start on January 1, 1999. Four of the fifteen members of the European Union remained outside: Great Britain, Sweden, and Denmark did not wish to participate at that time; and Greece did not qualify for membership. The decision to begin stage 3 of the EMU followed a procedure prescribed by the Treaty of Maastricht. The Treaty lays down a procedure for deciding which countries would be allowed to participate in the single currency (Art. 109j, para. 4 ECT2). The E.U. Commission and the European Monetary Institute (EMI) had to

1 2

Hereafter referred to as the "Treaty of Maastricht".

Citations to "ECT" refer to the Treaty Establishing the European Community, as incorporated by the Treaty of Maastricht in Title II, Art. G.

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report to the Council on "the progress made in the fulfillment by the Member States of their obligations regarding the achievement of economic and monetary union". This included, inter alia, reports on (a) the compatibility of the Member States' legislation, in particular regarding the statute of the Central Bank, and (b) the fulfilment of the so-called criteria of convergence, i.e., certain economic criteria to be met by the Member States to qualify for participation (infra Part III.l). On the basis of these reports and a recommendation by the E.U. Commission, the Council, meeting in the composition of the ministers of economy and finance (ECOFIN), assessed for each Member State whether it fulfilled the necessary conditions for adoption of a single currency. This assessment was to be made by a qualified majority as defined in Art. 148 para. 2(1) ECT (62 votes out of 87 votes with no further requirements as to the number of countries). ECOFIN recommended its findings to the Council, meeting in the composition of the heads of state or government, which received an additional opinion by the European Parliament. Taking into account these reports and opinions, the Council then confirmed which Member States fulfilled the necessary conditions for the adoption of the single currency. This decision was to be made by a qualified majority with the additional requirement, however, that at least ten Member States cast their votes in favor. The procedural law of the Treaty of Maastricht contains some ambiguities and open questions. The most important was whether the Treaty contained an automatic transition to stage 3. The Treaty states that the examination as to which countries met the convergence criteria was to be carried out, and if such examination was not made and a decision was not taken, the EMU irrevocably would start as of January 1, 1999. The question of whether there was an automatic transition built into the Treaty of Maastricht need not be answered, as the procedure for a decision was observed, and an affirmative decision was made. We can also leave open the strange question of whether a country could have been forced against its will to join the EMU after fulfilling the convergence criteria. The latter question was discussed for some time in Germany, where many people were and still are concerned that a switch from the hard German mark to the euro will bring a loss of monetary stability. From the perspective of German constitutional law, the German government was free to decide whether or not to join. It was obliged to examine carefully the fulfillment of the convergence criteria by Germany and by the other countries joining EMU before reaching its decision. The German Bundestag (Lower House of the German Parliament), when it voted to adopt the Treaty of Maastricht on February 7, 1992, reserved its right to approve the entry into the third phase of the EMU on the basis of its own examination of whether or not the convergence criteria were met. The Federal Constitutional Court decided in October 1993 that under German constitutional law, there was no automatic transition with respect to Germany's participation in stage 3 of

The Institutional and Legal Framework for the European Monetary Union (EMU)

17

EMU.3 In May 1998, the German Bundestag voted in favor of participation in the EMU with the consent of all major parties including the social democrats, then the leading opposition party. A motion brought before the German Constitutional Court to enjoin the Government and Parliament from participating in stage 3 of the EMU was rejected by the Court.4 2. A Single Currency in 1999 The Maastricht Treaty states that the exchange rate parities between the participating countries are to be fixed irrevocably as of January 1, 1999. When the heads of state and governments made the decision on the transition to stage 3 of the EMU (Art. 109j(3) ECT) on May 2, 1998, they decided also on the parities between the national currencies of member countries relevant for the transition to the euro. The long used ecu5 will play a key role when determining the external value of the euro on January 1, 1999. When stage 3 begins, the euro will become a currency in its own right (Art. 1091(4)1 ECT). A regulation of the E.U. Council on the transition to the euro defines the technical details.6 The euro then replaces the participating national currencies at the fixed exchange rate. During a transition period of three years, the national currencies will still be in use, but only as sub-units of the euro, or as perfect substitutes (Art. 3, Council Regulation 974/98 on the introduction of the euro7). In other words, the national currencies of the participating states will be merely different denominations of the single currency. Official foreign exchange markets for the participating national currencies will disappear completely. A May 1995 Green Paper of the European Commssion describes a transition scenario, which stresses the importance of generating rapid momentum for the introduction of the single currency by the immediate creation of a critical mass of activities conducted in euros.8 This would require an initial change-over in the banking and financial sector, which would then have a maximum of three years to complete the change-over of remaining operations and systems.

3

Decision of October 12, 1993, BVerfGE 89, 155ff.

4

Decision of March 31, 1998, 1998 Neue Juristische Wochenschrift [NJW] 1934 (2 BvR 1877/97 u. 2 BvR 50/98).

5

"European Currency Unit", as defined in Council Regulation (EC) No. 3320/94 of 22 December 1994 on the consolidation of the existing Community legislation on the definition of the ecu following the entry into force of the Treaty on European Union, 1994 O.J. (L 350) 27. 6

1996 O.J.(C 369) (draft).

7

Council Regulation (EC) No. 974/98 of 3 May 1998 on the introduction of the euro, 1998 O.J. (L 139) 1. 8

European Commission, Green Paper on the Practical Arrangements for the Introduction of the Single Currency (31 May 1995), Eur. Pari. Doc. (COM 95) 333.

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Norbert Horn

To this end, the Green Paper recommends that the single monetary policy should be defined and implemented in terms of the single currency from the start of this phase by the European System of Central Banks (ESCB). In line with these proposals, the regulation on the introduction of the euro provides that even during the transition period, the Member States may take measures to convert into the euro their public debts.9 This includes debentures and other securities which are denominated in their national currency (Art. 8(4), Council Regulation 974/98). Moreover, the E.G. Council has enacted a regulation on "certain provisions relating to the introduction of the euro."10 This regulation provides technical rules for conversion and rounding up, and stresses the principle of continuity of existing contracts denominated in one of the participating currencies." After the three-year transition phase, the national currencies will disappear entirely and be replaced by the single currency as of January 1, 2002. This means that notes and coins will be exchanged for euros as the only legal tender. The change-over of the banks and financial systems will be complete. All means of payment will be converted into euros in conjunction with the domestic settlement systems. The private non-banking sector will conduct all transactions exclusively in euros. 3. The Political Dimension of the EMU The eleven countries which enter the EMU in the first round have a population of approximately 292 million, somewhat larger than the population of the United States. They have a GDP of US$ 6.6 trillion, compared with a U.S. GDP running at US$ 8.5 trillion.12 The prospective joining of the remaining four Member States of the European Union and the planned enlargement of the Union will make the euro zone a larger monetary area than the U.S. dollar area. The introduction of a single currency, however, should not be viewed only in terms of its economic size. It is a unique historical undertaking with an important political dimension that outweighs its economic and legal aspects. Modern monetary systems are so complex and sophisticated that only few people understand all three dimensions— economy, law, and politics. Sadly, the members of national parliaments are rarely

9

Council Regulation No. 974/98, supra note 7.

10

Council Regulation (EC) No. 1103/97 of 17 June 1997 on certain provisions relating to the introduction of the euro, 1997 O.J. (L 162) 1. 1

' On the question of continuity of contracts, see infra part VI.2.

12

Robert A. Mundell, International Consequences of the Euro, 1998 österreichisches Bank Archiv [ÖBA] 503.

The Institutional and Legal Framework for the European Monetary Union (EMU)

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among the few. Only an interdisciplinary approach to the EMU considering its legal, economic, and political aspects allows one to fully understand this project.13 In its Green Paper of May 1995, the European Commision praises the advantages of the EMU as being: (1) a more efficient single market once the single currency is established; (2) a stimulation of growth and employment; (3) the elimination of the additional costs connected with existence of several European currencies; (4) the increase in international stability; and (5) enhanced joint monetary sovereignty for the Member States. The first three points describe economic goals. There is some redundancy between a more efficient single market (no.l), and the elimination of additional costs caused by several European currencies (no.3). Both hint to the elimination of certain transaction costs. For example, exporters and importers often complained about the volatility of exchange rates in their cross-border transactions. The single currency will eliminate their costs stemming from such volitility. Tourists travelling Europe will also be happy to pay in a single currency and to be able to compare hotel and shoe prices in Rome and Berlin. With regard to the stimulation of growth and employment (no.2), it is certainly true that the common currency will facilitate financial transactions and help establish an integrated financial market with some potential for economic growth. On the other hand, employment will not necessarily benefit from this globalization. Labor markets in countries with high wages, like Germany, will suffer. The flexibility of an integrated European labor market is neither probable nor desirable. The migration of thousands of workers throughout Europe across national and cultural borders is not the desired outcome. The labor markets issue reminds us that the economic aspects of the EMU are closely connected with political issues. The central issue of the EMU is that it will bring together countries of very different political cultures with regard to inflation, i. e., countries such as Germany with a tradition of monetary stability and others with a tradition of inflation. The latter countries have made a short-term effort to achieve the monetary stability necessary to qualify for membership in the EMU. It is likely, however, that the euro will not have the same stability as the deutschmark, and that German, Dutch, and Austrian savings accounts will pay for the union. Also, it is likely that the euro is still too stable for many other regions, which will lead to social and political tensions. A comparison between Germany and Italy serves as an example. While the holders of German savings accounts in marks will not be very happy when their accounts are denominated in euros, the holders of Italian savings accounts in lira will be delighted. German car makers selling cars in Italy, however, will also be delighted. They sometimes lost hundreds of millions of marks when the lira was particularly weak and exports to Italy were maintained only to avoid losing the 13

Cf. Norbert Horn, European Monetary Union: Legal and Institutional Aspects in their Economic and Political Setting, 1998 Journal of International Banking Law [JIBL] 71 et seq.

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Norbert Horn

Italian market. At the same time, exporters from weak currency countries like Italy had the opportunity to increase their export sales. Italian car makers took advantage of this fact. In the future, these losses and advantages will no longer exist. More importantly, it is uncertain whether the Italian government and Italian borrowers in general have realized that it is much more difficult to pay back debts in a relatively harder euro than in lira. The Green Paper of the European Commission also describes political goals of the EMU when it invokes international stability (no.4) and joint monetary sovereignty (no.5). It does not directly mention the most important political goal from a German perspective as expressed by the former chancellor, Helmut Kohl, i.e., to use EMU as a tool to promote European integration. It is a crucial question whether a monetary union can bring about political and economic integration of the Member States. Their political and cultural traditions as well as their economic situation does not make them fit to join in a true political union. At the same time, it is a high risk experiment to establish a monetary union for a great number of states that in other respects remain sovereign and independent. The outcome of this historically unprecedented experiment is entirely uncertain. Germany's neighbors were not so naive as to strive for a monetary union in order to bring about the political union that most European countries do not yet want. For decades, France, as a country with great sensibility for its own national independence, struggled for a common monetary system with Germany and other European states for the sole purpose of getting some political control over the German monetary system. It thus hoped to overcome domination by the German monetary system of all other national monetary systems in Europe. For decades, the deutschmark was and still is the anchor currency for Europe. The more today's politics depend on monetary policy, the more Germany's European neighbors felt it an unsatisfactory situation that their national monetary policy more or less depended on the decisions of the German Federal Bank. By establishing the EMU, the existing system of the German Federal Bank leading monetary policy in Europe is replaced by a system where a common institution, the European Central Bank (ECB), makes the monetary decisions. The European Commission's Green Paper nicely describes this as "enhanced joint monetary sovereignty." From a German perspective, the question is not whether Germany lost some of its economic power in Europe or not. The crucial question, however, is whether the Member States will be willing and able to cooperate in the ESCB in a way that will bring about jointly a reasonable monetary policy in the long run.

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II. The European System of Central Banks 1. The ECB and the ESCB The monetary system of the euro is carried out by the European System of Central Banks (ESCB). The ESCB is composed of the European Central Bank (ECB) and of the national central banks of the Member States (Art. 106(1) ECT). The ECB has a legal personality of its own (Art. 106(2) ECT). Its decision-making bodies are the Governing Council and the Executive Board. These bodies also govern the ESCB (Art. 106(3) ECT). The statute of the ESCB is laid down in a protocol annexed to the Treaty of Maastricht.14 From the beginning on January 1, 1999, the European Central Bank has to exercise the full range of functions of a central bank and lender of last resort for the EMU. The Executive Board consists of the President, the Vice President and four other members (Art. 109a(2)(a) ECT, Art. 11.1 ESCB Statute). The Board has the sole and unalienable responsibility of carrying out the monetary policy of the ECB according to the guidelines and decisions of the Governing Council (Art. 12.1 ESCB Statute). The Executive Board is entitled to give directives to the participating national central banks (Art. 12.1 ESCB Statute). Moreover, the Executive Board carries out the current business of the ECB, prepares the meetings of the Governing Council, and draws up the annual financial statement of the ESCB (Arts. 11.6, 12.2, 26.2, and 26.3 ESCB Statute).15 The Governing Council is the supreme decision-making body of the ESCB. It is composed of the members of the Executive Board and the presidents of the national central banks of the participating countries (Art. 109a(l) ECT, Arts. 10.1 and 45.2 ESCB Statute). It makes all decisions of a fundamental nature as to monetary policy, targets, and interest rates. It must be noted that the votes in the Governing Council are not distributed among the Member States according to their economic or political weight. A "one member, one vote" rule has been adopted (Art. 10.2 ESCB Statute). A weighing of votes according to the capital shares of the Member States is applied only with regard to decisions on contributions to the capital and the distributions of profits and losses (Arts. 32, 33, and 51 ESCB Statute). The members of the Executive Board do not participate in those decisions (Art. 10.3 ESCB Statute). The ECB enjoys complete autonomy, just as the German Bundesbank has traditionally. Similarly, all national banks of the participating countries have been given the same independent status in preparation for the EMU. The Treaty of

14

Protocol on the Statute of the European System of Central Banks and of the European Central Bank, hereafter referred to as "ESCB Statute." 15

On the organizational structure of the ESCB, cf. Martin Weber, Das Europäische System der Zentralbanken [the ESCB], 1998 Wertpapier-Mitteilungen [WM] 1465.

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Maastricht clearly states that "neither the ECB, nor a national central bank, nor any member of their decision-making bodies shall seek or take instructions from Community institutions or bodies, from any government of a Member State or from any other body" (Art. 107 ECT). Only in the case of formal agreements on exchange rate systems of the euro in relation to third country currencies will it be the Council of Economic and Financial Ministers (ECOFIN) of the Member States that makes the relevant decisions (Art. 109(1) ECT). If the ECOFIN Council, however, gave recommendations to the ESCB as to informal exchange rate policy measures, these proposals would not be binding. There have been some concerns that France and other Member States with a tradition of state interventions in monetary policy could try to use the ECOFIN Council as a tool to unduly influence the monetary policy of the ESCB. At present, it is not possible to verify these concerns, but it is hoped that the independence of the ESCB will be respected. The institutional independence of the ESCB is accompanied by the personal independence of the members of the Executive Board, who are appointed for the relatively long term of eight years but cannot be re-elected. This enforces and underscores their personal independence. The ECB is obliged to report publicly on its activities and its monetary policy (Art. 109b(3) ECT; Art. 15 ESCB Statute). The account of the ECB and of the national central banks will also be audited by independent external auditors recommended by the Governing Council and approved by it. In principle, the ESCB and the ECB are subject to the jurisdiction of the European Court of Justice with regard to their legal acts and other activities (Art. 183, para. 3; Art. 175, para. 3; and Art. 177, para. l(b) ECT; and Art. 35 ESCB Statute). One should keep in mind, however, that the ECB enjoys wide discretion in its decisions and that judicial control will only become operative in cases where this discretionary power is clearly misused. There is a debate as to whether the ECB is a "person" of public international law. It is true that the ECB is entitled and even obliged to maintain communications with national central banks and financial institutions, and with international organizations where appropriate (Art. 23 ESCB Statute). On the other hand, the ECB is not entitled to enter into formal treaties with other subjects of public international law. Rather, it is the ECOFIN Council that will conclude exchange rate agreements with outside states (Art. 109(1) and (3) ECT). Accordingly, the ECB is not a subject of public international law.16 It is true that the ECB is independent in its activities as well as in its financial status, with the national central banks as shareholders of the ECB capital (Art. 28.2 ESCB Statute). Moreover, the ECB is liable for its contractual and non-contractual obligations. In the end,

16

Weber, supra note 15, at 1471.

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23

however, the Member States would have to be responsible for non-contractual liabilities of the ECB.17 2. The Monetary Policy of the ESCB The primary objective of the ESCB will be to maintain price stability (Art. 105(1) ECT; Art. 2 ESCB Statute). Without prejudice to the objective of price stability, the ESCB will support the general economic policies in the Community with a view to contributing to the achievement of the objective of the Community. It will act in accordance with the principle of an open market economy with free competition, favoring an efficient allocation of resources (Art. 105(1) ECT; Art. 2 ESCB Statute). The basic tasks to be carried out through the ESCB are: (1) to define and implement the monetary policy of the Community; (2) to conduct foreign exchange operations consistent with the provisions of Art. 109 ECT (dealing with exchange rate policy); (3) to hold and manage the official foreign reserves of the Member States; and (4) to promote the smooth operation of payment systems (Art. 105(2) ECT; Art. 3 ESCB Statute). The ECB is located in Frankfurt/Main, Germany, one of the leading financial centers of Europe. The choice of Frankfurt was a political concession to the Germans, who had to sacrifice their hard deutschmark on the altar of a hopefully enhanced European integration. A renowned Dutch banker, Wim Duisenberg, was elected first president of the European Central Bank. According to a political arrangement, Duisenberg will step down before the end of his eight-year term to make way for a French successor, the result of unpleasant political pressure by France. The ECB commenced its work in June 1998, preparing for the entry into stage 3. The work of the ECB was prepared in many ways by the European Monetary Institute (EMI), established in 1993 according to Art. 109f ECT. EMI undertook, in particular, to prepare a range of instruments and procedures to conduct the single monetary policy in the future euro area and to analyse potential monetary policy strategies for promoting the harmonization of euro area statistics with respect to money and banking. EMI also sought to develop a framework for conducting foreign exchange operations and to promote the efficiency of crossborder payment and securities settlement transactions. Furthermore, EMI elaborated on harmonized accounting rules and standards to make possible the construction of a consolidated balance sheet of the ESCB for internal and external reporting purposes. It established the necessary information and communication systems support for the operational and policy functions to be undertaken within the ESCB. It also studied the possible ways in which the ESCB would contribute

17

Weber, supra note 15, at 1470.

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Norbert Horn

to the policies conducted by the competent supervisory authorities to foster the stability of credit institutions and the financial system.18 EMI has outlined the range of instruments and procedures to conduct the single monetary policy. Various types of open market transactions are envisioned as the main tools, accompanied by overnight facilities. The German technique of rediscounting bills of exchange will survive only with modifications in the framework of pension transactions. By the end of September 1998, the ECB published a report describing the monetary policy instruments and procedures to be applied by the ESCB in stage 3 of the EMU.19 The report first sets out the criteria for banks to be eligible as counterparts to ESCB monetary policy operations. It then presents the features of the different types of open market operations which might be conducted by the ESCB: (1) the main refinancing operations; (2) the longer-term refinancing operations; (3) fine-tuning operations; and (4) structural operations. This set of instruments is completed by two standing facilities: (1) the marginal lending facility; and (2) the deposit facility. Furthermore, the report specifies the eligibility criteria and the risk control measures to be applied to assets underlying the ESCB's liquidity-providing operations. On July 7, 1998, the Governing Council of the ECB recommended an EU Council Regulation on the application of minimum reserves by the ECB. The Regulation will set the framework for the main features of any minimum reserve system that may be used by the ESCB in stage 3. The Governing Council identifies three main functions of a minimum reserve system. First, it may contribute to the stabilization of money market interest rates. Second, such a system may contribute to enlarging demand for central bank money, thus creating or enlarging a structural liquidity shortage in the market. This is considered helpful in order to improve the ability of the ESCB to operate efficiently as a supplier of liquidity. Finally, the ESCB's minimum reserve system may also help to control the expansion of monetary aggregates by increasing the interest rate elasticity of money demand.20 The Council had an intensive debate on the question of whether the target of the monetary policy should be defined by an inflation rate or by the volume of liquidity. A combination of both aspects is also in discussion. In this author's view, the definition of a target for monetary policy in terms of an inflation rate has an adverse psychological effect. It misleads the economy into anticipating at least the stated inflation rate. On the other hand, the monetary policy definition debate 18

European Central Bank, Press Release of September 1998, Overview of the Preparatory Work Undertaken by the EMI. 19 The Single Monetary Policy in Stage 3: General Documentation on ESCB Monetary Policy Instruments and Procedures (European Central Bank eds.). 20 European Central Bank, Press Release of July 1998, The Use of a Minimum Reserve System by the European System of Central Banks in Stage 3.

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demonstrates a large consensus on the many criteria that have to be taken into

account.21 III. The Fight for Monetary Stability 1. The Criteria of Convergence The Treaty of Maastricht allowed participation in the EMU to only those countries whose economies showed a sufficient degree of convergence towards stability and that were ready and able to overcome any temporary shortcomings by internal action. The Treaty of Maastricht defines the following convergence criteria (Art. 109j(l)ECT):22 (1) Price stability: The inflation rate may not exceed the respective rates of the three most stable countries by more than 1.5 percent. (2) Government budgetary position: (2.1) The annual public sector budget deficit may not exceed three percent. (2.2) The accumulated public debt may not exceed 60 percent of the gross domestic product. (3) Participation in the exchange rate mechanism of the European Monetary System: The currency of a prospective member must have belonged to this mechanism for at least two years without any tensions. (4) Convergence of interest rates: The prospective Member State must have had, over a period of one year before examination, an average nominal long-term interest rate that does not exceed by more than two percent that of at most the three best performing Member States. As mentioned above, the Council of the European Union decided on May 2, 1998 that the eleven participating countries met the criteria, or most of them, for monetary unification. Only Greece failed to do so. Great Britain, Sweden, and Denmark, however, chose not to participate. The decision on the qualification of the eleven participating States was a political decision and not an economic one. A strict application of the criteria would have left outside a large number of them. As of 1996, no country besides Luxembourg had met all four criteria, and the pros-

21

Interview with the President of the European Central Bank, Wim Duisenberg, in Brussels on September 22, 1998; Frankfurter Allgemeine Zeitung (FAZ), September 23, 1998, at 15. 22 Together with the Protocol on the Convergence Criteria referred to in Art. 109j of the Treaty Establishing the European Community, Arts. 1 -4.

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Norbert Horn

pects for meeting any in 1997 remained bleak.23 Even Germany was not able to meet all the criteria, although it came close. To a large extent, this can be explained by the heavy and continuing economic burden in reconstructing the formerly communist East Germany with its completely inadequate industrial infrastructure. Remarkable progress in reconstruction and privatization could only be reached by the annual capital infusion of DM 150 billion. When the convergence criteria were formulated in 1992, everyone was convinced that the public debt criterion—that the accumulated public debt may not exceed 60 percent of the gross domestic product—was easy to fulfill. The following years showed a real folly of accumulating public debt, particularly by Ireland, Belgium, and Italy. A number of countries also had difficulty in keeping the annual public sector budget deficit at or below three percent. It is true that all countries made remarkable progress in fighting inflation, which dropped in every European country that was a candidate for the EMU. The interest rates of national capital markets began to come closer, partly as a result of the curbed inflation, and partly for the simple reason that the markets anticipated the achievement of the EMU. In 1997, a moderate softening of the criteria and some special techniques to meet them could be observed. Eurostat, the statistical office of the European Union, suggested the elimination of public health insurance debt from the accounting of public debt. In Italy, to prevent a current budget deficit from violating the convergence criteria, the government levied a temporary tax that would be credited at a later time. Other countries had to resort to the privatization of state-owned enterprises to reduce their current budget deficit. By these measures, public confidence in the future stability of the new currency was not enhanced. 2. The Provisions for Monetary Stability While the convergence criteria focused on the monetary stability of participating States at the time they entered the EMU, the crucial question remains whether the same countries are willing and able to maintain stability in the future. The convergence criteria are meaningless in this respect. The Treaty of Maastricht, however, contains some further legal provisions to maintain stability. One very important safeguard is the independence of both the ECB and of the ESCB in its monetary policy, as described above in Part II.2. Under the Treaty of Maastricht, the member countries of the European Union "shall conduct their economic policies with a view to contributing to the achievement of the objectives of the Community" (Art. 102a ECT), and "shall regard their

23

Cf. Annual Report of EMI 1996; Horn, supra note 13, at 72.

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economic policies as a matter of common concern, and ... coordinate them within the Council" (Art. 103(1) ECT). Also under the Treaty of Maastricht, the ECB will not be allowed to give any Member State overdraft facilities or any other type of credit facilities, or to purchase debt instruments directly from them (Art. 104(1) ECT). Moreover, the Community "shall not be liable for or assume the commitments of central governments, regional, local or other public authorities, other bodies governed by public law or public undertakings of any Member State" (Art. 104b(l) ECT). In this manner, the Treaty of Maastricht strives to discourage Member States from incurring unreasonably high public debts and pursuing a policy of deficit spending in the public sector, relying on the ESCB. At the same time, creditors of those government or other public bodies of a Member State should be discouraged from giving too much credit to those governments and other public bodies with a hope that, in case of need, the ESCB will bail out the respective governments. The "nobailing-out-rule" of Art. 104b ECT is meant as a safeguard. It is unlikely, however, that the international financial markets will heed the warning of this rule. In fact, it is difficult to believe that this rule would be strictly applied in an emergency situation. 3. Coordination and Monitoring of National Economic Policies This leads us to the crucial and unresolved problem that the EMU, as a single and integrated monetary system, is made up of great number of sovereign and independent States with independent economic policies. How can it be assured that the various political and economic forces that formulate a Member State's economic policy—specifically, the national parliaments, the banking industry as lenders, and the trade unions making their wage policy—can be obliged to constantly pursue an economic policy of stability in line with the monetary policy of the ESCB? The Treaty of Maastricht prescribes a coordinated economic and monetary policy for all Member States in the common interest of the Community. Art. 102a ECT states that Member States shall conduct their economic policies with a view to contributing to the achievement of the Community's objectives, as defined in Art. 2 ECT. Art. 2 ECT states that by establishing a common market and an economic and monetary union, the Community shall promote a harmonious and balanced development of economic activities, sustainable and non-inflationary growth respecting the environment, a high degree of convergence of economic performance, a high level of employment and of social protection, and the raising of the standard of living. This is a nice collection of political goals and wishes. Art. 103(1) ECT goes on to state that "Member States shall regard their economic policies as a matter of common concern." Art. 104c(l) ECT states, "Member States shall avoid excessive governmental deficits." The Treaty of Maastricht provides for a complicated procedure in case a Member State does not fulfill its duties. First, the Commission will prepare a report on the situation. Next, a

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Norbert Horn

committee will formulate an opinion on this report. The Council will then decide whether or not to give notice to the Member State, and will inform the European Parliament. In the end, the Member State can be obliged to make a non-interestbearing deposit with the Community, or it may even be fined. The whole procedure is very complex and time-consuming, and there is little chance that such a fine would ever be imposed on a Member State. This is not surprising given the fact that each Member State remains sovereign and independent with the exception of the coordinated and integrated monetary policy. 4. The Stability Pact of Amsterdam In December 1996, the Heads of State and Government agreed in Dublin on a Pact on Stability and Growth, which they later enacted in Amsterdam on June 16-17, 1997 (Amsterdam Stability Pact). This new pact contains provisions to facilitate and accelerate the mechanisms of supervising the budgetary discipline of Member States as provided in Art. 104c ECT. The notion of an "immoderate budget deficit", however, remains undefined. The Amsterdam Stability Pact tends to enhance the surveillance of budget policy through regular reports by member countries on national budget data. There are still no automatic sanctions. This is in line with the simple fact that there is a discrepancy between the sovereignty of Member States with their own national budget policy on the one hand, and the stability requirements of the EMU on the other. The gap between these two positions could not be closed by the Amsterdam Stability Pact for the same reason that the Treaty of Maastricht failed to do so. In addition, the Amsterdam Stability Pact was accompanied by a resolution on the creation of jobs and growth, pressed for by the French government. It is not difficult to predict that in the future, any failure to maintain a stable budget policy will be excused by a Member State with a Keynesian explanation that the creation of jobs made deficit-spending inevitable.24 IV. The EMU Monetary Area and the Euro Financial Market 1. The Enlarged Euro Monetary Area and its Single Financial Market Stage 3 of the EMU means the sudden creation of a large monetary area as a large transactions domain. As the size of a single-currency area determines its liquidity, we have to face a situation of increased liquidity within the euro monetary area as compared to previous liquidity with individual national currencies.25 This has a number of different effects. First, we can expect a sudden, once and for all in-

24 25

Horn, supra note 13, at 75. Mundell, supra note 12, at 503 et seq.

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crease in the European money supply with proportionate inflationary effects. The ECB will have to cope with this problem. On the other hand, the larger a monetary area, the better it can act as a cushion against shocks. Moreover, the enlarged monetary area of the euro will be the basis for an enlarged and more effective single financial market. For example, bonds with a large market are more liquid than bonds with a small market. The redenomination of national debts and corporate bonds from local currencies to euros will create a vast single market in eurodominated bonds, comparable to the market of the United States. 2. Supervision of Banks and Financial Services Over the last years, the European Community has made much progress in the harmonization of its banking supervisory legislation. At the same time, the members of the Community have agreed to allow every bank that has been licensed in a participating state to do business in the territories of all Member States. Accordingly, a bank based and licensed in Italy can also conduct business in Germany. The liberalization of the market for banking services goes even beyond the Community allowing banks of certain other countries to also conduct business within the common capital market. There are still some gaps in the supervisory system with regard to financial services. Financial service providers will, in the future, also be subject to supervisory laws as an important step to protect the stability of the European market for these services. V. The EMU and the Outside World 1. The Euro Exchange Rate Policy of the ECB The ECB will not automatically inherit the high reputation of the Deutsche Bundesbank (German Central Bank). The euro will also not be the same strong currency the deutschmark has been. The ECB will have to win credibility step by step. We can expect that the ECB will be serious in its endeavours to maintain euro stability. This is a prerequisite for the international role the euro is expected to play in the future, as no currency has ever obtained or preserved the role of an international currency with a high rate of inflation. The lower the rate of inflation, the lower the cost of holding money balances, and consequently, the more of them that will be held.26 The Treaty of Maastricht clearly makes price stability the overall target of monetary policy. There remains considerable discretion for the ECB on how to achieve this target. The Treaty provides for the possibility to fix external exchange

26

Mundell, supra note 12, at 504.

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Norbert Horn

rates and to pursue an active exchange rate policy (Art. 109 ECT). It has been advised that the ECB should abstain from an active exchange rate policy in the first years and that the Council of Ministers should not try to impose such a policy towards either the U.S. dollar or the yen. One should add that it is also not advisable to conclude any formal agreements on an exchange rate system for the euro in relation to non-Community currencies, as has been made possible by Art. 109(1) ECT. 2. The New Exchange Rate Mechanism (ERMII) The Member States of the European Union, in their majority, were members to the European Monetary System (EMS) until the beginning of stage 3 of the EMU. The EMS was established to cope with the situation where the exchange rates of all member countries floated against each other in the market. It was an agreement of the Member States that their central banks should keep these fluctuations within a certain margin and prevent the exchange rate from going beyond this margin through market interventions. At various instances, the EMS failed to maintain the exchange rates of a certain currencies (e.g., the lira and the pound sterling), and the fluctuation band was widened to a plus or minus fifteen percent deviation from a defined central rate. From the start of stage 3 of the EMU, the EMS was replaced by a new exchange rate mechanism (ERM II). According to a resolution adopted by the European Council during its June 1997 meeting in Amsterdam, ERM II was created for those Member States which do not participate in stage 3 of the euro. It is designed to ensure that non-euro area Member States orient their policies towards stability to foster convergence, and thereby to help them in their efforts to adopt the euro. Participation in ERM II will be voluntary for all non-euro area Member States. The operating procedures for ERM II have been laid down in an agreement between the ECB and the non-euro area national central banks. For each Member State participating in ERM II, a central rate of its currency against the euro and a standard fluctuation band of plus or minus fifteen percent will be defined. If the currency rate of a Member State reaches or crosses the margin, an automatic unlimited intervention at the margins will take place with very short-term financing available. However, the ECB and the participating noneuro area national central banks can suspend automatic intervention if this intervention were to conflict with their primary objective of maintaining price stability. Additionally, the June 1997 resolution of the European Council allows the further strengthening of exchange rate policy cooperation. For example, it allows closer exchange rate links between the euro and other currencies in the exchange rate

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mechanism where and to the extent that these are appropriate in the light of progress towards convergence.27 VI. Problems of Transition to EMU 1. National Legislation on the Introduction of the Euro While the Community has issued two regulations on the introduction of the euro and certain problems related to its introduction,28 each member country has to adapt its national legal system to the new legislation. Using Germany as an example, this meant that a great number of legal provisions that contained a reference to the existing monetary system of the German Federal Republic had to be changed. Such provisions are found in a variety of laws. As a result, an omnibus law containing a number of individual laws on various topics was necessary to carry out the required adaptations. The German Parliament has enacted the Law on the Introduction of the Euro to this effect.29 Some of the individual laws contained therein shall be briefly described to illustrate the problem of adaptation. For example, the new law contains a discount rate transition provision.30 The discount rate was a traditional and important tool of monetary policy for the German Central Bank. It defines the rate at which the Central Bank buys firstclass bills of exchange and thus provides liquidity to the banks. This discount rate and its change by the Central Bank were not only an important indicator of the monetary policy of the Central Bank, but at the same time a term of reference in 59 different legal provisions of German law. For example, German consumer credit law (Verbraucherkreditgesetz, VerbrKrG) defines the interest rate to be paid by the defaulting borrower as five percent above the Central Bank discount rate (Art. 11(1), Consumer Credit Law). In stage 3 of the EMU, the German Central Bank is no longer competent to fix discount rates, and the ECB will probably not use the same technique as a tool for its monetary policy. The German legislature, therefore, had to replace the discount rate with a so-called "basis rate", which will be defined later by the Central Bank in reference to a suitable and comparable tool of the ECB.31

27

ECB, Press Release of September 1998, Conventions and Procedures for the New Exchange Rate Mechanism (ERMII). 28 As mentioned supra and discussed infra part VI.2.a. 29 Euro-Einfllhrungsgesetz [Law on the Introduction of the Euro], BGBI. I, 1998, S. 1242. 30 Diskontsatz-Überleitungs-Gesetz; Art. 1, Law on the Introduction of the Euro, id.. 31 At the time of the enactment of the German law, the tools of the ECB's monetary policy were not yet defined.

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Another provision in this omnibus law deals with the conversion of deutschmark-denominated debentures into the euro during the transition period. A change of the German commercial code (Handelsgesetzbuch, HGB) will oblige enterprises to draft their annual financial reports in euros from the year 2002 (§244 HGB). Another provision deals with the many changes necessary in the field of company law (Gesellschaftsrecht). Companies in Germany as well as in all other countries of the European Community have a fixed nominal capital identical to the sum of the nominal value of the shares issued. The provisions dealing with the minimum nominal capital of public limited companies (Aktiengesellschaft, AG) and private limited companies (Gesellschaft mit beschränkter Haftung, GmbH) had to be changed to sums denominated in euros. In spring 1998, the German legislature also allowed the issuance of shares that do not bear a nominal value on their face.32 The German Currency Law of 1948 contained a provision that made maintenance-of-value clauses dependant on permission by the German Central Bank. The Central Bank had traditionally banned such clauses from the labor market and the capital market and allowed a number of other clauses only under restrictive conditions (Art. 3, Currency Law of 1948). This policy of distrust against such clauses was dictated by the concern for maintaining monetary stability and the fear that maintenance-of-value clauses might increase inflationary trends. It was held that the relevant provision no longer applies in stage 3 of the EMU, as the competence for monetary policy implied in this article is transferred to the ECB. The German legislature, however, is still free to prescribe the extent to which it approves or disapproves of such clauses in private contracts. Accordingly, the legislature has inserted a new provision restricting maintenance-of-value clauses in its law on price information.33 The Federal Minister of Economy can confer exemptions from this prohibition. Transactions in the money and capital markets are not affected by the prohibition.34 2. The Principle of Continuity of Contracts a) Lex Monetae and Continuity of Contracts The introduction of the euro has an immediate effect on existing private contracts that contain a monetary debt denominated in the national currency of a Member State. The conversion of the relevant national currency into the euro leads to an

32

Gesetz über die Zulassung von Stückaktien [Law on the Admission of Non-Par-Value Shares] (March 25, 1998), BGB1.1, 590. 33 Art. 2, Law on Price Information and Price Clauses. 34 For a more detailed survey on the German law on the introduction of the euro, cf. Michael Hakenberg, Das Euro-Einführungsgesetz, 1998 Der Betriebs-Berater [BBJ1491.

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automatic conversion of all monetary debts denominated in the national currency. This automatic conversion is widely recognized and explained by the overruling effect of the monetary law (lex monetae) over private law (lex contractus). The legal doctrine, at least on the European continent, explains this effect through a distinction between lex monetae and lex contractus, i.e., between the sovereign right of a state to change its currency (lex monatae) on the one hand, and the contractual relationship between private parties governed by private law (lex contractus). A change in a currency has to be taken as a given fact by the parties to a contract. This legal effect does not depend on whether the contract is generally governed in its private legal effects by the private law of the country that has changed its currency. The principle of the immediate effects of a change in the lex monetae is accompanied and supported by the principle of the continuity of existing contracts. This means that no party can claim that a contract is voided or terminated by a change in the currency in which the contractual monetary claim is denominated. This principle of continuity of contracts is expressed in E.U. Council Regulation No. 1103/97, which states in Art. 3: The introduction of the euro shall not have the effect of altering any term of a legal instrument or of discharging or excusing performance under any legal instrument, nor give a party the right unilaterally to alter or terminate such an instrument. This provision is subject to anything which parties may have agreed. b) Extraterritorial Effects of Lex Monetae If a U.S. company and a Japanese company enter into a contract to which Swiss law is applicable according to a choice of law clause, but where the monetary claims are denominated in deutschmarks, the debt will automatically be denominated in euros. The fact that the parties to this contract are not citizens of Germany or any other Member State of the EMU, but instead, of outside states, does not exempt them from the effect that all deutschmark denominated debts are converted into euro denominated debts according to the regulation on the introduction of the euro. The law applicable to the contract, Swiss law in our example, neither prohibits this effect nor helps to avoid it. The rule that lex monetae has the immediate effect on existing contracts as described, and that this effect extends also to extraterritorial parties to a contract, is widely recognized internationally as a conflict of laws rule.35 Accordingly, the principle of continuity of contracts accompanying the conversion from deutschmarks (or other national currencies of Member States) to euros will also be applied to the respective contracts. There has been a discussion

35

F. A. Mann, The Legal Aspect of Money 50 et seq. (5th edition, 1992); id. at 359 et seq.; id. at 459 et seq. In the same sense, see Recital 8 of Council Regulation 1103/97, supra note 10.

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Norbert Horn

about whether parties to a contract denominated in a currency replaced by the euro, if they are citizens of third states, are bound by the principle of continuity of contracts.36 It appears that this principle is in fact widely recognized. It has been held that if, for example, a contract is subject to the law of New York as lex contractus, the parties nevertheless cannot void or terminate such a contract on the ground that the national currency they used to denominate their monetary claims has been changed into euros.37 New York and other states of the United States have enacted new legislation to this effect, making sure that their high reputations as international financial market centers will not suffer by unforeseen legal problems.38 c) Adaptation of Contracts? There remains nevertheless the question of whether the parties, or one of them, can obtain a legal remedy under the applicable private law (lex contractus) if it suffers a substantial loss as a consequence of converting the currency of denomination into the euro. This question has particular relevance as to interest rates agreed in contracts concluded before the introduction of the euro. Credits and debentures denominated in a weak currency like the Italian lira bear a higher interest rate to make up for this disadvantage. After the lira credit or lira debenture has been converted into a euro denominated credit or debenture, the debtor (borrower or issuer of the debentures) has to bear an interest rate much higher than that prevailing in the integrated European financial market of the euro area. Council Regulation No. 1103/97, in its Recital 7, expresses the opinion that the principle of continuity of contracts "implies, in particular, that in the case of fixed interest rate instruments the introduction of the euro does not alter the nominal interest rate payable by the debtor." It is very doubtful, however, that such a principle could overrule the recognized general principles of the applicable civil law as to the variation of contracts in order to adapt them to new situations.39 Art. 3 of Council Regulation 1103/97 is on the borderline between monetary law (lex monetae) and contractual law (lex contractus), as it defines the private legal effects of a currency change. It is

36

The Financial Law Panel "Economic and Monetary Union," London, has issued a number of working papers on the recognition of the principle of continuity of contracts in connection with the introduction of the euro in the laws of Hong Kong, Japan, New York, Singapore, and Switzerland. 37 Michael Gruson, Altwährungsforderungen vor US-Gerichten nach Einführung des Euro [Oldcurrency-claims Before U.S. Courts After the Introduction of the Euro], 1997 WM 699. 38 New York: 1997, N.Y. S.B. 5049 (April 6, 1997); California: Cal. A.B. 185 (August 29, 1997). 39 On this problem, cf. Horn, supra note 13, at 777 et seq.; Dorthy Livingstone & Bill Hutchings, Legal Issues Arising from the Introduction of the Euro, 1997 JIBL 63.

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questionable whether the European Union has any legislative power with respect to the private legal effects of the euro's introduction. Legislation on general private law is still in the competence of the individual national Member States. They can regulate certain private legal effects. The parties, in turn, can agree to provisions on how to react to the change of currency. The latter right is expressly mentioned in the end of Art. 3 of Council Regulation 1103/97. As a consequence, parties can also rely on remedies provided by the applicable private law (lex contractus) in cases of hardship or force majeure as long as they do not have the legal effect of denying the currency change as such. The regulation recognizes that the parties may agree on maintenance-of-value clauses in their contracts with respect to the euro. But even if they fail to do so, they can rely on remedies that are normally provided under the applicable national private law in situations of frustration of purpose or force majeure.w VII. Concluding Remarks The introduction of the euro is an epoque-making event in the history of modern international economic and political cooperation. This step could only be carried out on the basis of the important legal and institutional changes described. It is certainly true, however, that institutions and legal provisions as such cannot bring about economic and political effects. The success of the euro as an internationally accepted currency depends on its monetary stability. The monetary stability, in turn, depends on the willingness and ability of all Member States to pursue an economic policy that avoids inflationary effects as far as possible. In this respect, a crucial political learning process for a number of Member States of the European Union still lies ahead. One of the lessons to be learned will be that the harder the currency, the bigger the burden for debtors, be it governments, other public bodies, enterprises, or private debtors. We cannot rule out that some countries will fall back on their usual habits of deficit-spending and accumulating public debt with the hope that the "no-bailing-out-rule" of EMU will not be applied against them. On the other hand, there are evident opportunities for a larger monetary area and accompanying financial markets, which will enhance the prosperity of their Member States and even of the countries outside the euro zone.

40

Cf. generally Norbert Horn, Changes in Circumstances and the Revision of Contracts in Some European Laws and in International Law, in Adaptation and Renegotiation of Contracts in International Trade and Finance 15 (Norbert Horn ed., 1985).

Chapter Three

Prudential Supervision of Banks in Germany and in the European Economic Area Anja Gläser

I. Purpose of Prudential Supervision A function of outstanding importance to any national economy is accomplished by banks as collectors of money, procurers of money and capital, and providers of a wide range of financial services. Substantial contributions are made by banks to the progress of financial markets, which have become a major growth factor on account of technological achievements and the international trend towards deregulation. The services rendered to every citizen by banks today are indispensable and are comparable to supply of water, power, and telephone facilities.1 Banking in Germany is supervised by the Federal Banking Supervisory Office (FBSO; Bundesaufsichtsamt für das Kreditwesen, BAKred), a federal agency instituted to monitor banks for due prudence, caution and responsible risk management and to prevent disorder in the banking community or in a particular institution that might endanger deposits and, eventually, even jeopardise the stability of the financial market. Supervision of banking in Germany is legally based on the German Banking Act (Kreditwesengesetz, KWG). The latter is oriented to the principles of market economy, and implies leaving the definition of business policy and the decision of particular transactions solely to the responsibility of the bank's management. Freedom of banking is only limited by framework legislation and regulation, foremostly quantitative standards, which aim at the containment of risk, and by statutory accountability to the FBSO. The FBSO authority is under the strict rule of law. The KWG does not permit direct administrative interference with actual transactions, as long as they stay within the legal framework. If, however, objec-

1

Prefatory note to the 1995 Business Report by the President of the Federal Banking Supervisory Office.

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tionable facts are discovered in a bank, the FBSO may resort to a wide range of supervisory instruments to deal with the shortcomings. II. Historic Background of Prudential Supervision in Germany Nation-wide supervision of banking is of relatively recent origin. German banking used to be governed by the principle of freedom of trade until 1931. Supervision was restricted to central banks, saving banks, and mortgage banks. The world economic crisis of 1931 had repercussions also for the German banks. An emergency decree was issued by the Head of State (Reichspräsident} to appoint a National Commissioner of Banking (Reichskommissar) as an executive body, and a Board of Trustees (Kuratorium) as a co-ordinating body to deal with the general banking crisis. These bodies were to ensure co-operation between the German Central Bank (Reichsbank) and the German central government. The German Banking Act (KWG) came into force on January 1, 1935, and provided the legal basis for supervision of banking. The above Board of Trustees was replaced by a Department for Supervision of Banking (Supervisory Department) that was attached to the German Central Bank (Reichsbank). The Supervisory Department issued directives, and the National Commissioner had to take care of enforcement. The material provisions have largely survived all changes over time and still are valid law. Among them are licensing requirements, rules on liable capital, liquidity and lending business as well as mandatory notification and reporting. The KWG was revised in 1939. The Supervisory Department was dissolved, its responsibilities being shifted to the German Ministry of Economics. The responsibilities of the National Commissioner were shifted to a newly established German Agency for Supervision of Banking. While the KWG continued to be valid law after the end of World War II, actual supervision was decentralised and came under the control of ministries of economics at state level. Their policies were co-ordinated by a "Special Committee" for Supervision of Banking. Instead of the former Reichsbank, the regional central banks (Landeszentralbanken) became involved in supervision. Preparatory efforts for a new KWG were initiated 1955/56. Reintroduction of national supervision of banking rather than specific details was the primarily disputed issue in the context of revision. A new KWG finally was adopted against resistance of the states and came into force on January 1, 1962, to provide for centralised supervision by the FBSO in co-operation with the Deutsche Bundesbank. The dispute between federal and state governments was settled in 1962, when the Federal Constitutional Court (Bundesverfassungsgericht, the highest court of Germany), ruled that the KWG did not constitute a violation of Art. 87, Sub-clause 3, Sentence 1, of the Constitution of the Federal Republic of Germany. That ruling set a standard according to which the federal government was ac-

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corded the right to set up an federal authority, provided that such authority's responsibilities were confined to issues under federal legislation. The KWG, in the meantime, has been considerably enlarged and revised by five amendments. The sixth and most recent amendment was adopted in Parliament and largely will come into force on January 1, 1998. The KWG, since the 1980s, has been characterised by growing internationalisation of banking. Amendments are adopted in ever shorter intervals, with the view to translating EU Directives into national law for national implementation. This is aimed at mutual adjustment of national supervisory standards among EU member states. Common supervisory and safety standards are considered to be a substantive prerequisite for unobstructed financial services across the European Single Market. The amendments so far can be summarised as follows. The 1st amendment of December 23, 1971 (BGB1.1 Federal Gazette I, p. 2139), in force since January 1, 1972, was primarily limited to elevating from DM 1.000 to DM 2.000 the amount of saving deposits which could be withdrawn by a depositor without giving notice of withdrawal. The 2nd amendment of March 24, 1976 (BGB1.1, p. 725), in force since May 1, 1976, was a so-called "emergency amendment" to close gaps in prudential supervision which had become evident by the collapse in 1974 of the I.D. Herstatt Bank. The Large Exposures regime was tightened, the so-called "foureyes principle" was introduced, the FBSO was empowered to institute on-siteinspections without specific cause (§44, Sub-clause 1 KWG2). Over and above that, the FBSO was accorded the power to impose a moratorium on a bank, if need be, and the sole right to file a petition for bankruptcy. The third amendment of December 20, 1984 (BGB1.1, p. 1693) came into force on January 1, 1985. It was the first major amendment and resulted from a report under the heading of "Policy Issues of Banking" which was submitted in May 1979 by a fact-finding commission appointed in 1974.3 Growth, interdependence and intemationalisation of markets had led to change in the risk situation. Risks relating to credit standing and solvency had been aggravating in banking business. Legislators responded to the problem by passing new regulations on liable capital and permanent holdings of banks. The 1st EC Consolidation Directive, as of June 13, 1983, issued to strengthen existing supervision of the individual bank by consolidated supervision, was incorporated into German law by the Act. The term of "consolidation", in this context, stands for higher complexity of supervision, including monitoring of liable capital (§10a, Sub-clause 1 KWG) as well as of market risks and large exposures (§13a, Sub-clause 1 KWG), in that it

2

All references to §§ of KWG are related to KWG in the version for the 5th amendment. Any reference to the sixth amendment will be denoted KWG(6).

3

See Bericht der Studienkommission, Schriftenreihe des BMF, No. 28, Bonn 1979.

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broadens the focus from the supervision of a bank on a stand-alone basis to consolidated supervision of a banking group. Legislators, in this amendment, explicitly limited the public mandate of the FBSO to protect the public interest (§6, Sub-clause 3 KWG) to guard the federal budget from depositors claiming damages in the wake of a bank bankruptcy. The fourth amendment of December 21, 1992 (BGB1.1, p. 221), in force since January 1, 1993, was primarily aimed at implementation of the EC Own Funds Directive and the EC Second Banking Directive (for co-ordination of laws on banking). Banks whose business is to receive deposits or other repayable funds from the public and to grant loans for one's own account (so-called EC-type banks) were provided with the right to transact banking business throughout the European Single Market (also referred to as "European Passport") . To win the European Passport, an EC-type bank requires only a license from the member state where it is domiciled. The EC principle of "single license" encompasses the free provision of services but also the establishment of branches throughout the European Single Market without need for a further license by the authorities in the host member states. As a further implication of the European Passport, the bank (including its cross-border activities in other member states) is subject only to the supervision by its home regulator, in principle (so-called mutual recognition). The way to mutual recognition of home supervision as the second essential element of the European Passport was prepared by foregoing EC legislation which had led to the harmonisation of the notion of "own funds" and introduction of a common definition and of common techniques for a solvency ratio. Under the solvency ratio, own funds of a bank are related to that bank's risk-adjusted assets and offbalance sheet items. Theßßh amendment of September 28, 1994 (BGB1.1, p. 2735), in force since December 31, 1995, was to implement the 2nd EC Consolidation Directive, as of April 6, 1992, and the EC Large Exposures Directive. Compulsory consolidation was enlarged and includes not only banks but also financial institutions, and procedures of consolidation were modified. Consolidation, for the first time, was to be applied also to minority interests, as of 20% of capital or voting rights. Large-exposures provisions were tightened. The new definition of exposure basically covers all assets and off-balance sheet items which involve credit-risks. The large-exposures limit was reduced from 15% to 10%, while the upper limits for one single large exposure was brought down from 50% to 25%. Generous transitional provisions were issued to help banks adapt more smoothly to the new rules and regulations. The sixth amendment has already been adopted by Parliament. It will be promulgated in autumn 1997, and major parts of it will come into force on January 1, 1998. It is an amendment to implement the EC Capital Adequacy Directive (CAD) and EC Investments Services Directive (ISO). The latter Directive, molded on the respective EC banking legislation, is to harmonise licensing and

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supervisory rules regarding investment firms in the European Union to give these firms the European Passport as well. III. Position and Organisational Set-up of the FBSO The FBSO is a government agency which directly reports to the Federal Ministry of Finance, and is thus part of the national executive. It is headed by a President, who is appointed by the Head of State at the recommendation of the federal government. The FBSO breaks down into seven divisions. Division Z is in charge of organisation, personnel and general administration as well as of persecution of illegal banking transactions and money laundering. Policy planning, legislation, regulation and litigation issues are within the scope of Division /, the policy planning department. Divisions II to V carry out actual supervision of private commercial banks, representative offices, branches and subsidiaries of foreign banks (Div. II), saving banks, central giro institutions, mortgage banks as well as building and loan associations (Div. Ill), credit co-operatives and their central banks (Div. IV), investment companies and trade in foreign investment fund shares (Div. V). Division VI is responsible for aspects relating to currency conversion to DM from former GDR banks and for resolution of so-called equalisation claims. Two more divisions are planned. Once the 6th KWG amendment has come into force, they will have to supervise financial service providers and track down those of them who operate without license. The FBSO at present has about 500 employees on its payroll. Supervision is carried out by the FBSO in co-operation with the Deutsche Bundesbank (§7 KWG). The KWG, however, vests the executive power in the FBSO. Only the FBSO has the right to pass administrative orders and to directly intervene. Instituted as a so-called "unabhängige" Bundesoberbehörde without an administrative sub-structure of its own, the FBSO has to resort to the Deutsche Bundesbank with its given sub-structure, i.e. the regional central banks and their numerous branches. These actually collect and process data received from banks. They also evaluate specific data on the business situation of a given bank and contribute comments on supervisory measures planned by the FBSO. Policy decisions with relevance to supervision of banking, as a rule, are jointly discussed beforehand by the FBSO and the Deutsche Bundesbank. The two institutions are linked to each other by comprehensive exchange of information. Both of them have free access to the other side's data, with no need for formal requests for specific information. Investment firms as well as banks who are at the same time providers of investment services are jointly supervised by the FBSO and another federal agency, the Federal Securities Trading Supervisory Office (FASTO). The FASTO is primarily preoccupied with market conduct of traders in securities, its supervisory

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responsibilities being based on the Securities Trading Act. For its part, the FBSO is in charge of licensing and wide-ranging monitoring of solvency. There are certain categories of banks, i.e. saving banks and central giro institutions, which are additionally supervised by state ministries of economics or finance on the basis of what is called "mandatory supervision of institutions" (§52 KWG). While supervision by the FBSO and the FASTO is primarily oriented to risk control, the latter type of mandatory supervision is of a more supporting and stimulating nature to ensure that the institutions concerned live up to their duties towards the general public, the purpose for which they had been established in the first place. Yet all major decisions on supervision, including that of the latter institutions, are taken by the FBSO. For all practical purposes, the FBSO and mandatory supervision are closely related, last but not least to help the FBSO to draw in its own decision-making on field experience and knowledge from mandatory supervision. IV. Europe's Impact on German Supervision of Banking There is no centralised European authority for supervision of banking. All supervision is carried out by national authorities, though there is something like a European bank supervision law. It is positioned within the framework of the European Union (EU) and its 15 member states at present. The EU is working towards a European Single Market where services, capital and payments can freely circulate. This requires validity of equal standards for all players in the Single Market. Equal standards cannot be set unless obstacles to trade are definitely removed among the countries concerned. Yet, if we were satisfied with this approach, the standard applicable to all member countries would be equivalent to the smallest common denominator. Such approach to harmonisation is not acceptable for effective supervision of banking. Therefore efforts are made to harmonise supervision by means of another instrument, the "Directive". The Directive is addressed to all member states and provides for binding standards which are to be incorporated into national law via parliamentary legislation, decrees or administrative regulations, whenever and wherever current national law is still below EU standards. Separate and special rules for a given country cannot be passed unless minimum requirements of EU Directives are met. Higher stringency of national regulations will be hard to achieve by legislative procedures, since this might be unconstitutional discrimination against local citizens. In any case, this is a disadvantage to domestic banks in their exposure to international competition. EU Directives on prudential supervision of banks are being issued in a socalled "procedure of co-operation" which differs substantively from national legislation. First, a Directive is proposed by the European Commission, the highest executive body of EU. Next, the draft is submitted for comments to the

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European Parliament as well as to Economic and Social Committees. After that, it is passed on, together with the comments, to the Council of the European Union. Then, the Council will adopt, by qualified majority, a "common position" which is returned to the European Parliament for second reading. If Parliament is in agreement with the common position, the decision will be taken finally by the Council, again by qualified majority. In case of rejection by Parliament of the common position, the draft, to become a valid Directive, would have to be supported by unanimous Council vote. In other words, Parliament cannot enforce enactment of a Directive but can only make enactment more difficult. The great importance of EU Directives to national supervision of banking may be easily seen from the fact that the last three amendments to the KWG and the forthcoming sixth amendment were almost exclusively geared to implementation of EU law into national law. More specific effects of EU Directives on national law will be discussed in greater detail in the context of applications and provisions of the KWG. The European Single Market was factually enlarged by the Convention on the European Economic Area (EEA) which came into force on January 1, 1994. It actually enlarged the Single Market to include the members of the European Free Trade Association (EFTA), except for Switzerland. It had practical repercussions for only three of the new signatories, Iceland, Norway and Liechtenstein. All the other former EFTA members, in the meantime, had by then become full members of EU, i.e. the United Kingdom, Sweden, Denmark, Austria, Finland, and Portugal. Banks based in Iceland, Norway and Liechtenstein enjoy equal treatment to any EC-based bank. The condition that had to be satisfied by them was incorporation into their own national law of the EU banking Directives. V. Banking Groups in Germany The banks in Germany under the FBSO supervision may be grouped as follows: 1. Private Commercial Banks There are 2444 private banks which are full-service banks and thus provide services along all lines of banking (deposit, lending, investment, underwriting, securities). The market share of this group in the year 1996 came to 24.2%.5

4

If not otherwise mentioned, figures from 1996 FBSO Business Report (cut-off date: December 31, 1996). 5 Figures from busines report 1996/97 of Bundesverband öffentlicher Banken Deutschlands, cutoff date: December 1996.

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2. Foreign Banks Foreign banks from 60 countries with a business volume of DM 233.8 billion6 are represented in Germany at the following levels: • Subsidiary (122); • Branch (80), a distinction being made by location of head-offices, in an EU member state (§53b KWG), a third country on a decree-based equal footing with an EU member country (§53c KWG), or a third country (§53 KWG); • Representative office (194), according to §53a KWG; • Free provision of cross-border services (119 from EU and Norway), in line with Art. 20 EC Second Banking Directive. 3. Public Sector Saving Banks and their Central Institutions There are 607 saving banks, most of them public-law institutions, primarily involved in short-term deposit, lending and loan business. Their market share, including this of their central institutions, came to 38.1% in 1996.5 They are under dual supervision, as mentioned before, by the FBSO and state authorities on the basis of state legislation. There are twelve state banks (Landesbanken) which are not genuine commercial banks. They act, at the same time, as central institutions of the saving banks organisation and are "house banks" to their respective states to finance state projects, such as state supported housing construction or craft trades or farming. 4. Credit Co-operatives There are 2.514 credit co-operatives, a major group in today's banking environment. Their market share, including this of their central institutions, came in 1996 to 14%.5 They had originally been founded as self-help institutions for the middle classes, craftsmen, and farmers. There is an ongoing trend of fusions and mergers, accompanied by a trend of giving up saving and credit business and its small-scale clientele for wide-ranging full-service banks. 5. Building and Loan Associations There are 21 private and 13 public sector institutions in this category, taking deposits from future home building clients and granting from those deposits loans

6

Figures from "Foreign Banks in Germany 1997", published by the Association of Foreign Banks in Germany.

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for housing construction. Their market share is included in the figures for private commercial banks or public sector saving banks. 6. Mortgage Banks There are 27 specialised mortgage banks lending money on real estate and to public authorities (domestic institutions and corporations under public law, federal government, state authorities, local government and other public-law entities). Their market share came to 13.6% in 1996.5 They are the only institutions that are permitted to refinance their own operations by issuing mortgage bonds and municipal bonds. 7. Investment Companies/ Foreign Investment Funds Sixty-six investment companies are under supervision. They manage open-ended funds, 650 of them open to the general public (retail funds) and 2,914 so-called special funds. The volume of retail and special funds in 1996 came to DM 677 billion. In 1996, 379 applications were submitted by foreign investment funds to obtain permission to sell retail funds in Germany. 8. Special-Purpose Credit Institutions under Public Law These are institutions to hand out loans in support of middle class and other enterprises, usually in a multi-step procedure and from public funds and in cooperation with house banks. Hence, they are not really in competition to commercial banks. Nevertheless, they are - except the Kreditanstalt für Wiederaufbau under banking supervision. In 1996 their market share was up to 9.5%.5 9. Providers of Financial Services When the sixth amendment to the KWG will come into force, providers of financial services will be under supervision, just as banks already are (see §1, Subclause la KWG(6)). About 7,500 firms, according to cautious estimates, are expected to join with the groups of institutions supervised by the FBSO. VI. Legal Framework for Prudential Supervision of Banks in Germany Supervision of banking in Germany is based on the German Banking Act (KWG). For special technical issues, the Act authorizes the Federal Ministry of Finance to issue statutory orders (regulations) having the force of law. The Ministry has subdelegated the authority to the FBSO in accordance with the Act, and thereby instructed the latter to issue the necessary regulations in accordance with the Deutsche Bundesbank. There are certain categories of regulations on which the

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banking associations have to be consulted beforehand. The following regulations are of particular importance: • Reporting Regulations (§24, Sub-clause 4 KWG) which, in conjunction with the Exemption Regulations (§31, Sub-clause 1 KWG), define the type, extent and timing of compulsory reporting by banks • Large Exposures Regulations (§22 KWG) define upper limits for large exposures; percentual allowances being defined for certain categories of borrowers and certain transactions. They also determine accounting of so-called credit equivalent amounts for off-balance sheet items. There are certain netting agreements that are considered risk-reducing and thus eligible for the above allowances. These regulations have great importance for banks for their capacity to ease liable capital requirements; • Audit Report Regulations (§29, Sub-clause 3 KWG), complementary to provisions on annual accounts auditing in the German Commercial Code, define details of audit reports or of interim accounts of banks; • Monthly Returns Regulations (§25, Sub-clause 4 KWG) define the structure of monthly statements by banking groups (compound statements). Monthly balance sheet figures are submitted by individual banks to the Deutsche Bundesbank for statistical record-keeping, and are subsequently transferred by the Deutsche Bundesbank to the FBSO. Figures are treated as monthly bank statements and provide bank supervisors with high-continuity information on business developments. The regulations are complemented by official pronouncements and circular letters of the FBSO to the banking community. They are not legally binding, unlike the KWG, regulations, and formal administrative orders. They are, nonetheless, of great importance as they communicate how the FBSO intends to interpret the legal provisions and to use its given discretion. VII. Applications of the KWG The KWG is binding on all Germany-based banks which pursue one or more of the twelve lines of business enumerated in §1, Sub-clause 1 KWG(6). The wide range of transactions in which banks are involved is a true reflection of the universal (i.e. full-service) system. Emphasis is laid on deposit and lending business (§1, Sub-clause 1, Sentence 2, Nos. 1 and 2 KWG), and the banks involved are referred to as "EC-type banks". Three lines will be added to banking business by the sixth amendment to the KWG: underwriting [No. 10(6)], prepaid card business [No. 11 (6)] and cyber money business [No. 12 (6)]. Underwriting is based originally on the ISO. It had

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not required licensing in the past, but is a typical business activity of German banks and, consequently, has been listed under banking rather than financial services. Prepaid card business has been added to the scope of banking to protect integrity of settlements. The instrument of the prepaid card is highly suitable for replacement of cash payment. Yet, wider dissemination of prepaid cards and concomitant displacement of cash and cash payment may become a threat to security of settlements. It is necessary therefore to place introduction and management of electronic payment units in computer networks (cyber money) under supervision. Greater potential dangers are likely to result from electronic payments units, as counterfeits cannot be detected by physical banknotes or coins and because there are no limits to dissemination via computer networks. Implementation of the ISD means supervision of all commercial providers of financial services according to §1, Sub-clause la KWG(6). Four more categories of services were incorporated into the KWG from the Annex of ISD: (a) reception and transmission on behalf of investors of orders related to financial instruments, (b) contractual completion of such orders, (c) management of investment portfolios and (d) trading by clients for their own account. The definition of financial services was extended to include third-country deposit brokerage, and financial transfers as well as buying and selling of foreign exchange. German legislators have decided to define the latter types of business as financial services and place them under supervision to more effective fight against money laundering, thus strengthening Germany as a safe, dependable site of financial business. The notion of "financial services" as used in the KWG, consequently, is wider than the notion of "investment services" as used in the ISD. Implementation of the ISD has provided for more differentiated definitions, with "institutions" becoming the general term for credit institutions and financial service institutions. The "EC-type bank" is a sub-class of credit institution, while the investment firm is some sort of an interface between credit institution and financial service institution. The notions of "EC-type bank" and "investment firm" are of particular importance, since reference is made to them by a number of special provisions in EU law. Branches based in another EU/EEA country, basically, are supervised by the supervisory authority of the home country, according to §53b KWG. Neither in Germany nor in any other EU/EEA country do they need a separate license, or endowment capital. The FBSO simply has to be informed by the supervisory authority in the home country of the intention to have a branch set up in Germany. The same applies vice versa to German banks planning to set up a branch in another EU/EEA country or freely to provide cross-border services, with the procedure being defined in §24a KWG(6). The legal provisions valid in EU/EEA member countries are flanked by MoUs (Memoranda of Understanding), i.e. bilateral agreements on co-operation between supervisory authorities.

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However, branches of banks in third countries (outside EU/EEA), according to §53 KWG, need a license and endowment capital and are supervised by the FBSO like domestic banks. Exceptions are made in cases in which regulations have been issued by the Federal Ministry of Finance according to which the rules of the "European Passport" may be applied to a bank with headoffice in a third country. Regulations according to §53c KWG so far have been issued by the Ministry in two cases, in which an equal footing has been allowed for US and Japanese banks. VIII. Material Provisions of KWG 1. License System A formal license in writing must be obtained from the FBSO [§32, Sub-clause 1, Sentence 1 KWG(6)] by anyone intending to run banking or other financial services in Germany. A license may be limited to certain categories of bank transactions or financial services. Unlicensed operation is an offence subject to criminal prosecution (§54 KWG). No particular legal status is prescribed for an enterprise, though the status of sole proprietorship is ruled out, according to §2a KWG. An application for a license must not be declined unless at least one of the reasons listed in §33 KWG(6) applies to the applicant. The formulated reasons for rejection in fact reflect the conditions for licensing. A bank must have two executive managers (the "four-eyes principle") who are fit and proper, which requires inter alia a good personal reputation, sufficient experience, and professional qualifications. A bank must have a sufficient amount of own funds. EC Directives determine 5 million ECU as the initial capital that must be held by a EC-type bank and 730,000 ECU for investment firms which deal in instruments for their own account. In cases in which no EC Directives apply, the Act is rather vague in that it requires the funds necessary in the light of the prospective business. That gives the FBSO a broad room for interpretation. Mortgage banks, for example, usually are required to hold an initial capital of DM 50 million . An applicant is required to produce evidence of an adequate organisational setup. The EC Directive known as the BCCI Directive, promulgated in the wake of the collapse of the Bank of Credit and Commerce International (BCCI), issued new minimum standards for the establishment of a bank, notably for licensing: The shareholders must be trustworthy personalities. Effective supervision must not be impeded by a complicated network of intertwined, non-transparent intercompany links; adequate and co-operative supervision must exist in the home country of the parent company. Non membership in deposit guarantee schemes is not (yet) among the reasons for which a license may be rejected in Germany. Such membership is voluntary, though non-members have to explicitly advise their clients of the situation.

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Depositguarantee schemes are established for the purpose of ensuring repayment to depositors in case of bankruptcy of the deposit-holding bank. Deposits are guaranteed or protected in various ways. The schemes set up for saving and cooperative banks are primarily oriented to keeping the banks alive. Their funds are used to rehabilitate banks in difficulty and restore their solvency. The schemes of private banks, on the other hand, are geared to protection of every single deposit which is backed up by up to 30% of the liable capital. All schemes have in common that neither an individual creditor nor a bank in difficulty, supposedly, has a legal claim on the guarantee system. These voluntary, legally unregulated systems, on balance, have been shown to provide depositor protection of unique standards. Work has already begun on the seventh amendment to the K.WG which will deal, inter alia, with the EC Directive on Deposit Guarantee Schemes and its implementation in national law. Implementation of that Directive will ensure harmonisation of deposit guarantee at a minimum level in all member countries. Membership in a deposit-guarantee system will be compulsory for any EC-type bank. 2. Standard Provisions The above-mentioned licensing system is intended to keep unsuitable players away from the banking and financial services trade. On the other hand, certain rules are necessary by which licensed firms should operate. That is the purpose for which standard provisions have been formulated. These standard provisions have to be strictly observed by all licensed players. Generally speaking, banks are to be prevented from endangering their own existence and the assets of their creditors by indecent, high-risk business conduct. Liable capital, solvency, and credit business are the major aspects in this context. All licensed firms have to comply with wide-ranging mandatory notification and reporting duties to enable the FBSO to monitor compliance with standard provisions. a) Own Funds A bank must be furnished at any time with adequate own funds, sufficient to meet its obligations to its creditors and to ensure security of assets entrusted to it (§10, Sub-clause 1, Sentence 1 KWG). The amount of own funds and its financing are essential to the magnitude of lending business that can be done by a bank. Hence, the legal framework for own funds forms the basis for the starting position of a bank. Deviating national provisions within the EU may have repercussions for the competitiveness of banks based in member states and might well end in a competition of laxity at the cost of the stability of financial markets. That is why harmonisation of own funds regulations on the EC level appears to be of greatest importance. The EC Own Funds Directive and the CAD, following their imple-

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mentation into national law of EU/EEA countries, are the means by which such harmonisation is being achieved among EC-based banks and investment firms. Before the fourth amendment to the KWG had come into force, the liable capital of a bank was largely made up of paid-up capital and disclosed reserves. The notion of liable capital was identical with equity capital in terms of the balance sheet. Its connotation was substantially enlarged by the fourth amendment which among transposed the EC Own Funds Directive into national law. Now a distinction is made between core capital (or tier-one capital) and supplementary capital (or tier-two capital). Liable capital is the sum of those two. Two new components of supplementary capital were introduced: unrealised reserves in real estate and securities, and subordinated debts. When the CAD will be translated into national law through the sixth amendment, one more component will be added: tier-three capital. Tier-three capital is made up of subordinated debts with a minimum term to maturity of two years, and unrealised profits from trading book activities. Along with the introduction of new capital elements, the business of bank, the risk side, is conceptually divided into two categories: the trading book and the banking book. Every bank is now required to assign its balance sheet assets and off-balance transactions to a trading or banking book. The trading for a profit is the guiding criterion for assigning a particular position to the trading book rather than the banking book. The banking book represents by definition the remaining or residual variable, though in practical terms it will account for the lion's share of the positions of a universal bank. The formal approach is that all positions which do not fall within a trading book category will automatically come within the banking book. Core capital (tier-one) is the key variable for calculation of own funds. It is made up of high-quality capital, the safest components of liable capital or components of the lowest risk. Core capital is primarily composed of paid-up capital and disclosed reserves. Supplementary capital (tier-two) is subdivided into two quality classes. Firstclass supplementary capital or upper tier-two capital consists of undisclosed reserves (contingency reserves, reserves pursuant to §6 Income Tax Act, and unrealised reserves in real estate or securities); cumulative preferential shares; and capital paid up against the issue of certain loss sharing instruments (Genussrechte') Upper tier-two capital may be taken by a bank up to 100% of the core capital. Second-class supplementary capital or lower tier-two capital, i.e. subordinated debts with a minimum term to maturity of five years, may be taken up only to 50% of the core capital. Shares in other banks or financial institutions or certain debt instruments will have to be deducted from the total of core and supplementary capital (gross liable capital), as these are items of liable capital in the books of those banks or financial institutions.

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Additionally taken tier-three capital may be used only to support certain market risks or counterpart risks from the trading book. Since the net profit part of tier-three capital is made up of pure book profits which may easily volatise, an upper limit has been defined for maximum utilisation of tier-three funds. That limit is close to 250% of free core capital, i.e. core capital not needed to support risks from the banking book. The latest approved balance sheet for a given business year used to be the criterion for calculation of liable capital until the fifth amendment came into force. Any bank used to calculate its own liable capital on the basis ofthat balance sheet. An administrative order of the FBSO used to be the only way to allow for variations of capital in the course of a business year. That concept was not satisfactory, since up to the next annual account it was quite possible that some of the liable capital components stayed in a calculation although they had already been lost. The sixth amendment will provide for complete dynamisation of the hitherto static definition of liable capital. Liable capital components not directly associated with an approved balance sheet will now be calculated by the bank on a daily basis with due consideration of the given risk situation. Calculations will be audited together with the annual account. b) Principles Concerning the Capital and Liquidity of Banks The FBSO in conjunction with the Deutsche Bundesbank has defined principles for general assessment of own funds and its adequacy to the environment of a given bank or banking group (Principles I and la, § 10, Sub-clause 1, Sentence 2, §10a, Sub-clause 1 KWG) and for assessment of liquidity (Principles II and III). These Principles, technically, are administrative rules complementary to existing legal standard provisions. The Principles were first published by the FBSO in Bulletin 1/62, March 8, 1962, and ever since have been enlarged to the level of a comprehensive set of rules. Principle I will have to be totally revised along with implementation of the CAD. Principle I is geared to minimisation of counterpart and settlement risks. It is based on the EC Solvency Ratio Directive. The liable capital of a bank is considered adequate if a solvency ratio of 8% is observed. The solvency ratio is defined as the percentage by which a bank has to hold liable capital in support of its riskweighted assets. In other words, the total of risk-weighted assets must not be higher than 12.5 times the liable capital according to Principle I. Risk assets, apart from loans and shares, include off-balance sheet transactions, such as guarantees, financial swaps, futures and options. Every single asset is weighted by its risk potential. Claims on regional or local government, for example, are weighted zero. Loans granted by building and loan associations are weighted 70%, while fixed assets are weighted 100%. At least half, i.e. 4%, of own funds needed in support of risks must be from core capital.

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Implementation of the CAD will be followed by inclusion into Principle I of rules on own funds to support market risks. Items in the trading book with risks relating to interest rates and share prices will have to be determined and supported together with counterpart risks in the trading book and foreign exchange risks from transactions in both the trading and banking books. Mobilisation of own funds in support of price risks will be based on net items resulting from clearing of buying against selling items in one and the same financial instrument. The new Principle I also will have included to it the enlarged own fund agreement of the Basle Committee for Supervision of Banking of January 1996, providing for own funds support of market price risks. Defined in that enlarged version are rules on own fund support for risks relating to options as well as rules on application of bank-devised in-house risk measurement and control models to determine the amount of own funds needed in support of market price risks. The own fund basis is made up of liable capital and tier-three capital. Rules regarding counterpart and settlement risks for banking book transactions are adapted from Principle I in its present form. Principle la sets a limit of 42% relative to liable capital to price risks from open positions. The overall limit breaks down into the following three sub-items: • 21% for open foreign currency and precious metal positions; • 14% for risk-increasing open positions arising from interest rate forward contracts and interest rate options; and • 7% for open positions arising from other forward contracts and options. Principle la will be deleted by revision of Principle I. Principles II and III (liquidity) have to be observed by banks by investing their assets for sufficient liquidity at any time. Principle II provides that the total of certain long-term assets and loans, less value adjustments, should at no time exceed the total of long term available financial resources. These include liabilities with maturities of four years and more as well as a certain percentage of shorter-term liabilities which, however, by experience are longer-term available to the bank ("permanent average balances"). Principle III provides that the total of certain short-term and mediumterm assets should not exceed the total of certain short-term and medium-term financing funds plus a financial surplus or less a financial deficit relating to financing funds from Principle II. c) Supervision of Credit Business Experience so far obtained in the course of supervision of banking has shown that lopsidedness of a bank in most cases is caused by losses in credit business. Supervision of credit business, therefore, is a priority of the KWG. Special rules have been adopted for certain types of credits.

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Large exposures rules are the most important of them. "Large exposure" is related to a loan to one recipient which reaches or exceeds 15% of the liable capital of the lending bank (10% as of January 1, 1999). Loans of such magnitude have to be approved by the executive managers of the bank and must be notified without delay to the Deutsche Bundesbank, by which the information together with comments is passed on the FBSO unless the latter has waived beforehand its claim on information. The rules are based on a broader concept of exposure (§19, Subclause 1 KWG) which is largely identical with the notion of "risk asset" in Principle I. One single large exposure must not exceed 25% of a bank's liable capital, and the total of all large exposures of one bank must not exceed 800% of its liable capital. These individual and compound upper limits are among the most important supervisory standards. The very existence of a bank and safety of deposits may be jeopardised even by short-term, or less than one day, exceeding of upper limits. A bank exceeding those limits may be fined by the FBSO, though exceeding may be permissible with explicit approval by the FBSO. The entire amount (100%) in excess of upper limits has to be secured by liable capital. The amount of liable capital used in securing such excess cannot be used at the same time for calculation of principles of adequacy of liable capital. The large exposures regulations have complementary provisions on percentages to which certain types of credits may be accounted against upper limits, as well as on procedures by which to determine credit equivalent amounts for derivative transactions. Large exposures rules will be rendered much more complicated by the sixth amendment. A distinction will be made between banks which have to use the rules by their trading book (trading book institutions), on the one hand, and those exempt from that obligation on account of the small volume of their trading book, on the other (§2, Sub-clause 11 KWG). On balance, banks with a voluminous trading book will be favoured by implementation of the CAD, since they have to keep available a relatively lower amount of liable capital to allow for large exposures. Large exposures rules will continue to be almost unchanged for banks not working by a trading book [§13 KWG (6)]. The following differentiation will be applied in the future to trading book banks[§13aKWG(6)]: • Large exposure, made up of the totality of all loans to a debtor, no matter whether they are assigned to the trading or banking book, which may not without prior consent of the FBSO - exceed 25% of the own funds (= liable capital + tier 3) of the institution; • Banking-book large exposure, made up of the totality of all loans, without consideration of debtor-related trading book position, which may not - without prior consent of the FBSO - exceed 25% of the liable capital of the institution; and

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• Trading-book large exposure, made up of the totality of loans granted to one debtor and assigned to the trading book, whereto special sub-limits apply. Upper limits generally may be surpassed if approval is obtained from the FBSO. Exceeding of upper limits for banking book large exposures must be supported 100% by liable capital. Exceeding of upper limits for whole-book large exposures, according to the Large Exposures Regulations, must be supported by own funds (including tier-three capital). The Large Exposures Regulations will provide for clearly lower coverage rates in this case. The KWG, after all, provides for specific upper limits for large exposures which are related to the trading book. Large exposures of this kind to one recipient must not exceed 500% of those own funds that are not used in support of banking book risks (free own funds). If an upper limit for one single whole-book large exposure is exceeded for more than ten days, the amount in excess must not be higher than 600% of free own funds. Observance of these new rules on own funds and large exposures will call for time-consuming changes which have to be undertaken by banks, primarily in the context of electronic data processing. Application of these rules to banking, therefore, will not be compulsory until October 1,1998. Earlier application will be possible by banks ready to do so and willing to use the advantages, but must be immediately reported to the FBSO and the Deutsche Bundesbank. Monitoring of loans of more than DM three million, according to §14 KWG, is an important instrument of supervision and source of information for the bank or insurance company concerned. It provides that such loans granted by banks or insurance companies have to be notified by the latter to the Deutsche Bundesbank which, in turn, will add together all loans received by a debtor and will advise the creditor on the debtor's overall indebtedness and the number of creditors involved. d) Consolidation for Prudential Supervision Purposes Ever since the third amendment to the EC Consolidation Directive was implemented on June 13, 1983, supervision of singular banks has been accompanied by "consolidated supervision" of a group of institutions. The parent institution, leader of the group, has to use a specifically defined consolidation procedure to provide evidence of the availability of adequate liable capital in the group as a whole, and of full compliance with large exposures upper limits. All information herefor required has to be supplied by the institutions involved in the group. This Directive was passed to tackle two problems by which supervision of banking had been accompanied from its very outset. One is related to the possibility of dedicating available liable capital to other banks by means of participation and thus to use it twice or more. The other results from the need to side with closely associated banks in trouble. Consolidation for prudential supervision purposes may be briefly described as follows: consolidation of all funds owned by the parent and subordinated institu-

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tions; deduction of book values of intra-group participations and own funds; consolidation of risk assets of the group; and determination of consolidated solvency coefficient by juxtaposition of risk assets and own funds of the group. A consolidated group is made up of parent and subordinated institutions. Consolidation was originally introduced with only one bank as parent institution. This obviously implied a risk of circumvention. Consolidation could be avoided by connecting a non-bank as holding company. The loophole of circumvention has been eliminated by the fifth amendment, by which supervision of banking is extended to include also financial holding groups led by a financial holding company. Subordinated institutions now include banks and other financial institutions as well as providers of ancillary banking services based in Germany or abroad. The sixth amendment will further extend the consolidation range by adding financial services institutions which may hold a parent or subordinated status. As it stands today, to be included in consolidation are all of the above firms in which the bank or the financial holding company holds directly or indirectly at least 40% of shares or voting rights (significant participating interest) or a dominant position of influence. Qualified minority participations are also involved. They must make up at least 20% of its shares or voting rights must be directly or indirectly held by one of the group-linked enterprises and - this is why they are so called - they must meet additional requirements. Apart from qualified minority participation, the threshold of participation calling for consolidation will be elevated that the firm has in principle, to be qualified as subsidiary in order to become subject to mandatory consolidation. It should be noted, however, that the concept of "subsidiary" in the banking supervisory context also extends to firms over which the bank has a dominant position of influence rather than being limited to firms in which the bank has the majority of voting rights. The quota of participation and the matchable risk assets or own funds are determined by two different procedures, full and pro rata consolidation. Full consolidation provides for inclusion of participating interests held by companies outside the group. In other words, risk assets of a subsidiary have to be taken into due consideration by a parent company even in case of participation below 100%. In pro rata consolidation, liable capital and risk assets according to the applicable quota are consolidated in conformity with capital participation. Majority participations and subsidiaries must be fully consolidated. Minority participations between 20% and 50% are to be consolidated according to the applicable quota. IX. Regular Supervision The FBSO supervision, as of December 31, 1996, covered 3,675 banks with 66,683 branches and a business volume of DM 9,100 billion.

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In regular supervision, emphasis is laid on monitoring banks or groups for compliance with legal provisions and for developments by which their existence might be endangered. Notifications, annual accounts, and audit reports are the major sources of information. 1. Compulsory Notification Banks have to comply with a great number of notification duties. Notification of exposures ranks very high on the list of priorities which, according to §24 KWG, includes the following items: appointment or retirement of a manager, changes in participating interests, changes in legal status and changes in liable capital, and above all - loss amounting to more than 25%. Nature, scope, and timing of reports and printed notification forms are given in the Reporting Regulations. Banks, in addition to annual accounts, have to submit to the Deutsche Bundesbank latest index figures listed in so-called monthly returns. These monthly returns are passed on together with comments by the Deutsche Bundesbank to the FBSO. They help the FBSO in high-continuity analysis of business developments and, at the same time, are tools by which to verify compliance with the Principles. Enlargement of supervision to include financial services institutions called for adaptation of the Monthly Returns Regulations to extract informative data also from these institutions, with differently structured set-up and balance sheets which quite often may consist merely of few items. The annual account is the most important source of information on the assets, yield, and solvency situation of a bank. Banks are legally obliged to submit an annual account within the first three months of the business year, drawn up, approved, and eventually audit certified. The auditor, a certified public accountant or an audit company, of saving banks or co-operatives has to submit to the FBSO and the Deutsche Bundesbank an audit report within five months and immediately after auditing. Auditors have to meet particular demands. They have to check if the economic situation of the given bank is sound and if the bank has complied with the statutory and regulatory framework, notably if it has accomplished its numerous notification duties. Details regarding set-up of and items in an audit report are defined in Audit Report Regulations issued by the FBSO. 2. Information and Inspection Rights The FBSO, according to §44 KWG, has the right to obtain comprehensive information and to initiate thorough inspection. The FBSO and its authorised personnel may require a bank to produce information on business matters, and may inspect books and records. They have the right to attend shareholder meetings convened. The second amendment established the right of the FBSO to undertake on-site inspections without specific cause. Such inspections are of a regular, specific, and limited nature (e.g., credit business, commercial transactions, participations, etc.).

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The instruments available to the FBSO to fight illegal banking and other financial service operations have been substantially extended [cf. §44c KWG [6)]. Firms suspected of running illegal business are obliged to provide information on request to the FBSO and the Deutsche Bundesbank and to submit files requested. The FBSO is also authorised to physically inspect the premises of a suspect firm. Representatives of the FBSO and the Deutsche Bundesbank have the right to enter such premises; search the premises; and retain books, notes, and other compromising evidence. 3. Measures to Cope with Extraordinary Situations The FBSO can undertake a wide range of interventions if objectionable facts are detected in a bank. Offences against legal provisions may be punished, depending on severity, by formal disapproval, reprimand (§36, Sub-clause 2 KWG), opening of regulatory offence proceedings, dismissal of managers (§36, sub-clause 1 KWG), opening of regulatory offence proceedings, dismissal of managers (§36, sub-clause 1 KWG) or revocation of the license (§35, Sub-clause 2 KWG). Inadequate capital or insufficient solvency, according to §45, Sub-clause 1 KWG, may result in FBSO instructions to limit distribution of profits or granting of loans. Any disregard of such instructions may lead to the above-mentioned sanctions. In situations of serious economic difficulties which may have an adverse impact on the bank's obligations towards creditors or may threaten deposited assets, the FBSO can resort to temporary measures to avert such dangers (§46 KWG). It may, for example, restrict or prohibit acceptance of deposits or granting of loans, curb or ban owners' and managers' activities, or appoint supervisors. These measures are primarily oriented to avoidance of bankruptcy. In cases of imminent insolvency or excessive indebtedness, several options may be available to the FBSO (§46a KWG). For example, a bank can be temporarily closed down until a solution has been worked out for crisis management. A petition in bankruptcy can be filed only by the FBSO, according to §46b KWG, lest enforcement of any of the above measures should be blocked or prevented. If general business problems may be expected to affect not only the banks concerned but bring about danger to the national economy as a whole, the federal government has the right to rule by means of a decree temporary closure of a bank or stock exchange (§§47,48 KWG). The FBSO is authorised to use sanctions for enforcement of its decisions (§50 KWG). The framework for coercive payment, DM 50,000, had been unchanged since 1961. It will be increased by the sixth amendment to a maximum of DM 500,000, depending on the case at hand. Possible fines for regulatory offences will be increased by the sixth amendment from up to DM 100,000 now to up to DM one million.

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X. Contributions, Expenses and Fees of the FBSO Ninety percent of those expenses of the FBSO which are not covered by fees or particular reimbursement schemes is reimbursed to the federal budget by the banking industry. More details regarding contribution procedures are defined in Contribution Regulations issued by the Federal Ministry of Finance.

Chapter Four The German System of Securities and Stock Exchanges Stefanie Tetz

I. Introduction Few domestic financial markets in the world show such rapid and far-reaching changes in their legal framework as the German capital markets currently do. On the one hand, the European liberalisation and harmonisation process with regard to banking and financial services, particularly in the area of regulatory law, required and continues to require the implementation of various EC directives into German national law. On the other hand, the German government, realising the increasing competition between financial centres around the world, attempts to promote Germany, and especially Frankfurt, as an international financial marketplace by abolishing unnecessary statutory and administrative restrictions. The successful global equity offering of Deutsche Telekom in November 1996 as well as the search of the German futures and options exchange DTB (Deutsche Terminbörse) for international cooperation partners show, among many other examples, that the domestic German capital markets are preparing to become a vital part of the future European capital markets. The forthcoming European Monetary Union and the already perceptible increase of competition among banks and other financial institutions in Germany will lead to a further internationalisation of the German capital markets. II. Regulatory Environment With respect to capital markets and securities trading, the German regulatory framework comprises a variety of laws. They aim at improving overall transparency, market supervision and the protection of the investor or customer. Most of these laws result primarily from the transformation of European directives into German law. The core of the German regulatory regime is made up of the Banking Act (Kreditwesengesetz, KWG), the Exchange Act (Börsengesetz, BörsG) and the Securities Trading Act (Wertpapierhandelsgesetz, WpHG). This legal basis is supplemented, inter alia, by the Securities Sales Prospectus Act (Verkaufs-

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prospektgesetz), the Stock Exchange Admission Ordinance (BörsenzulassungsVerordnung), the Securities Sales Prospectus Ordinance (VerkaufsprospektVerordnung), the Securities Exchange Regulation (Börsenordnung) and the German Futures Exchange Ordinance (Börsenordnung für die Deutsche Terminbörse). III. Supervision and Rules of Conduct Two main regulatory bodies are involved in the supervision of the German financial services industry. To ensure the proper functioning of the financial services industry and to protect the safety of assets entrusted to credit institutions, the Federal Banking Supervisory Office (Bundesaufsichtsamt für das Kreditwesen, BAKred) is responsible for the initial licensing of banks and their continuous supervision, including compliance with solvency ratios, liquidity rules, and limits of large exposures. Its supervisory functions are exercised in close cooperation with the Deutsche Bundesbank. Together with the BAKred, the Federal Securities Trading Supervisory Office (Bundesaufsichtsamt für den Wertpapierhandel, BAWe) claims regulatory control of the German financial market at the federal level. It is responsible for the supervision of the securities and derivatives market with respect to insider trading, rules of conduct (Wohlverhaltensregeln), and disclosure of shareholder interests. As part of the Federal Securities Trading Supervisory Office, a Securities Council (Börsenrat) will be formed, composed of representatives of the federal states. It will act as an advisor to the BAWe. In addition, state supervisory authorities (Landesaufsichtsbehörden) and trading supervisory offices at the regional stock exchanges (Handelsüberwachungsstellen an den Börsen) supplement the supervision of exchange-related trading activities. The effectiveness of supervision is to be ensured by comprehensive reporting obligations on the part of all market participants. The Securities Trading Act contains severe restrictions to fight insider trading, and establishes rules of conduct (Wohlverhaltensregeln) for service providers in the field of securities and derivatives. The rules of conduct are designed to protect investors against being taken advantage of by so-called "capital market experts", including banks and other investment services enterprises. Their scope of applicability, therefore, is not limited to investment firms domiciled in Germany. The rules of conduct also apply to securities services provided from abroad, as long as at least some of these services are provided within Germany. Under the rules of conduct, an enterprise providing services relating to securities is obliged to: • provide these services with due skill, care and diligence in the interest of its customers; • avoid conflicts of interest;

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• require from its customers information regarding their knowledge or experience of business related to the securities services and their financial circumstances; and • provide its customers with all pertinent information available. While violations of the provisions against insider dealing are subject to monetary fines or may lead to criminal punishment (imprisonment of up to five years), there are no criminal or administrative punishments for violations of the rules of conduct. However, the Federal Supervisory Office for Securities Trading has certain administrative rights. In addition, violations of the relevant provisions of the Securities Trading Act can lead to private law liability in tort with respect to the damaged customers.1 IV. The German Bond Market The German bond market, which occupies an important position in Europe, has undergone dramatic changes over the last few years. Since 1980 the volume of outstanding domestic DM issues has risen by an average of 12% per year. The DM bond market has gained increasing importance as an attractive investment alternative to the US bond market for many international investors. By 1990, the total volume of DM bonds outstanding had roughly doubled. The market for Deutschmark-denominated Eurobonds has experienced similarly rapid growth. Measured in terms of the nominal amount of bonds outstanding, the German bond market ranks third in the world after the US and Japanese markets. In terms of net sales of fixed interest securities, it has been the second largest market since 1992 by international standards. The most important German long-term government bonds are Federal bonds (Bundesanleihen, commonly known as Bunds). Bunds traditionally have been the main long-term borrowing vehicle of the Federal government since they were first issued in 1952. They play a key role in the German capital market and in financial transactions with non-residents. Bunds are issued with 10-year maturities in minimum denominations of DM 1,000 by the Federal Bond Consortium under the lead management of the Bundesbank. The members of the Federal Bond Consortium are credit institutions located in Germany which engage in securities business and have significant power to place federal securities. Until July 1986 the range of syndicate banks was limited to German institutions; thereafter foreignowned, legally independent credit institutions located in Germany were also admitted as members. Since 1992, membership of the Federal Bond Consortium is, in principle, also open to legally dependent branches of foreign banks.

1

See infra Horn, chapter 5, V.

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Trading of bonds is either on the exchange or over-the-counter (OTC). The bulk of daily turnover is in the OTC market. Over the past few years, almost all trading in bonds on the exchange in Frankfurt was in public bonds. During official exchange trading, a fixing price for all bonds is settled, via open outcry, at which the highest turnover can be made for the given orders at that specific moment. The fixing on all eight national exchanges is managed by official brokers who are supervised by the local finance ministry. V. The German Stock Market On a European comparison, Germany ranks second in terms of market capitalisation with a share of 13.5% of the European index, followed closely by France. The UK remains the unchallenged leader with a proportion of more than 34%. The global share of market capitalisation accounted for by German stocks is 3.9% in terms of Morgan Stanley's world index. This share is unrepresentative in so far as the gross domestic product (GDP) accounts for a much larger proportion, i.e. 11.6% of the world total. Three domestic indices are of particular relevance for the German stock market: • The DAY" index is composed of the 30 most actively traded German blue chip stocks. It represents over 60% of the total equity capital of German exchangelisted companies. • The MDAX contains the 70 continuously traded stocks which, in terms of market capitalisation and trading volume, follow the 30 DAX shares. • In addition, the DAX 100 reflects the trend in the share prices of the 100 largest, most actively traded German companies listed. The main criteria for including a stock corporation in one of these three indices are the volume of trading within the last 12 months and the market capitalisation. VI. Stock Exchanges In Germany, there are eight stock exchanges, namely in Frankfurt, Düsseldorf, Hamburg, Munich, Berlin, Bremen, Hannover and Stuttgart. The Frankfurt Stock Exchange (Frankfurter Wertpapierbörse) is by far the largest and most important player. In 1996, the Frankrurt Stock Exchange recorded an overall volume of DM 5,827 billion for the period of time between January and October, ranking fourth after New York, Tokyo, and London. The Frankrurt Stock Exchange has three groups of exchange participants: banks, specialist brokers (Kursmakler), and independent brokers (Freimakler). With respect to their legal form, the German stock exchanges are public law institutions. The Frankrurt Stock Exchange is owned and operated by the German

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Stock Exchange Corporation (Deutsche Börse AG), the latter having taken over the responsibility for the Frankfurt Stock Exchange from the Chamber of Industry and Commerce. As the responsible institution (Träger), this Corporation provides the human, material and financial resources that allow the Exchange to function and to offer all market participants an environment in which to engage in securities trading. Banks are the majority shareholders of the Deutsche Börse AG, holding an 81% ownership stake. Foreign banks make up over 40% of member banks, reflecting the international outlook and significance of the Frankfurt financial marketplace. Aside from operating the Frankfurt Stock Exchange, the German Stock Exchange Corporation also operates the German Futures and Options Exchange (Deutsche Termin Börse, DTB). The latter was created in 1990, in acknowledgement of the global trend towards using derivatives as a means of portfolio risk management. When the exchange opened for trading, it began with options on 14 German stocks. Since then, the amount of stock market index futures and options on German stocks has grown steadily. 1. Placement Between 1977 and May 1997 there were 246 initial public offerings in the German capital market, including six privatisations of government-owned companies, 15 spin-offs, 12 initial public offerings of large-scale enterprises, and 213 of mediumsized companies. The main event for the German equity market in 1996 was the privatisation of the Deutsche Telekom, the largest single equity issue in German financial history. It reflects the development of the German equity market and the potential for privatisation of further government-owned companies. The legal requirements applying to the placing of securities in Germany largely depend on whether a private placement or a public offering is involved. A private placement is generally understood to be a placement addressed to a limited number of investors; a public offering would be addressed to an undefined number of persons, with the offerer having no specific relationship to the parties addressed. A share offering is deemed to be public if it is directed to the general public by any form of media, soliciting purchase orders. By contrast, an offering is deemed not to be public if it is directed at a limited group of persons, i.e. persons who are individually known to the issuer, approached by the issuer, selected on the basis of individual criteria, and who do not need, in view of their specific knowledge, disclosure by way of a sales prospectus. Accordingly, for an offer to qualify as a private placement, a relationship between the offeror and the investor must have already existed at the time of the offer. Private placements of securities are generally accepted and are not subject to any special restrictions under German law. In particular, they do not need to be listed on an rospectus has been published in accordance with the Securities Sales Prospectus Act.

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Any violation can trigger a variety of sanctions by the Federal Securities Trading Supervisory Office. However, certain exceptions apply with regard to the type of offer (e.g., to a restricted group of people), or issuer, or with regard to specific securities (e.g., Euro-securities). 2. Listing Before being accepted for trading on a German stock exchange, securities must be officially admitted by the relevant authorities. The requirements for such admission depend on the market segment concerned. Securities in the first and second segment must undergo a formal listing process. This process is designed to ensure the prescribed disclosure of information for the investing public. Of course, the most important listing requirement is the publication of a listing prospectus which has been approved by the stock exchange concerned. Only bonds issued by the German Federal Government, the federal states, or the European Union are exempt from the formal listing process. 3. Trading Securities transactions which do not concern new issues or bonds must be done by intermediaries (banks or brokers) on commission. The commissioned bank or broker deals in its own name, but for account of customers. Banks can also trade for their own account. Customer buy and sell orders are only allowed to be brought to the exchange by the banks themselves. Orders are either specified precisely by the bank customer or are unlimited, in which case the transaction is conducted at the best price available. All buy and sell orders are entered in the order ledgers of the official brokers. Transactions conducted under the system of fixed prices are negotiated at least once a day during the exchange trading session, usually at noon. These are generally odd lots or small orders for a listed security. The highest volume securities are traded and continually re-priced in the listings throughout the floor trading session, between 10.30 am and 1.30 pm. Contracts in these securities are transacted by the stock exchange firms at the prevailing market price - otherwise known as the "continuous price". Floor trading has been supplemented by electronic trading since 1991, when IBIS (integrated stock exchange trading and information system) was first introduced. This fully computerised system makes it possible for domestic and foreign exchange participants to trade from 8:30 am to 5:00 pm (Frankfurt time) not only the 30 blue chips contained in the D AX index but also the next 70 stocks (in terms of market capitalisation and trading volumes) included in the German MDAX index as well as other high turn-over stocks, warrants, government bonds, and selected foreign DM bonds. At the end of this year IBIS will be replaced by XETRA, the new electronic trading system for the cash market. It will set new standards of liquidity, perform-

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ance, and cost-effectiveness in trading and settlement. The XETRA market model provides for two trading forms: auctions and continuous trading. A central order book offers market players equal access to the setting of prices. Equality of opportunity is also facilitated through decentralised access to the market. XETRA will thus enhance the ongoing trend of internationalisation by further expanding access to DM securities business with a system that can be used from any location and at low cost. In 1995 the Federal Banking Supervisory Office issued a statement concerning minimum requirements for the trading activities of banks institutions, setting forth: • general requirements concerning the responsibility of the management, qualification and behaviour of the staff, and preservation of documents; • risk controlling and management requirements (e.g., the use of risk limits, proper documentation, and rules on business risks); • requirements on the organisation of trading activities (e.g., separation of trading and back office, monitoring of risk positions); • requirements on audits; and • rules for special types of transactions (e.g., forex dealings). 4. Exchange Market Segments Within the framework of the stock exchange three market segments exist: • First segment trading (official market, Amtlicher Handel). Most blue chip companies, and certainly the larger and well-known companies, are traded in this segment. • Second segment trading (regulated market, Geregelter Markt). This is a semiofficial market whose admission regulations are less rigorous and also cheaper to comply with. • Third segment trading (Freiverkehr). Very few formal listing requirements are demanded in this trading segment. Aside from a few German equity securities, trading activity mainly revolves around traded options and foreign stocks. In addition, the German Stock Exchange recently launched a new initiative for the German stock market: the New Market (Neuer Markt). This is a new and independent trading segment of the Frankfurt Stock Exchange, to which the statutory minimum standards of the regulated market apply, but which extends beyond it as far as the preconditions of admission to the market and consequential

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duties are concerned. The key purpose of the special requirements imposed on the issuers is a high degree of transparency. The initiative intends to bring together growth companies and risk-conscious investors. The target group of the New Market includes, above all, small and medium-sized innovative growth enterprises with an international orientation and a willingness to adopt an active investor relations policy. 5. Settlement and Clearing In the securities business German law distinguishes between the initial transaction (purchase or sale) and its settlement (delivery and payment). The settlement of traded securities normally requires that payment and delivery of securities are made on the second business day following the trading day. Domestic settlement and clearing are usually completed via the central depository, Deutscher Kassenverein (DKV, soon to be renamed Deutsche Börse Clearing), a German securities clearing and deposit bank which can be used only by banks. The DKV belongs to the Deutsche Börse AG and is responsible for the settlement and collective safecustody of securities, whereby it cannot be held liable for counterparty default. VII. Regulatory Reform Capital markets in Germany are expanding and changing. As a consequence, market sophistication is constantly increasing. The regulatory framework of capital market transactions reflects such changes by more and more amendments to existing statutory and regulatory provisions. The sixth Amendment to the German Banking Act supplies impressive evidence for the legal adaptation of Germany's financial and capital markets. Here is just one example. While the purchase and sale of securities for the account of others (securities business) had always been defined as banking business under German law, the underwriting and issuing of securities did not yet constitute such banking business. This will be changed by the sixth Amendment to the Banking Act; accordingly, primary market activities will also be qualified as banking business requiring a license. This requirement is general, irrespective of whether such business is conducted through an entity incorporated in Germany or through the German branch of a foreign entity. However, the amendment to the Banking Act will by no means be a final step in the regulatory changes in the German banking and financial services industry. In addition, the so-called Third Financial Market Enhancement Act, which took effect on January 1, 1998, intends to amend the existing stock exchange and securities trading law. Among the amendments in this area are the following: • shortening of the period of limitation for prospectus liability with respect to a listing prospectus (official listing), a business report (unofficial listing), as

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well as a sales prospectus (publicly offered securities not admitted to trading on a German exchange), from five years to a maximum of three years; abolition of the minimum time of existence of an issuer in order to support young enterprises in applying for inclusion in the regulated market; recognition of prospectuses of foreign issuers in a foreign language under certain conditions (e.g., assuring satisfactory information for investors); facilitation of a listing without listing prospectus if the securities of the issuer are already officially listed for at least three years in another member state of the European Union or the European Economic Area; shortening of the time period between the issue of a listing prospectus and the start of trading from three days to one day; and increase of the possible administrative fines in connection with a violation of the Securities Sales Prospectus Act to a maximum of DM 1 million. VIII. Legal Implications of EURO2 The current implementation of the European Monetary Union will largely benefit market transactions since they will become domestic transactions for currency purposes. The changeover to the new single currency is expected to commence on January 1, 1999 with the European Council fixing the conversion rates as between the different national currencies and the EURO. After a period of dual circulation the EURO will finally replace all former national currencies by July 1, 2002. It is becoming increasingly probable that the forthcoming European Union and the resulting introduction of the EURO will have a major influence on the development of the European capital markets. Given that the German stock exchanges have already announced that all listed securities will be quoted in EURO as of January 4, 1999, shares need to be redenominated. A conversion mechanism for the existing Deutschmark-denominated shares will soon be presented by the German legislator. The governments of participating Member States are also expected to take measures to redenominate some or all of their outstanding bonds. It still has to be seen whether the German capital market will maintain its important position in Europe once the Deutschmark ceases to exist. However, given the strength of the German economy, the competence of German market participants and the quality of the technical infrastructure, there is reason to be optimistic. From a legal perspective, it is probably fair to say that the German system of securities and stock exchanges is well prepared to meet the challenge of the future.

2

See also supra Horn, chapter 2.

Chapter Five The Internal Market for Banking and Investment Services Norbert Horn

I. Introduction: EMU and the Various Approaches to Create an Internal Financial Market The establishing of the European System of Central Banks (ESCB) and of the European Central Bank (ECB) in summer 1998, together with the introduction of the single currency on January 1, 1999, are a unique historical process and experiment. The EMU is designed to promote both political and economic integration of the Member States,1 as set forth in the Treaty on the European Union.2 One of the most important economic effects of EMU will be the achievement of an internal financial market as envisioned in Art. 7a EC Treaty (Art. 14 TA).3 The term "financial market" comprises both capital and money markets and will be functionally defined here as a market for banking and investment services.4 For such an integrated market, a single currency is extremely important if not indispensable. We will first look at the direct effects the introduction of the euro will have on the financial market (infra Part II). However, the integration of the national financial markets of Member States into one internal market of the Community could not be brought about by a single currency alone. Stage 3 of EMU appears to be a final step in a long and difficult path towards market integration. If we try to analyze the process preceding the introduction of the single currency, looking at

For a critical appraisal of the EMU in its political context, see Norbert Horn, European Monetary Union: Legal and Institutional Aspects in their Economic and Political Setting, 13 Journal of International Banking Law [JIBL] 71 (1998). 2

Arts. B-F. l EU Treaty (Arts. 2-7 as amended by the Treaty of Amsterdam).

3

EC Treaty refers to the Treaty Establishing the European Community, hereafter also referred to as "ECT." The future article numbers of the ECT are determined by the Treaty of Amsterdam ("TA") of Oct. 2, 1997, and are indicated in parentheses. 4

On the broader term "financial services", see infra part IV. 1.

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the regulatory and institutional framework of financial markets from a lawyer's point of view,5 we have to take into account at least three different layers of regulations and institutions: the establishing of freedom of payment and capital flows in the EC Treaty (infra Part III), the harmonization of supervisory laws for banks and other investment service providers (infra Part IV), and the development of harmonized rules for market operations (infra Part V). Given the great number of regulations, this analysis can only be carried out in a strictly selective way. We must also consider the persisting divergence of national laws, particularly in the field of private law (infra Part VI), and try to evaluate the degree of integration reached (infra Part VII). The achievement of an internal financial market within the EMU does not exclude other countries. Many integrative steps have been taken for all Members of the European Union, including non-participants in EMU. Many of the steps apply to the European Economic Area and some of them to many other third countries (infra Part VII). II. The Integrative Effects of Stage 3 of EMU 1. A Large Transaction Domain Stage 3 of the EMU means the sudden creation of a large monetary area as a large transactions domain within the eleven participating States. The invisible boundaries of their national markets constituted by their national currencies with variable exchange rates will disappear. As the size of a single currency area determines its liquidity, the euro monetary area will provide increased liquidity compared to previous liquidity in the individual national currency areas.6 This has a number of different effects. First, we can expect a sudden, once and for all increase in the European monetary supply with proportionate inflationary effects. The ECB will have to cope with this problem. On the other hand, the larger a monetary area, the better it can act as a cushion against shocks. The enlarged monetary area of the euro will be the basis for an enlarged and more effective single financial market. The different interest rates existing until now in the various national capital markets of the eleven States will disappear, to the extent that they reflect different levels of monetary stability and different national economic policies. The only remaining differences in interest rates will be those reflecting different credit standings of the individual issuers. With regard to public debt, it is unlikely that

5

Setting aside monetary laws and institutions of the EMU itself; see Horn, European Monetary Union, supra note 1. 6

Robert A. Mundell, International Consequences of the Euro, 1998 österreichisches Bank Archiv [ÖBA] 503.

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creditors and bondholders will make a distinction between the various member countries, even if these countries are in different economic situations. The market is unlikely to believe in the "no-bailing-out-rule"—the strict application of Art. 104b ECT (Art. 103 TA)—which excludes any liability of the Union or its Member States for the debts of another Member State. Investors and lenders would rather give credit to a government, even if it is in economic difficulties and has accumulated a heavy public debt. They will trust that the Union will not leave that Member State alone without help. The progress in market integration enhanced by the single currency will expose the banks to stronger competition both in lending and banking. Margins will shrink in corporate finance for large companies with access to all sectors of the integrated market. By that time, cross border competition may also be felt in consumer credit. The same is true with respect to investment services offered to the private clients. 2. A Euro Market for Bonds and Stocks The new euro area will have a single bond market for issuers of international standing, to the extent that it does not technically and legally conflict with individual country rules, whose subsequent amendment should be considered. It will offer all the advantages of a large market: e.g., enhanced liquidity of the bonds issued. In the beginning of stage 3, the redenomination of outstanding national debts and corporate bonds from local currencies to euros will create the necessary momentum for a functioning market. The euro area will swiftly create a vast single market in euro-dominated bonds, comparable to the market of the United States. The quick change to bonds issued in euros—in particular, for national debts as intended in Art. 8(4) of the regulation on the introduction of the euro7—can quickly create a critical mass for a functioning euro bond market, as suggested by the Commission in its Green Paper of May 1995." In the initial phase, however, one must reckon with a certain narrowness in the secondary market. We should also note that this new bond market will not mean a dramatic change or progress in international financial markets. An international market for bonds denominated in a hard currencies like the U.S. dollar or the deutschmark has developed since the late sixties in Europe ("eurobond market")9 and elsewhere. Council Regulation (EC) No. 974/98 of 3 May 1998 on the introduction of the euro, 1998 O.J. (L 139) 1. * European Commission, Green Paper on the Practical Arrangements for the Introduction of the Single Currency, (31 May 1995) COM(95) 333 final. 9

On the development of the eurobond market, see Norbert Horn, Das Recht der internationalen Anleihen (1972); Norbert Horn, A Uniform Approach to Eurobond Agreements, 9 Law & Pol'y in Int'l Bus. 753 (1979). See also Ulf R. Siebel, Rechtsfragen internationaler Anleihen (1997).

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Large parts of this international bond market will simply be substituted by the new market for euro-denominated bonds. The integration of national stock markets into one internal market will equally be enhanced. Already before stage 3 of the EMU, stock of major European companies with an international reputation were traded in a number of different stock exchanges throughout Europe and beyond. In the future, the prices for these stocks will be denominated in the same single currency. This will in time make it easier for large companies to float new shares throughout the euro area and thus, facilitate their access to an enlarged capital market. This enlarged capital market is heralded by an agreement between the Frankfurt and the London stock exchanges in the summer of 1998, establishing a uniform quotation of approximately 300 stocks in Frankfurt and London beginning the first business day after the introduction of the euro. It has been suggested that the American technique of issuing asset-backed securities of special purpose vehicles will be enhanced by the new single eurocapital market.10 This is possible, but we should not forget that in a number of countries, as in Germany, the liquidity needs of enterprises have already been satisfied through revolving credits or credit facilities secured by floating charges or revolving security schemes. Whether and to what extent other segments of the national markets for banking and investment services will be integrated into one internal market of the Community depends largely on the legal framework for these services, which will be discussed below. III. Freedom of Payment and Capital Movements in the EU 1. The Liberalization Process At the beginning of stage 2 of EMU on January 1, 1994, the new provisions of the EC Treaty adopted in Maastricht on the liberalization of capital movements and payments became effective. The new Art. 73b ECT (Art. 56 TA) prohibits "all restrictions on the movement of capital between Member States and between Member States and third countries" (para. 1). The same rule applies to payments (para. 2). Payments have been defined by the European Court as the current tansfer of money in exchange for the delivery of goods and services.11 The liberalization of such current payments had long since been established by virtue of Art. 106 ECT (Art. 107 TA) and, with regard to payments related to capital such

10

Gilles Thieffry & Jonathan Walsh, Securitization: The New Opportunities Offered by Economic and Monetary Union, 12 JIBL 463 (1997). 11

Luisi & Carbone v. Ministero del Tesoro (Joined cases 286/82 and 26/83), [1984-1] E.C.R. 377,404 (para. 21).

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as the transfer of interest and dividends, pursuant to former Art. 67(2) ECT.12 The liberalization of payments and all other current money transfers follows from Art. VIII, section 2(a) of the Articles of Agreement of the International Monetary Funds (IMF). The new Art. 73b(2) ECT (Art. 56(2) TA) merely codified the already existing practice of the complete liberalization of payments. The situation was quite different with regard to the free movement of capital, defined by the European Court of Justice as "financial operations essentially concerned with the investment of the funds in question rather than remuneration for a service."13 Art. 67(1) ECT provided the freedom of capital movement only "to the extent necessary to ensure the proper functioning of the common market". The European Court concluded that Art. 67 ECT on the freedom of capital movements was not directly effective in the same way as the provisions on freedom of establishment and of the movement of goods and services.14 Moreover, the old Art. 73 ECT (repealed in 1994) allowed Member States to introduce capital market restrictions to protect their own capital markets. The situation only changed in 1988, when the EC Council decreed Directive 88/361 on capital liberalization that ensured the freedom of capital movements in and between eight Member States.15 The new Art. 73b ECT (Art. 56 TA) completed this new development in 1994 when it established the principle of complete freedom of capital movements, prohibiting all restrictions.16 Remarkably, this freedom is extended to capital flows between Member States and third countries. As the Articles of Agreement of the IMF do not require a liberalization of international capital transfers, Art. 73b(l) ECT (Art. 56 TA) is a most important contribution to such international liberalization. 2. Remaining Restrictions: Third Countries We should note that the new EC Treaty provisions still contain some restrictions on the principle of complete freedom of capital movements. Art. 73d ECT (Art. 58 TA) specifies the extent of the liberalization and allows Member States to continue the exercise of certain restrictive State measures: in particular, with respect to tax law—as far as it distinguishes between the residence or place of investment

12

Art. 67 is obsolete since 1994 and was repealed by the Treaty of Amsterdam in 1997.

13

Luisi & Carbone v. Ministero del Tesoro, supra note 11.

14

Criminal proceedings against Guerrino Casati (Case 203/81), [1981-8] E.C.R. 2595,2614-15.

15

Council Directive 88/361/EEC of 24 June 1988 for the implementation of Art. 67 of the Treaty, 1998 O.J. (L 178) 5; Norbert Horn, Bankrecht auf dem Weg nach Europa, 1989 Zeitschrift ftlr Bankrecht und Bankwirtschaft [ZBB] 107, 109; Reno Smits, Freedom of Payments and Capital Movements under EMU, in Währung und Wirtschaft: Das Geld im Recht (Festschrift ftlr Prof. Dr. Hugo J. Hahn zum 70. Geburtstag) [Festschrift Hahn], at 245, 248 (Albrecht Weber ed., 1997). 16

Smits, supra note 15, at 249 et seq.

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of taxpayers—or with respect to distinctions that flow from restrictions on the right of establishment that are compatible with the EC Treaty. Furthermore, each State is entitled "to take measures which are justified on grounds of public policy or public security" (Art. 73d(l)(b) ECT, Art. 58 TA). With regard to the relations between Member States and third countries, further-reaching restrictions on capital flows and payments are allowed under Arts. 73c, 73f, and 73g ECT (Arts. 57, 59, and 60 TA). Art. 73c(l) ECT allows the continued application of restrictions that exist under national or European Community law with respect to the movement of capital to or from third countries involving direct investment (including real estate), establishment, the providing of financial services, or the admission of securities to capital markets. The European Court made it clear in the Sanz de Lera case17 that these restrictions are to be construed narrowly and do not leave room for discretion of the Member States or the Community legislature to apply other types of restrictions. Furthermore, the Council may, acting by a qualified majority on a proposal from the Commission, adopt measures on the movement of capital to or from third countries involving direct investment (including real estate), establishment, the providing of financial services, or the admission of securities to capital markets (Art. 73c(2)l and 2 ECT, Art. 57 TA). In exceptional circumstances, the Council may take safeguard measures with regard to third countries for a period not exceeding six months (Art. 73f ECT, Art. 59 TA). Finally, in the context of a decision under Art. 228a ECT (Art. 301 TA) on common political measures and economic sanctions against third countries, the Council may take the necessary urgent measures on the movement of capital and on payments such as the blocking of accounts or other freezing measures (Art. 73g(l) ECT, Art. 60 TA). In such a situation, even a Member State is entitled to take unilateral measures against a third country as long as the Council has not taken such measures (Art. 73g(2) ECT, Art. 60(2) TA). In summary, the EC Treaty still contains substantial restrictions on the free flow of capital in two respects. First, Member States are allowed to maintain certain restrictions and introduce others, even towards fellow Member States, in the cases described in Art. 73d ECT (Art. 56 TA). This includes measures justified on grounds of public policy or public security. In this manner, the important legal boundaries of the national financial markets are preserved." Second, the EC Treaty still makes a distinction between the internal relations among Member States on the one hand and the relations to third countries on the other, despite the seemingly clear wording of Art. 73b ECT (Art. 56 TA) omitting such a distinc17

Criminal proceedings against Lucas Emilio Sanz de Lera and others (Joined cases C-163/94, C165/94, and C-250/94), [1995-12] E.C.R. 1-4821,1-4842-43 (para. 44-47).

18

Seidel, Recht und Verfassung des Kapitalmarktes als Grundlage der Währungsunion, in Gedächtnisschrift Grabitz at 763, 770 et seq. (1995).

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tion.19 With respect to relations to third countries, the EC Treaty does not abolish existing restrictions on capital movements, but tries to freeze these restrictions. However, even measures that would constitute a "step back" in the liberalization on the movements of capital to or from third countries remain possible if such measures are taken by the Council on the basis of a unanimous vote (Art. 73c(2)2 ECT, Art. 57 TA). The new provisions make it clear, however, that further restrictions on capital movements to or from third countries have become a matter of the Community and only remain a matter of a single Member State in exceptional cases.20 IV. A Level Playing Field for Market Operators 1. Financial Services and the Freedom of Establishment and Services under the Treaty The term "financial services", in the language of the European Community, includes banking, insurance, fund management, and investment services. An integrated "internal" market for financial services as envisioned in Art. 7a(2) ECT (Art. 14 TA) presupposes, among other things, that all market operators have an unrestricted access to all parts of this market's territory, i. e., that they can act within all Member States of the E.U. This is not so much a question of freedom of cross-border capital flows, but instead, a question of freedom of establishment under Art. 52 ECT (Art. 43 TA) et seq. and of the freedom of services under Art. 59 ECT (Art. 49 TA) et seq. In fact, these freedoms are the legal basis for the regulatory measures taken in the Community to create a level playing field for actors in the market for financial services. One may ask why the freedom of establishment and the freedom of services have not been used earlier as a legal basis for the liberalization of banking services. Art. 61(2) ECT (Art. 51 TA), however, limits the obligation to liberalize banking services to the extent that capital freedom is liberalized. As a consequence of this linkage, the liberalization of the free flow of capital in 1988, as described above in Part III, was necessary before the full freedom of services could also be applied to banking. The main obstacle for the unrestricted access to all parts of the market was created by the many separate and differing national supervisory laws to which the operators in markets for financial services were subjected. It was necessary to simplify and harmonize these supervisory laws and regulations. The necessary 19

Smits, supra note 15, at 250; Patrick Juillard, Lecture critique des Articles 73B, 73C et 73D du Traite" de Communauto Europoenne, in Festschrift Hahn, supra note 15, at 177. 20 Smits, supra note 15, at 256. For serious political reasons and on grounds of urgency, a Member State may take unilateral measures against a third country with regard to capital movements and payments as long as the Council has not taken measures. The council may subsequently amend or abolish such measures (Art. 73g(2)2 and 3, Art. 60 TA).

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measures have been taken in all fields of financial services. In the following, we will focus on banking and investment services. 2. Free Movement of Banking Services: the European Passport for Banks The decisive steps for establishing a common market in banking services were taken in 1989. In that year, the Second Banking Directive 89/646/EEC21 was adopted and subsequently came into force on January 1, 1993. It amended the First Banking Directive22 through new rules to promote and achieve the integration of the common market in banking services. Also in 1989, the Own Funds Directive 89/299/EEC23 to harmonize the capital adequacy requirements for banks, and the Solvency Ratio Directive 89/647/EEC24 for the harmonization of prudential control of credit institutions were adopted. These three Directives, taken as a whole, were a breakthrough in the long-lasting debate on the integration of the banking market in the Community.25 This integration had to be carried out in the field of banking supervisory law.26 As the adoption of a true uniform banking supervisory law for the whole Community was out of reach, the integration was brought about through a combination of two policies: (1) the mutual recognition of national banking licences, and (2) a minimum harmonization of the supervisory laws of Member States at a Community level. Since 1993, credit institutions licenced to do business in one Member State have been able to extend their banking services beyond their domestic market to any or all other Member States of the Community. They may do this through branches or direct service without separate licences from the competent banking authorities in the host States. If a bank does business in another Member State

21

Second Council Directive 89/646/EEC of 15 December 1989 on the coordination of laws, regulations and administrative provisions relating to the taking up and pursuit of the business of credit institutions and amending Directive 77/780/EEC [Second Banking Directive], 1989 O.J. (L 386) 1. 22

First Council Directive 77/780/EEC of 12 December 1977 on the coordinating of the laws, regulations and administrative provisions relating to the taking up and pursuit of the business of credit institutions, 1977 O.J. (L 322) 30. 23 Council Directive 89/299/EEC of 17 April 1989 on the own funds of credit institutions, 1989 O.J. (L 124) 16. 24 Council Directive 89/647/EEC of 18 December 1989 on a solvency ratio for credit institutions, 1989 O.J. (L 386) 14. 25 Horn, Bankrecht auf dem Weg nach Europa, supra note 15, at 110 et seq.; Norbert Hörn Entwicklungslinien des europäischen Bank- und Finanzdienstleistungsrechts, 1994 ZBB 130 et seq.; George S. Zawos, The Integration of Banking Markets in the EEC: The Second Banking Coordination Directive, 3 JIBL 53 (1988). 26 See generally, Louis et al., Banking Supervision in the European Community: Institutional Aspects (Brussels, 1995).

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through a subsidiary, however, the subsidiary, as a legally independent entity, needs a banking licence from the authorities of the country where it is situated. At the same time, the subsidiary is included in the control of the parent bank's consolidated capital by the authorities of the parent's home country.27 The principle of mutual recognition thus makes the bank's home State license a "European passport" that provides access to the whole market for banking services within the Community. The principle of mutual recognition is accompanied by the concept of home country control, equally incorporated in the Second Banking Directive. A bank incorporated and licensed in one Member State remains subject to its home State supervision and regulation with respect to its operations in other countries, with a few exceptions.28 A bank seeking to expand its activities to other Member States must receive prior authorization from the authorities of its home State.29 The Second Banking Directive follows a rather broad concept of banking services to be offered throughout the Community, ranging from opening an account to securities transactions, loans, or portfolio management.30 No distinction is made between investment banking and commercial banking. The Second Banking Directive, however, did not include a number of financial activities such as leasing. As a result, a wider concept of banking services has been advocated.31 The principle of mutual recognition of bank licences and continuing home country control implies that each Member State must be able to trust the quality of banking supervision of fellow Member States. This was possible only through a harmonization of the supervisory laws and standards of Member States to make them equivalent. This was ensured by the three Directives mentioned above. 3. Free Movement of Investment Services: the European Passport for Investment Service Providers The Investment Services Directive 93/22/EEC of May 10, 1993,32 which came into force on January 1, 1996, largely follows the model of the Second Banking Directive when it paves the way for an integrated ("internal") market for invest27

Troberg, in Schimansky et al., Bankrechts-Handbuch HI §35 Rz.25 (1997).

28

See e. g., Art. 14(2) Second Banking Directive that confers competence on the host State to monitor and supervise the monetary policies pursued by foreign banks; see also Horn, Bankrecht auf dem Weg nach Europa, supra note 15, at 111. 29

Art. 19, Second Banking Directive, supra note 21.

30

Annex to Art. 18, Second Banking Directive, lists 14 different types of banking activities, supra note 21. 31 32

Horn, Bankrecht auf dem Weg nach Europa, supra note 15, at 112.

Council Directive 93/22/EEC of 10 May 1993 on investment services in the securities field, 1993 O.J.(L 141)27.

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ment services in the field of securities. Through this directive, the freedom of establishment and the freedom of services for the securities investment field were founded. The legal scope of the directive includes securities law, stock exchange law, financial services law, and bank supervisory law, because the stocks and bonds business has traditionally been a banking business, seized on a large scale by full service banks. Since 1996, investment service providers can obtain from the competent authority in their home State a licence to do business, which also functions as a "European passport" for extending their services to all Member States of the Community. The "European Passport" for financial service providers was modelled after the "European Passport" for banking institutes created by the Second Banking Directive. There were significant differences for businesses that did not fall within the traditional concept of banking under national banking law because of the harmonized supervisory law created by the Investment Services Directive. For example, in England more so than in Germany, many firms that offered certain financial services but did not fall within the scope of banking regulation, eventually fell within the broader notion of "investment services." Under Art. 1(1) of the Investment Services Directive, stocks and bonds commission firms with investors, property administration firms for investors, issuing firms, single trade firms, and pure investment brokerage firms all fall within the notion of "investment services." In the broadest sense, the financial instruments of securities businesses can be stocks, bonds, money market instruments, futures, interest, foreign exchanges, and options. The Investment Services Directive is accompanied by Directive 93/6/EEC on the Capital Adequacy of Investment Firms," which regulates the capital supply of investment services providers. Supervision in this regard also followed the principle of home State control by the supervisory authorities of the State in which a company is based. The "European Passport" authorizes securities firms licensed in their home States to also become members of the stock exchanges in other States. Because this admission of foreign firms to domestic stock exchanges contradicted the legal traditions of all the Romanic States, longer transition periods were provided for them, which last expire for Spain and Portugal in 1999. In Germany, because of the Directive on the Capital Adequacy of Investment Firms, investment service providers are now subject to the banking supervisory law (Kreditwesengesetz; KWG) in the same way as are banks (§1(1 a) KWG).

33

Council Directive 93/6/EEC of 15 March 1993 on the capital adequacy of investment firms and credit institutions, 1993 O.J. (L 141) 1.

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Other aspects of Directive 93/6/EEC have been implemented through the new Securities Trading Act (Wertpapierhandelsgesetz; WpHG).34 4. Further Steps to Harmonize the Laws on Banking and Securities Markets A great number of further measures have been taken in order to promote the integration of the markets for banking and investment services. We should selectively note the harmonization of the law for deposit guarantee schemes of banks throughout the Community through Directive 94/19/EC.35 Directive 94/19/EC prescribes for each Member State guarantee schemes with a minimum protection of 20,000 euros for each customer. The Community's legislature was aware that some countries, like Germany, had reached a much higher level of protection for bank customers with their existing deposit guarantee schemes. This could have led to a competitive advantage for branches of German banks doing business in other Member States with lower levels of protection. Directive 94/19/EC, therefore, prohibits exporting a higher protection level from the home State to the host State. Accordingly, subsidiaries of German banks cannot make use of their relatively higher protection level when acting in other countries. On the other hand, subsidiaries of banks with a relatively lower protection level are obliged to increase their guarantee to the level of the host State in which they operate. The German federal government was not pleased with Directive 94/19/EC and brought claim to declare it null and void. The European Court, however, rejected this claim.36 With some delay, the German legislature implemented Directive 94/19/EC together with the Directive 97/9/EC37 on investor compensation in a new law of 1998 on deposit guarantees and the compensation of investors.38 The problem with the prohibition by Art. 4(1)2 of Directive 94/19/EC on the export of higher levels of deposit protection, however, was not settled. The prohibition infringes on the freedom of establishment. In its judgment, though, the European Court did not take a position on this problem. Fortunately, according to 34

See infra part V; see also Berthold Kusserow, Germany Implements ISD and CAD: the 6th Amendment to the German Banking Act, 11 JIBL 477 (1996). For France, see Philip Woolfson, Implementation of the Investment Services Directive in France, 12 JIBL 24 (1997). 35 Directive 94/19/EC of the European Parliament and of the Council of 30 May 1994 on depositguarantee schemes, 1994 O.J. (L 135) 5. 36 Federal Republic of Germany v. European Parliament and Council of the European Union (Case C-233/94), [1997-5] E.C.R. 1-2405. 3 Directive 97/9/EC of the European Parliament and of the Council of 3 March 1997 on investorcompensation schemes, 1997 O.J. (L 084) 22; Wolfgang Kessel, EU-Richtlinie über Systeme für die Entschädigung der Anleger, 1997 Die Aktiengesellschaft [AG] 313. 38 Einlagensicherungs- und Anlegerentschädigungsgesetz (EAG), BGB1 1998 I, 1842. See Meinrad Dreher, Die neue deutsche Einlagensicherung im Bereich der privaten Banken und das Europarecht, 1998 Zeitschrift für Wirtschaftsrecht [ZIP] 1777.

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Art. 4(1)2, the export prohibition is limited to December 13, 1999. The Commission has until then to determine whether it is still necessary, Art. 4(1)3. Only in the case of necessity does Directive 94/19/EC provide for the extension of the export prohibition. Hopefully, this violation of basic rights will be eliminated after the required review, and a path for Community wide competition in deposit security schemes—if necessary, with minimum standards but without maximum limits—will be cleared. Among the many other directives aimed at the harmonization of banking law, we should finally mention Directive 86/635/EEC of December 8, 1986 on financial statements of banks, and Directives 83/350/EEC and 92/30/EEC on consolidated financial statements of banks.39 A number of other directives concern the harmonization of regulations of stock exchanges, others the harmonization of investment funds on the basis of Directive 85/61 I/EEC of 1985.40 V. Common Rules for Market Operations In recent years, the Community legislature has not concentrated only on regulations concerning the legal status of market operators, such as the licensing and supervision of banks and of investment services providers. Instead, a number of regulations now deal with market operations, i.e., the transactions carried out in financial markets. They impose certain duties on market operators and prescribe rules for their conduct. The main idea behind these regulations is the enhancement of financial market transparency and the proper information of investors. The Investment Services Directive 93/22/EEC contains a number of such duties and transparency rules. Investment service providers under the directive must comply with prudential rules drawn up by the home Member State, including provisions on sound administrative and accounting procedures, on adequate internal control mechanisms, on the protection of investors' ownership rights, on keeping records of transactions, and on the avoidance of conflicts of interest. Furthermore, investment service providers are obliged to act in the best interest of clients and the integrity of the market. They have the general duty to know their client.41 The duty to know clients and to give them the proper information about investment products according to their needs was incorporated into German Law in the Securities Trading Act.42 39

Horn, Entwicklungslinien des europäischen Bank- und Finanzdienstleistungsrechts, supra note 25, at 135. 40 On this Directive and more recent regulartory measures, see Thomas Paul, New German Investment Fund Legislation: Amendments to the Investment Companies Act and the Foreign Investment Act, 13 JIBL 185 (1998). 41 For a short survey, see Woolfson, supra note 34, at 25. 42 Wertpapierhandelsgesetz, Arts. 31 and 32.

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The EEC Sales Prospectus Directive of 198943 has been implemented in Germany through the Security Sales Prospectus Act of 1990,44 equally designed to enhance transparency in the market. The same is true with the harmonization of requirements for the admission to stock exchanges and on the use of prospectus.45 Last but not least, Directive 89/592/EEC46 on insider trading must be mentioned here. This Directive has been implemented through the aforementioned Securities Trading Act, which contains strict disclosure requirements and penal sanctions with respect to insider trading. VI. Remaining Divergencies in the National Laws on Banking and Investment Services 1. Limits to Harmonization Harmonization does not mean uniformity of laws and regulations throughout the Community. There remain differences in national laws implementing the directives. Divergences can be observed both in the laws restricting cross border capital flows (supra Part III.2) and in the laws on the supervision of banks and investment service providers (supra Parts IV.2 and IV.3). We have already mentioned the example that the laws on deposit guarantee schemes for bank customers vary from country to country and do not have the same level of protection. More importantly, the so-called "European passport" (home country control) does not work for subsidiaries (supra Part IV.2). It can be expected that, in one case or the other, the Community and the European Court will have to deal with the question of whether a Member State correctly implemented a given directive or whether there are shortcomings. Even if we take into account the great number of directives in the field of banking and investment services, some of which could not be

43

Council Directive 89/298/EEC coordinating the reqirements for the drawing-up, scrutiny and distribution of the prospectus to be published when transferable securities are offered to the public, 1989O.J.(L124)8. 44 Wertpapier-Verkaufsprospekt-Gesetz now amended as of July 17, 1996, BGB1 I S. 1047. On the new official announcement by the German Securities Trading Supervisory Commission (Bundesaufsichtsamt für den Wertpapierhandel), see Berthold Kusserow & Kurt Dittrich, German Securities Trading Supervisory Commission Comments on Sales Prospectus Requirements, 12 JIBL 113 (1997). 45 See Council Directive 79/279/EEC of 5 March 1979 coordinating the conditions for the admission of securities to official stock exchange listing, 1979 O.J. (L 066) 21; and Council Directive 80/390/EEC of 17 March 1980 coordinating the requirements for the drawing up, scrutiny and distribution of the listing particulars to be published for the admission of securities to official stock exchange listing, 1989 O.J. (L 100) 1. 46 Council Directive 89/592/EEC of 13 November 1989 coordinating regulations on insider dealing, 1989 O. J. (L 334) 30.

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mentioned here, we do not have a complete harmonization of supervisory laws in every respect. 2. National Private Laws Business transactions of banks with other banks and with their customers are governed by private law. The European Community legislature has no general competence to create harmonized or uniform private law. There is, however, a competence with respect to the protection of consumers and investors.47 In fact, a number of directives have been adopted to harmonize certain areas of private law: e.g., the law on consumer credits, the law on standard clauses in consumer contracts, and the aforementioned directive on investment services, which has established a duty of the investment services provider to inform his client or investor properly. There remain, however, differences in the level and methods of protection in a number of areas. For example, the German Stock Exchange Act protects private investors against the risks of futures contracts. Such contracts are only binding for private investors if the investors have previously been informed about the risks of such transactions through a written communication, accompanied by oral explanations if necessary.48 A private investor not duly informed can use this fact as a defense against the payment of claims. In one case, a German investor concluded a futures contract in Austria and suffered a subsequent loss. When he was sued for payment in Germany, his defense was that he was not duly informed because Austrian law does not impose a duty of disclosure. He claimed that he was not liable, because such liability would violate German public policy (prdre public). The Federal Court held that the investor was nevertheless liable under Austrian law and that German public policy does not prohibit the recognition of the validity of such a futures contract under the applicable Austrian or German law.49 The decision is in line with a tendency in Community law of national courts respecting the laws of other Member States as equivalent to domestic law50 and restraining the application of domestic public policy.

47

Norbert Horn, EG-rechtlicher Verbraucherschutz im deutschen Privatrecht, in Norbert Hörn et al., 40 Jahre Römische Verträge—Von der Europäischen Wirtschaftsgemeinschaft zur Europäischen Union at 151 (1997). 48 Norbert Hörn, Börsentermingeschäfte nach neuem Recht, 1990 ZIP 2. 49 1998 Wertpapier-Mitteilungen [WM] 1176. 50 Jürgen Basedow, Der kollisionsrechtliche Gehalt der Produktfreiheiten im Europäischen Binnenmarkt: favor offerentis, 59 Rabeis Zeitschrift für ausländisches und internationales Privatrecht [RabelsZ] l, 3 et seq. (1995); Stephanie K. Giesberts, Anlegerschutz und anwendbares Recht bei ausländischen Börsentermingeschäften 134 et seq. (1998).

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VII. Market Integration with Open Boundaries 1. Open Boundaries The many legal measures described to establish the freedom of cross border capital flows and a level playing field for market operators and their transactions do not have an excluding effect with respect to third countries. We have seen that the new provisions on freedom of capital movement in the EC Treaty (Art. 73b ECT, Art. 56 TA) also cover the relation to third countries with some restrictions (supra Part III.2). Furthermore, the Community has entered into agreements on the liberalization of capital movements with third countries. The most important agreement in this respect is the Treaty on the European Economic Area (EEA) of May 2, 1992. It contains provisions on the liberalization of payment and capital movements in the EEA based on the principles found in the Community law prior to the new regulation in 1994.51 The harmonization of banking supervisory laws has been extended to the EEA so that the principle of mutual recognition of banking licences and home country control (the "European passport") applies in the entire European Economic Area." Some of the harmonization even goes beyond the boundaries of the EEA. The requirements for the ownership of capital by banks, worked out by the Basel committee, have set standards for the capitalization of banks observed in many countries outside the EC, including the United States.53 2. Enhanced Market Integration The establishment of the principle of full freedom for transborder capital flows within the Community (supra Part III) and the many measures taken to harmonize and simplify the supervisory laws and market rules for banking and financial services (supra Parts IV and V) have remarkably improved the legal prerequisites for the development of a truly integrated internal financial market for the European Community. The divergencies in national laws did not disappear entirely (supra Part VI. 1), which reminds us that national boundaries still exist. More importantly, from the years of the new liberalization efforts described (1988 and 1994) until the beginning of stage 3 of the EMU in 1999, one cannot say that the national financial markets, with their distinct market operations and customer relations, disappeared. Integration was incremental, not dramatic. Access to a

51

Kommentar zum EU/EG-Vertrag (I) 1582 et seq. (Hans von der Groeben et al. eds., 5th ed. 1997). 52 Agreement on the European Economic Area and the protocol of Oporto adjusting it, 1994 O.J. (L 1); Smits, supra note 15, at 246 n.5. 53 Horn, Entwicklungslinien des europäischen Bank- und Finanzdienstleistungsrechts, supra note 25, at 141.

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given national market is still carried out through mergers and acquisitions of domestic banks with established customer relations rather than by opening new branches in a host country. One may say, however, that the legal and de facto level of integration reached layed the groundwork for the boost in integration we can expect from the EMU. The integrative effects of the single currency are in fact substantial, as described. They will not yet make the national or local financial markets disappear entirely. Rather, we will have an integrated market with many local markets as subparts of the market system. These local (national) markets, however, will be more or less open to the integrated market. Market integration will be most efficient with regard to big transactions with customers of international standing (corporate finance, syndicated loans, issuance of stocks and bonds, project finance). Nonetheless, it will also be felt in other areas such as investment services. Market operators from countries outside the EMU and even outside the European Community, in particular those from EEA, will be able to participate in the market. We can expect the EMU to develop a certain magnetism attracting other Member States of the EC and perhaps also of the EEA into joining the EMU, despite the system risks it implies. In this manner, the euro area will expand and continue to contribute to market integration.

Part Two: Bank-Customer Relationship; Credits and Export Financing

Chapter Six Bank-Customer Relationship in German Law and Practice Harald Herrmann

I. Introduction The bank-customer relationship is not the subject of special legislation. Typically it is based, instead, on one or more contracts concluded between a bank and its customer. Accordingly, the legal basis is provided by various chapters of the German Civil Code (Bürgerliches Gesetzbuch, BGB), and the Commercial Code (Handelsgesetzbuch, HGB), which apply very generally to the conclusion of contracts (§§145 BGB et seq.), to loan contracts (§§607 BGB et seq.), agency (§§675, 662 BGB et seq.), suretyship (§§765 BGB et seq., §350 HGB), regular and irregular safe custody (§§688 et seq., 700 BGB), etc. Additionally, the general provisions of the law of confidential relations, which are partially mere case law and partially belong to the law of tortious relations (§§823 BGB et seq.), are to be taken into consideration. Other special legislation is also relevant, especially the Standard Terms Act (Gesetz zur Regelung des Rechts Allgemeiner Geschäftsbedingungen, AGBG) and the Consumer Credit Act (Verbraucherkreditgesetz, VerbrKrG). None of the above-mentioned legal sources specifically address the bank-consumer relationship. They apply very generally to all business transactions if they can be defined as an agency, a suretyship, a safe custody or the like. The provisions which are specific for bank relations can only be found in the case by case reasoning of the courts. Hence, restrictions unavoidably have to be placed on the subject of this chapter. The law regarding prices and fees for banking services is dealt with in a later chapter.1 Here, the focus lies only on provisions which, more or less, apply generally to all of the abovementioned banking contract types and related confidential relations. Finally, it seems useful to restrict this chapter to aspects revealing the basic structure of private banking law, which leaves the responsibility and

1

See Köndgen, chapter 7.

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the economic efficiency to the autonomous decision-making of the transaction subjects themselves, without trying to influence this directly through government authorities. In this sense, banking services are not different in principle from industrial products, being market goods governed by competition functions of supply and demand; and I shall try to demonstrate that the German private law of bank-customer-relation can be seen in accordance with the related market economy principles. We cannot overlook, however, that the freedom of competition and the freedom of concluding banking contracts is not granted without certain constraints aimed at diverse forms of social protection which are not expected to be realised by means of market functions. In this respect, the law may not only regulate the framework of workable competition, but it must follow regulatory concepts of market complementation or even market substitution. Certain concepts of consumer protection and of investors' protection have to be discussed mainly in this respect. I shall try to show, however, that even the market substituting regulations of private banking law do not collide fundamentally with the principles of a market economy and the related German business law. For this reason I have further focussed this chapter on some current problems which are discussed broadly in terms of optimal compatibility of social protection and freedom of competition. In this chapter, I will provide a short explanation of some basic terms and of the legal sources for the bank-customer relationship (Part II). Next, I will focus on contract law (Part III), and then on quasi-contracts and the law of tort liability (Part IV). While the report on contract law will be quite general, the part on quasicontracts and on torts, is restricted to some current problems in investors protection. II. Banking Business and Legal Sources of Private Banking 1. Business Types and Customer Relationship As to the basic terms, I have to say that the private law of banking does not apply only to banks in a narrow sense of the word, but also to all financial services institutions (Kreditinstitute) within the meaning of the Financial Services Act (Kreditwesengesetz, KWG). Section 1 KWG defines financial service institutions as enterprises performing banking business, provided that the scope of it requires commercial business organisation. Financial services are defined in Nos. 1-6,8 and 9 of the same Article: deposits (Einlagengeschäft'), loans (Kreditgeschäft), discounts (Diskontgeschäft), securities (Effektengeschäft), safe custody (Depotgeschäft), investment (Investmentgeschäft), guarantees (Garantiegeschäft) and current account transfers (Girogeschäft). I will not provide here deetails of these types of banking business. For special legal implications I refer to other chapters.

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It is important, however, to see that the business types defined under §1 KWG can be performed not only by commercial banks and investment banks, a distinction which does not exist at all in Germany but also by savings banks, mutual benefit associations, mortgage banks etc. In order to be regarded as a commercial organisation within the meaning of §1 KWG, the scope of business requires a more formal organisational structure and skilled management such as book keeping and accounting as provided for under §238 et seq. HGB. Banks, savings banks and mortgage banks normally fall within the scope of §1 KWG. The term "customer relationship" will also be used in a broad sense. It is not a statutory term. A similar but narrower term is "business relationship" (Geschäftsbeziehung) in §347(1) HGB, which provides for the due diligence of ordinary merchants for banks and other merchants, even if they have not (yet) completed a certain contract with somebody. Banks are merchants within the meaning of §1(2) no.4 HGB. The term "business relation" (Geschäftsverbindung) in clause 18 of the General Business Conditions of banks (AGB-Bankeri)2 is likewise a similar but narrower term. This only means contract relations. Customer relationship, however, comprises both; business relationships and business relations. Additionally, it seems useful to include the confidential relation of quasi-contract law (so-called culpa in contrahendo) and the equivalent relation in the law of torts. The relevant business duties and standards of fair play are very similar to the due care duties under contract law. Hence, the German courts do not yet apply exact, differentiating criteria. As to the term customer, it follows that contract partners and others are included who are not bound by contract, but by the provisions of a confidential relation. 2. Contract Types of the BGB, General Banking Contract, and the Law of Adhesion Contracts The legal regime of private banking law is constituted, as already mentioned, by the principles of general contract law and the provisions of the abovementioned contract types: §§607 et seq., 675, 765 et seq. and 788 BGB et seq. No special provisions exist for the bank-customer relationship as a whole. Sometimes the courts call one of the various contracts of a bank a "banking contract" without reflecting on a certain legal basis.3 This language and the common features of different contracts between a bank and its customers have led some authors to

See Appendix General Business Conditions. 3

See Bundesgerichtshof [BGH (German Federal Court)], 23 Entscheidungen des Bundesgerichtshofes in Zivilsachen [BGHZ] 222, 223; see also Horn, in Heymann, Handelsgesetzbuch, at §372, para. 5.

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develop a theory of a general banking contract. This general contract is said to be concluded when contact between the bank and its customer first takes place. It is seen as a source of the duties of care and diligence and as a contractual basis for the application of the general conditions of contract (adhesion contract) used by the banks. The theory of a general banking contract has been of some value for analysing similar duties of care in different contracts which may be concluded later. This is especially true for the so-called altruistic duties, such as the duty of confidentiality and the duties to inform or warn. The common concept in these duties is the obligation to act in the interest of the customer (Interessenwahrungspflichteri). The legal basis of the altruistic duties is, first of all, the law of agency (§662 and §§665 BOB et seq.), and secondly the special provisions for brokers in §384(1) HGB which state that the broker has "to safeguard the interests of the principal and to follow his advice". Very similarly, the bank has to act in the interest of its customer even if the completed contract is not an order to buy or sell securities or the like. Also, the bank must give preference to the interests of its customers when performing a current account transfer or when being party to a safe custody contract, a credit contract, etc., despite the fact that the relevant provisions of the BOB do not say anything about such a duty. For instance, the bank has to give a warning to its customer (A) when the latter orders a transfer to the current account of another customer (B), and the bank knows that B is going bankrupt and A is paying in advance.4 Also, the duty of confidentiality is just as essential a part of a savings account as of a current account. The prevailing opinion, however, does not accept this theory for the following reasons.5 The general contract would be a kind of framework agreement without a main duty since the bank, uncontestedly, is not obliged to conclude special bank contracts after having accepted the general banking relationship. Instead, the bank can terminate the customer relationship at any time and without being bound to a certain termination period. Such a contract, which would be exclusively designed to provide a basis for duties of care and to integrate general contract conditions into a later contract, is unknown in German law. Additionally, the exact content of the duties of care differs with regard to the concrete content of the main duties of the special banking contracts concluded later. The bank as a party to a securities transfer contract, for instance, can act somewhat more egoistically in capital markets than when it has to perform an order for a current account transaction. Certainly, the obligation of duties of confidentiality is generally accepted even if the parties do not conclude a contract in the end. The general contract theory, however, is not needed in order to construe such quasi-contractual duties because

4

See BGH, 1986 Wertpapier-Mitteilungen [WM] 1409.

5

See Horn, in Heymann, supra note 3, §372, para. 6.

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culpa in contrahendo liability has been generally accepted. The concept of a general banking contract therefore cannot be accepted as a legal source of private banking law. Instead, the customer normally enters into a bundle of different contracts with the bank: a contract opening a bank account or concluding a loan, a contract for buying and selling securities, or a contract for using a safe. Typically, the basic contract is one of the use of a bank account for receiving and executing payments by remittance, cashing cheques, debit notes, or the use of cheque cards and credit cards or other multi-functional cards used in modern electronic payment systems. The abovementioned contracts can be legally characterised as follows. Opening a bank account is normally regarded as a contract of agency (Geschaftsbesorgungsvertrag, §675 and §§662 BOB et seq.). The same legal regime can be analysed for cashing cheques, credit cards, etc. A loan contract falls under the provisions of §§607 BOB et seq. The contractual relation in buying or selling securities is regulated by §§383 et seq. HOB (Kommission). Also, §§672, 662 BGB et seq. have to be taken into consideration for this kind of banking contract. Additionally, the General Business Conditions of banks (AGB-Bankenf and of savings banks (AGB-Sparkassen) normally come into play when one of the banking contracts is concluded. Another term for such contracts is general contract conditions or standard term contracts. They have been published by the responsible banking trade associations such as the Federal Association of German Banks, the Federal Association of German Savings Banks, the Federal Association of German Mortgage Banks, etc. While these publications can be seen as anticompetitive recommendations, they are exempted from the German antitrust law by §102(1) GWB. From time to time, the AGB are amended by the respective trade associations. The last amendment of the AGB-Banken and of the AGBSparkassen dates from 1993. Despite being published, the AGB are not of the same legal quality as the abovementioned statutory sources. They are not statutes; but can be parts of the contract, if the parties integrate them properly into their agreement. Section 2 AGBG stipulates that it is sufficient for the integration of AGB if the contract contains an express reference to them and if the customer has had an opportunity to inspect the text before the conclusion of the contract. Also, unusual clauses which a customer would not expect do not become part of the contract (§3 AGBG), and unclear formulations have to be interpreted in favor of the customer (§4 AGBG). Clauses that in an unfair way are to the disadvantage of the customer are void (§§9-11 AGBG). While §§2, 10 and 11 AGBG do not apply to merchants within the meaning of §§2 HOB et seq., the banks try to mantain their AGB in

See Appendix (General Business Conditions).

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accordance with these provisions since otherwise, they would have to accept the risk of uncertainty as to whether or not some of their customers were merchants in a legal sense. 3. Quasi Contractual and Tortious Liability Besides the legal sources of contractual relations, the aforementioned confidential relationship without contract has to be characterised. The most important legal basis is the concept of culpa in contrahendo, which has been developed from various provisions of the BOB but nowadays is widely accepted in Germany both in case law and in academic theory. Under the culpa in contrahendo regime the potential parties to a contract are bound by certain duties of care and diligence even if they never reach a binding contract. The reason for these duties stem from the insufficient protection by the law of torts. The relevant §§823 BOB et seq. do not provide liability for simple damage to property. Generally, §823(1) BOB provides tort liability only in the case where an absolute right, like a person's life, health or property has been violated, and this violation causes damage. Damage to property, without violation of absolute rights, may only come under §§823(2) and 826 BOB if the damage is caused by a violation of a statutory provision or by an action which is against good morals. The German courts have unanimously held, however, that this interpretation of the law of torts has to be completed by covering damage to property in cases where customers may place confidence in a potential contract partner, and the confidence is violated, instead of a violation of an absolute right. The confidential relationship between a bank and its customer can be analysed under §§823(2) and 826 BGB. Under the former position, the bank must also have violated a statutory provision which aims at consumer protection or which,at least has the like intention as a sub-purpose. It must be said, however, that the provisions of the most important KWG are no longer interpreted as directly intending consumer protection because §6(3) KWG stipulates that the Federal Banking Supervisory Office (Bundesaufsichtsamt für das Kreditwesen, BAKred) act only in the public interest.7 Section 826 BGB seems to be somewhat more important in private banking law. It provides for compensation if the damage is caused by an action against good morals and with the intention to damage somebody. Both, the concept of good morals and the intention to damage are interpreted broadly. Good morals are violated if the action is against the judgement of all fair thinking people. The tortfeasor, in this respect, does not have to intend to violate good morals. It is sufficient if he or she violates good morals by failing te exercise due diligence. As

For former, differring views of the courts, see 74 BGHZ 144; 75 BGHZ 120; 90 BGHZ 310.

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to the damage intent, §826 BOB will apply if the actor does not intend the damaging consequences directly, but knowingly accepts the risk. III. Banking Contract Law 1. Conclusion of Contract and Pre-Contractual Duties to explain and give information Following my outline of the legal nature of the sources of private banking law, I would now like to present a more detailed analysis of the concrete understanding of the relevant provisions. Let me begin with the law of banking contracts. First of all, a banking contract must have been concluded properly. The conclusion of banking contracts sometimes causes difficulties because the banks must have an opportunity to check the credit worthiness of its customer before entering into a credit contract or even current account obligations with occasional credit transactions. The general contract law simply provides for an informal offer and an informal acceptance." Both are declarations of intention which become binding when they reach the contract partner (§130 BOB). Offer and acceptance must contain consent in all essentials of the contract. Banks normally use offer forms which have to be completed by the customer, most often assisted by one of the bank's employees. The employee, however, does not have representative power to accept the completed offer form immediately. Instead, the form will be sent to the bank's main office and, after a certain time of checking the creditworthiness of the customer, it will be accepted by a formal statement of the bank: §145 BGB et seq. stipulate that the customer is bound to his offer from the time it is given to the bank's employee until one can reasonably expect an acceptance (§145 BGB et seq.). During the same time, the bank has the possibility of refusing acceptance. Additionally, this waiting period of the customer can be extended by adhesion contract if the time of extention is not unfairly long or unclear (§10 no.l AGBG). The questions of fairness are left to the courts. The Federal Court of Justice (BGH), in the famous "widow" case, held that a waiting period of 3 weeks may not be too long in a case of a multi-million German Mark credit contract, and it is not regarded as being unclear if this period begins after the application has reached the central office of the bank. Accordingly, the contested adhesion

Only specific credit contracts that create a duty to provide a mortgage or a lien result in the necessity of notarization. This necessity of notarization stems from the real estate registration office's requirements, pursuant to §29(1) GBO (Grundbuchordnung), for the filing of such documents. Pursuant to §766 BGB, sureties must be in writing, if the guarantor is a non-merchant. If the guarantor is a merchant, there are no form requirements according to §350 Handelsgesetzbuch [HGB].

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contract clause did not violate §10 no.l AGBG, but it comes under the general unfairness provision of §9(1) AGBG. The customer could not control how long the waiting period would really last, while the bank would not only be easily informed, but could also voluntarily extend or shorten the waiting period. The court, therefore, held the bank's declaration of acceptance not to be binding. The customer who had preferred a cheaper credit from another bank, in the meantime, was not bound to his contract offer. The unforeseeable period of waiting would have prevented him from making reasonable use of his market chances. Banking practice has reacted to this decision. Nowadays a waiting period of two or three weeks is still usual, but the period begins when the customer gives his offer to the bank's employee or when it reaches one of the bank's subsidiaries by mail. The "widow"-case, however, is even more important for general reasons. There, the BGH held for the first time that adhesion contract provisions are not allowed to prevent the consumer from taking fair chances in the relevant competitive market. Similar, but much more evident, is the competitive aspect of the recent regulation of legal capacity for futures trading on the Stock Exchange (Börsentermingeschäftsfähigkeii). The Stock Exchange Act (Börsengesetz, BörsG) amendments of 1989 and of 1994, in case of private customers, have bound banks to certain duties to explain and to give information.9 While futures contracts of private customers have been held void in order to keep non-merchants out of this risky business, these contracts shall now be valid if the "mature citizen" has been given proper sources of information for taking his own market chances.10 Section 53 BörsG actually provides that the non-merchant must be informed about the typical risks of futures transactions by a written document. The information must at least contain the following advice: • that the terminated rights received through futures transactions can expire or can be devalued; and • that the risks of losses will be intensified if the consumer takes out a credit for fulfilling his contractual obligations under the futures' contract or if the obligated payments of the consumer are in foreign currencies. The trade associations in the banking business have edited a more concrete checklist of the necessary information which the banks normally send to their customers and which has to be signed and sent back. The BGH, in 1994 and again in 1997, held that this checklist is in accordance with the provisions of §53 9

See Schwark, in Festschrift fur Ernst Steindorff zum 70. Geburtstag am 13. März 1990 [Festschrift Steindorff] 473 (Baur, et al. eds., 1990). 10

See Begründung zum Regierungsentwurf der Novellierung des Börsengesetzes, 11/4177 Federal Gazette [Amtliche Drucksachen des Deutschen Bundestages], at 10.

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BorsG." In the literature this is seen as a market opening concept (Marktöffnungskonzepf) as opposed to a social-protectionist concept (Schuizkonzepi).n This concept of market orientation and of the mature consumer is also continued and completed by a more recent judgement of the BGH13 and the amendment of the BörsG of 1994.14 The consumer information has not to be given within a period of exactly one year: a time corridor of ten to twelve months is sufficient if the bank wants to continue the legal futures market capability for another 3 years.15 This ruling has been commented on as follows: Legal capacity for futures trading on the Stock Exchange must not be misused by such a strict interpretation of the provisions that the mature citizen, after having effected a transaction on the Stock Exchange having been well informed to all extents and purposes, and having suffered losses in so doing, can subsequently pass these onto the bank by pleading an alleged lack of information.16 The information provisions described, however, do not apply generally to the completion of banking contracts, but are restricted to futures agencies. Nor do they go as far as §5a VVG does in granting information for the "mature consumer" as a future party to an insurance contract.17 Before an insurance contract becomes binding, an insurer has to transfer a package of so-called consumer information containing the relevant general and special adhesion contracts, and the insured can revoke the contract within two weeks after having received the information. This is evidently better at serving the purpose of making marketoriented consumer decisions possible than the abovementioned provisions of banking law. The consumer may compare the standard term contract conditions as part of the price-quality relation. In the banking business, however, it has still been held that the integration of adhesion contracts is possible under §2 AGBG, provided that the bank simply

11

See BGH, 1994 Zeitschrift für Wirtschaftsrecht [ZIP] 693, 694; 1997 ZIP 972.

12

See Horn, 1997 ZIP 1361, 1362 with further references in note 2 thereof.

13

See BGH, 1997 ZIP 972.

14

See Baumbach/Hopt, Handelsgesetzbuch, Schlußanhang III (1995,29th ed.).

15

See Horn, 1997 ZIP 1361, 1365; for a further period after the expiration of the 10 -12 month period, see id at 1365. 16

17

See id at 1364.

Although there is nothing exactly comparable to Section 5a VVG, it can be generally compared to §1(1) HausturWG, but is applied only very restrictively in banking contract law. For surety law, see 113 BGHZ 287; but now, see BGH, References for a Preliminary Ruling of the European Court of Justice, 1996 Neue Juristische Wochenschrift [NJW] 930; Pfeiffer, 1997 NJW 3297 et seq.

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offers to send its customer the general conditions "on his request".18 In the light of the increasingly accepted "mature consumer" concept, banks will also have to send their general contract conditions without further demand of the customer.19 Finally, a further important aspect of the banking contract has been stressed by the courts in recent cases of investment recommendations by professional consultants and banks, as in former cases of bank-to-bank information on behalf of customers. In the leading case of 1902 a buyer of real estate had asked the notary about the quantity of registered mortgages, and the notary's information was negligently wrong. The Reichsgericht (RG) held that the notary should have realised that the buyer wanted the information as a basis of an important business decision. The notary therefore implicitly declared the acceptance of a service contract offer when giving the information requested. Hence, liability follows for lack of due care.20 The notaries' liability has been subsequently regulated by the special BNotO (§19). For other liberal professions, however, the decision of the RG is still relevant. Tax consultants, attorneys, chartered accountants, business consultants and banks conclude information service contracts when they answer questions of clients, who are relying on the answers to make important business transaction decisioning. As to the banks' liability, the courts recently adopted the opinion of the RG and assumed a direct consumer contract in a case of inter-banking information. The inquiring bank is held to be a messenger for the contract offer of its customer. If more than one customer is asking, the number of potential contract partners must be relatively restricted and transparent for the bank.21 In investment business, the courts have been relatively generous in assuming an information service contract between an investor and the bank which performed the ordered investment transaction. There are, however, some restricting tendencies. In the well known Bond case of 1993, the BGH had to decide about an investment in the foreign currency bonds of an Australian enterprise group which had been sold by several German banks. While the Australian rating agency had already rated the bond as highly speculative (BB), it was admitted to the Frankfurt Stock Exchange in March 1989. The bank had informed its customer correctly that the investment did not contain currency risks, but it had not undertaken further 18

See Oberlandesgericht [OLG (Court of Appeal)] Köln, 1993 WM 369. But see Landgericht [LG (Trial Court)] Frankfurt, 1992 Neue Juristische Wochenschrift Rechtsprechungs-Report [NJWRR] 441; Köndgen, 1996 NJW 558, 564. 19

See Köndgen, supra note 18.

20

See Reichsgericht [RG], 52 Entscheidungen des Reichsgerichts in Zivilsachen [RGZ] 365; but cf. Olabend, 1903 Deutsche Juristenzeitung [DJZ] 262; Honsell, 1976 Juristische Schulung [JuS] 621,625. 21

See BGH, 1979 NJW 1595, 1597.

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efforts to find out about the Australian rating. The following bankruptcy of the Bond group resulted in a total loss of the bonds' value. The BGH held that a contract had been concluded, following the decision of the RG in the notary case because the bank must have realised the investors' substantial interest in the information and, therefore, was contractually bound either to find out about the rating or to tell the investor that it does not make rating investigations. The defendant bank was held liable for the total market price of the bonds for which the plaintiff had paid. In the meantime, however, the BGH has held, a little more restrictively, that no information service contract will be concluded if the customer initiates the investment contract and if she clearly intends an order for certain bonds right from the beginning. The buying bank does not have to assume contractual duties to explain and to give information if the customer evidently does not want this and seems to have already decided on certain bonds.22 Some scholars have pointed out, for good reasons, that the contract construed by the prevailing opinion is based on a fiction about the contractual intent of the bank. If the contract law abstracts too far from the real intention of the parties, important competition functions of the capital markets would be impeded. One cannot say that this opinion has become dominant, until now, but the recent restriction of banking contract liability seems to be a further step in the procompetitive direction. 2. Duties of the Bank Before we come to the banking contract itself and the relevant contractual duties, let us look briefly at the discussion of the obligation to contract (Kontrahierungspflichten). In a way, these are still pre-contractual duties. But the principle of contract liberty is directly implied. a) Obligation to Contract? In the German literature, it has sometimes been argued that some banking services have become such essential factors of modern life that people have a right not to be excluded from them. One of the most recent discussions of these problems is related to the current account transfer banking service. People shall have a "right to a current account".23 The prevailing opinion, however, does not agree. The reasoning for a right to a current account is based on the constitutional principle of a social state (Sozialstaatsgebot, Art. 20(2) GG) and on its consequences for §826 BOB. People at the lower end of the social scale would be 22

See BGH, 1996 WM 906; Horn, 1997 Zeitschrift für Bankrecht und Bankwirtschaft [ZBB] 139, 143 et seq. 23 See Reiffher, 1995 ZBB 243, 246 et seq.; but see Köndgen, 1996 NJW 558, 559.

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excluded from a basic necessity if they were cut off from the current account transfer services of banks. Hence, it would be against good morals within the meaning of §826 BOB if a bank refused to consent to the current account contract offer of somebody. The courts, however, have provided for the obligation to contract under much more restrictive pre-conditions than the mere fact that the desired economic good is very common. Instead, in principle, discrimination and unequal treatment are allowed in private law, and even seem legitimate as long as workable competition and the principle of contract liberty are granted. Only in pases of economic monopoly conditions, or of misuse of market power, have special obligations to contract been developed. A cautious extension of these opinions to cases of misuse of political power is possible, if special constitutional liberties are affected by a demand for certain public goods, such as membership in trade or sport associations with political functions. Similar facts can hardly be found in the cases of refused current account contracts even if one were to attribute public functions to banks with regard to the supply of capital in a national economy. Therefore, the prevailing opinion is well-founded. In German law no right to a current account can be claimed. b) Due Care and Diligence Let me now turn to the duties of banks when a contract really is concluded. I have already mentioned that I want to concentrate on the altruistic duties or the duties of safeguarding of interests. Most of them are duties of information because the bank, typically, is better informed about the economic conditions of the banking service. The interest safeguarding function of the duties to explain and to give information can best be characterised in cases of conflicts of interests. The bank must not give preference to its own interests or the interests of some of its special customers. The conflict has to be decided by a fair weighing of interest. A good example for this kind of weighing of interests can be shown in the case of two bank customers, one of them (A) planning to give a surety to the bank (G) for the obligation of the other (B). If the bank G knows that B is no longer credit worthy because of check fraud, G must warn A before signing the surety contract.24 The bank is also not allowed, in such cases, to insist on its duty of confidentiality. It must try to be released from it by customer B. If such an attempt is not proven, the bank has clearly acted illegally by not providing information warning its customer A. If B does not release the bank from its duty of confidentiality, he himself is acting illegally. Hence, the bank must give preference to the interest of A and give her the warning.

24

See OLG Hamm, 1982 ZIP 1061; OLG Köln, 1990 WM 1616.

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Another example has been mentioned already. Customer A orders a current account transfer to customer B, thereby paying in advance for something bought from B. The bank knows that B has already applied for bankruptcy because of non-liquidity. Here, the bank must also try to release itself from its duty of confidentiality and inform A.25 If the bank has a self-interest in the payment to B because it has given B a major credit which could be saved by fresh money from A, the bank nevertheless must postpone its own interest and give A the warning.26 The duties to explain and to give information have been differentiated as: duties to answer concrete questions or to provide reports (Auskunftspflichten), duties to explain or to give information (Aufklärungspflichten), duties to give advice (Beratungspflichten), duties to warn (Warnpflichten), and duties of inquiry (Erkundigungspflichten). First of all, the characteristic feature of the duties to answer concrete questions or to provide reports is that the customer asks for relatively concrete information. In comparison to the duties to explain or to give information, the customer knows about her lack of information and can define the possible relevance of it for her business interests. She knows, roughly, what she does not know. The right to be informed is well founded under §242 BOB, the general good faith or fairness rule of the Civil Code, if the information requested can be given by the banks without undue effort and the customer has a lot more difficulty in getting the information. Evidently, as all duties to safeguard interests, the duty to answer concrete questions depends on a weighing of interests in the light of contractual purposes. The following example may serve for further illustration. A customer was heir to a bank account. He asked the bank for information about possible donations of the testator which could be recorded as debit items on the bank account. The BGH gave a positive ruling based on the abovementioned principles.27 It seemed easy for the bank to provide the requested information since it had performed the donations inquired about by order of the testator. The heir did not have a comparable source of information. The weighing of interests, hence, was to the advantage of the heir. In this case, the BGH awarded a right to performance as opposed to specific damages. This can happen only in exceptional cases where the claim is not a main contractual obligation, but rather, a secondary obligation. Generally, the legal consequence of violating secondary obligations would only be a damages claim. However, a right to performance can be given if the damages claim would not give full compensation. Here, the plaintiff could not define his damages claim because he did not know about the possible donations of the testator.

25

See BGH, 1960 WM 1321, 1322; BGH, 1961 WM 510, 511; BGH, 1986 ZIP 1537. With regard to the enlistment of a customer as a credit-provider for another customer that is not credit-worthy, see BGH, 82 BGHZ 92, 103. 27 See BGH, 107 BGHZ 104, 108. 26

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Duties to explain or to give information (Aufldärungspflichten), as mentioned, are related to facts which the customer cannot indicate concretely. She can only ask very generally, if at all21 the planned investment will be safe or risky. The bank must decide which information the customer needs for her concrete investment purposes on the basis of its superior knowledge of the business. The duty to explain or to give information simply requires that the customer be provided with the relevant information and the necessary explanations, as is the the prevailing opinion in the business.29 Examples for such duties have been given above. Duties to give advice (Beratungspflichten) can be differentiated because they contain value judgements which may be combined with factual information. In many aspects, these duties are similar to the duties to explain or to give information. Here too, the main legal question is whether the customer can fairly expect the advice of the bank.30 The literature partially differentiates further between duties to give advice and duties to warn, finding the latter only if the relevant information refers to a "concrete danger or risk".31 This is true because the more distinctly one can predict dangerous consequences, the more a duty to explain or give advice has to be assumed. A clear distinction of duties to give advice and to warn seems impossible. Finally, the duties of inquiry (Erkundigungspflichten) are very important. They have been developed by the BGH in the context of the liability for investment advice, especially in the abovementioned Bond case of 1993. In the meantime, the Federal Securities Trading Supervisory Office (Bundesaufsichtsamt für den Wertpapierhandel, BAWe) has given them concrete form by issuing guidelines on the interpretation of §§31-33 WpHG.32 The bank is obliged to advise the customer adequately with regard to his individual investment purposes and the concrete conditions of the investment object (anleger- und objektgerechte Beratung). However, it may differentiate between customers with professional knowledge and others. If the bank does not know the knowledge of its customer, it is obliged to ask adequate questions to be able to see how far the customer needs to be informed and consulted. The duty of inquiry seems to be derived from the other duties to explain or give information. A more detailed discussion of these duties

28

Contrary to the duties to answer concrete questions and to provide reports [Auskunftspflicht], the duty to inform [Auflclarungspflichi] is independent from any request for information by the client, see Heinrichs, in Palandt, Kommentar zum Bürgerlichen Gesetzbuch, at §242, para. 37 (58th ed. 1999). 29 See BGH, 1970 NJW 655; Heinrichs, in Palandt, supra note 28, at §242, para. 37. 30 See note 29. 31 See Horn, supra note 22, at 141. 32 Of May 26, 1997, 98 Bundesanzeiger 6586 et seq. (June 3, 1997).

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will follow below." As a general tendency, the imposition of duties to explain and to give information has gone too far in the past. It partially relieves the consumer of normal market risks which the law of capital markets lays on the consumer for purposes of market workability. Yet the practice seems to have accepted the need that private banking law must be related to capital markets law. c) Computation of Time for Interest Calculation Another much disputed problem is the computation of time for interest calculation. This is not necessarily the same as crediting or debiting the account. The date of crediting or debiting an account can be different from the date relevant for the interest calculation. This difference makes sense if the bank, for instance, after having received money for the customer, cannot yet dispose of it. Until the mid-1980s, it was usual for mortgage banks to calculate the amount of a mortgage credit on the basis of the repayments at the end of the previous year even if the debtor has paid back principal monthly in the current year (so-called "annuities credit", Annuitätendarlehen). For a long time this was supposed to be necessary since the banks, without today's data processing facilities, needed a certain time to book and re-dispose of the money it had received from the repayments of the customer. The practice in the current account business was similar, but there was a difference between the treatment of credits and debits. While the computation date for debits was the actual day of the respective order of the customer, or only one day later, credits were processed up to five days later. This asymmetry can only be justified if the reasons for crediting and debiting are different in a way that the bank typically cannot dispose of the crediting amount before the time of computation for interest. The terms of computation of time for interest calculation are usually determined in the general contract conditions or in the special adhesion contracts of the banks. Hence, they can be controlled under §9(1) and (2) AGBG. The BGH, for the first time, criticised the relevant general contract conditions of the mortgage banks, arguing that customers could not see how much interest they would have to pay in addition to the interest under conditions of prompt evaluation. This lack of clarity (Intransparenz) was seen as a violation of the general fairness provision of §9(1) AGBG.34 In addition, the court considered the customer to be unfairly disadvantaged within §9(2) no.l AGBG because he partially had to pay interest on a credit amount which had had already been paid back, while §608 BOB provides that interest can only be agreed upon "for a credit". Section 9(2) no.l AGBG provides that general contract conditions cannot derogate from the essence of §608 BOB.

33 34

Infra part IV. on Quasi-Contractual and Tortious Liability. See BGH, 106BGHZ42.

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Time lags in the computation could only be accepted if important economic and organisational reasons justifed them. The opinion of the BGH has been confirmed by various later decisions. Today, a maximum time lag of three months seems to be justified. Additionally, the Price Announcement Regulation (Preisangaben-Verordnung, PreisAngVO) provides that, in cases of consumer credit, the banks have to indicate the so-called effective interest rate in the written contract which gives relatively exact information on how much the time lag in the computation raises the interest expense. The customer can thus compare other market offers. Therefore, in a more recent judgement, the BGH has held that the indication of the effective interest rate is in accordance with §9 AGBG." The question of whether this also applies when the bank fixes the time computation of interest at intervals of longer than three months has not been settled yet. One would have to accept this because the necessary transparency is ultimately intended to make the customer able to compare other market offers and to base banking business on conditions for workable competition. A few final words should address the asymmetric treatment in the current account business. Here, the courts have insisted on prompt evaluation of credits and debits if they result from current account transactions. The BGH, in January 1989, held that the bank must compute the time of receipt of the money if the customer is a private individual.36 A further judgement of June 17, 1997, has even confirmed this for cash payments into merchant customers' accounts.37 Only in cases of check payments is a time lag of several days accepted by the courts and the literature, since the bank cannot dispose of the value promptly.38 This is relatively restrictive compared to the parallel problems of mortgage credit, but the difference can probably be justified since in the current account business an indication of effective interest rates is not possible. d) Confidentiality and the Right to Give Information about the Customer As a rule, the bank must keep confidential the customer's affairs and, in particular, not give information about the latter's assets with the bank or plans for certain financial transactions unless the customer has given his or her consent. This duty does not have an express statutory basis, but is derived from the contractual relationship between the bank and the customer which implies a general fiduciary duty. The bank secrecy covers all "facts the customer wants to be held confiden35 36

See id at 51; Heinrichs, in Palandt, supra note 28, at §9, para. 15.

See BGH, 106 BGHZ 259,265, concerning the Heidelberger Stadtsparkasse. Case No. XIZR 239/96, Press Release from August 20, 1997, Handelsblatt, at 33. 38 See Billow, Entscheidungen zum Wirtschaftsrecht [EWiR] No. 12 AGB-Banken 1/97, 723, 724. 37

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tial". This duty of the bank to observe bank secrecy (Bankgeheimnis) includes the right of the bank to refuse testimony in civil proceedings (§383(1) no.6, §384 no.3 ZPO). In criminal proceedings, however, the bank has no such right (§53 StPO). The tax authorities have a limited right to ask for information from the bank (§30a AO); in tax fraud proceedings, however, the bank has an unlimited duty to inform the authorities (§385 AO). It is commercial practice in Germany to ask a bank to give standard information about its customer's general creditworthiness. This information is normally given in general terms without disclosing precise figures. The information is only passed on to another bank representing the party that seeks this information, and is only given if the customer has agreed to it. Business customers normally agree to such information in order to enhance their credit standing, since the refusal of a bank to give any information about that customer could damage the latter's credit standing more than less favourable information would. General consent to such information providing is contained in the general conditions of contract agreed between the bank and its customer. The general conditions make a distinction between a business customer and a private customer, the latter often not being as inclined to allow information to be given about his or her financial situation. The bank will not give any information about private customers unless they expressly agree to it. Besides this principle of the confidentiality of banks as part of private law, there exists a specific duty under the legislation on personal data protection. This protection of personal data is guaranteed by the German Constitution. 3. Duties of the Customer and Problems of Post-Contractual Securing Of course, the most important obligation of the customer is that she pays for the banking services, most frequently by paying interest for the given credit, or by paying an extra amount for the organisation of the banking account, the use of certain data processing facilities or over-the-counter services etc.39 Here, the secondary obligations and the duties which are based on the general good faith or fairness provision of §242 BGB will be discussed. The duty to give the bank clear, correct and complete information is very important. Other duties include being precise when giving certain orders (e.g., ordering current account transfers) and duties to check (e.g., checking the current accounts or the statements of certain transactions the bank has carried out for the customer). Generally, the violation of such duties leads to damage claims. In some exceptional cases, claims to performance can be awarded by the court if the plaintiffs interests would not be satisfied by damages. The pre-conditions of such excep-

39

On this, see Köndgen, chapter 7.

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tional specific performance claims are no different from the cases of violated duties of the bank mentioned above. Other duties are to the advantage of the customer himself and are called special obligations (Obliegenheiten). They can serve the purpose of avoiding or minimizing the damage when a bank has violated its duties or duties to explain or to give information, or duties of confidentiality. The legal basis of such special obligations is §254(2) sentence 1 BOB, which states that the customer is obliged to minimize a damage even if it is caused by the bank. The following are examples of such duties and obligations. The customer must give the bank notice within a reasonable period of time when facts change which are relevant for the performance of the contract, e.g., the name or the address of the customer has changed, or the customer no longer has full power to dispose of his goods. In cases of current account transfer orders, the customer must not state incorrectly the name or the current account number of the receiver of the transfer. However, there are different opinions on the question of duties to explain or to give information if, in cases of transfer delays or incorrectly addressed transfers, special damage risks exist.40 A general solution to this problem seems to be impossible since it is a question of weighing interests. Other problems arise from the general contract condition under which the customer has a duty to give further sureties or mortgages if his financial situation worsens. This so-called duty to extend sureties (Nachsicherungspflichf), in clause 13(2) of the banks' general business conditions is premised on the following facts: (i) the economic status of the customer has changed or threatens to change in a negative manner; or (ii) the value of the existing security has deteriorated or threatens to deteriorate. The BGH has held a similar clause to be in accordance with §9(1) AGBG.41 Although there has been overwhelming agreement in the literature on this clause, it has been disputed whether in order to establish an obligation to extend sureties, it must be proven that the bank has a good economic reason or not4243, or whether the only requirements are that the extension of sureties not lead to an excess of cover for the bank44 and that it is not demanded at an unfair time.43 The prevailing 40

See Löwe/v.Westphalen III 34.1 para. 22; but see Horn, in Wolf/Horn/Lindacher, AGB-Gesetz Kommentar, §23, para. 637 (3rd ed. 1994). 41 See BGH, 1981 NJW 1363, 1364; but see Grunewald, 1981 ZIP 586 because of the former unclarity in the case of the imminent deterioration of assets. 42 See Horn, in Heymann, supra note 3, at §372, para. 62; Brandner, in Ulmer/Brandner/Hensen, AGB-Gesetz, §§9 to 11, para. 661 (7th ed. 1993). 43 See BGH, supra note 41; Baumbach/Hopt, Handelsgesetzbuch, AGB-Banken 19, para. 1 (28th ed.). However, the commentary in the 29th edition has been changed, see Baumbach/Hopt, supra note 14, at AGB-Banken 13, para.7. 44 See i«pr