GENERAL FRAMEWORK AND CONDUCT OF BUSINESS
What legislation governs the authorization and regulation of banking activities in your jurisdiction? What have been the most significant regulatory issues recently?
The central body of law governing the authorization and regulation of banking activities is the German Banking Act (Kreditwesengesetz - KWG). The Banking Act defines which activities constitute banking or financial services activities (which require a licence), regulates the prerequisites for obtaining a licence and the licensing procedure, the qualifications for stakeholders in banks or financial services providers, capital requirements, restrictions on large credit exposures, reporting obligations, auditing procedures and various authorities of the relevant supervisory authority, the Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht - BAFin), formerly the Federal Banking Supervisory Authority (Bundesaufsichtsamt für das Kreditwesen - BAKred). Of course, various other sources of law are also of relevance in the context of banking activities, for example, the Investment Companies Act, the Foreign Investment Act, the Securities Custody Act, the Securities Trading Act and others.
The most significant regulatory issue has been the fact that the Fourth Financial Market Promotion Act (Viertes Finanzmarktförderungsgesetz) became effective on one July 2002. This act contains revisions to various acts such as the Banking Act, the Securities Trading Act, the Stock Exchange Act, the Investment Act and the Foreign Investment Act and aims at modernizing the legal framework for the German Financial Markets, to strengthen international competitiveness and confidence in the integrity and functionality of the financial markets. The changes affect the areas of securities trading law, organizational law for stock exchanges, the law on investment companies and banking supervisory law.
The most important revisions to the Banking Act were the implementation of the EU e-Money Directive, the licensing requirement for credit card issuers as financial services providers, a tightening of the tests applied to entities/persons controlling German banks and/or financial services providers, a change of the legal nature of capital adequacy rules and an expansion of the obligation of institutes to maintain certain information about clients' accounts in a separate database that can be accessed by the BaFin by means of automated procedures to quickly identify money launderers misusing an institute for their purposes.
What are the key activities for which authorization is required?
Authorization is generally required for banking activities, which are defined in section one paragraph one of the Banking Act as 11 different kinds of activities. These are: deposit business, lending business, discount business, principal broking services, safe custody business, investment fund business, the incurrence of the obligation to acquire claims in respect of loans before their maturity, guarantee business, giro business, underwriting business and e-money business. The same applies for activities that amount to the provision of financial services as defined in section one paragraph one (a) of the Banking Act, which are eight different kinds of activities. These are: investment brokerage, contract brokerage, portfolio management, own-account trading, non-European Economic Area deposit broking, money transmission services, foreign currency dealings and credit card business.
What sanctions are available to regulators when taking action against regulated bodies?
The Banking Act provides for a variety of sanctions that are either enacted by penal authorities or by the regulators themselves. Conducting banking business or providing financial services without a licence is a crime and subject to punishment by imprisonment or monetary fines. Non-compliance with various duties under the Banking Act amounts to regulatory offences that are sanctioned by regulatory fines in a range between €50,000 ($58,700), €150,000 and at maximum €500,000.
The Banking Act also provides for further measures to be taken by the BAFin, which range from information requests and audits. These the BAFin can carry out without specific reason, to measure for inadequate equity or inadequate liquidity (in which cases the BAFin may prohibit or limit withdrawals by proprietors or partners of the concerned institution, the distribution of profits and the granting of loans). In cases where the fulfilment of an institution's obligation towards its creditors and especially where the safety of the assets entrusted to it is endangered, the BAFin may issue instructions on the management of the institution's business, prohibit the acceptance of deposits, cash or securities from customers and the granting of loans, prohibit proprietors and managers from carrying out their activities or limit such activities and appoint supervisors. Under those conditions and where there is a risk of insolvency, the BAFin may, to avert insolvency, temporarily issue a prohibition on any sale and payments by the institution, order the institution to be closed for business with customers, and prohibit the acceptance of payments not intended for the discharge of debts owed to the institution, unless the responsible deposit protection scheme or investor compensation association undertakes to satisfy in full the beneficiaries entitled to satisfaction. The BAFin may also issue ordinances in relation to moratoriums and suspension of banking business and stock exchange business in cases where not only an institution encounters financial difficulties, but where the national economy is also endangered and in particular the functioning of general money transfers.
Does the regulatory regime for banking business include regulatory conduct of business rules?
The Banking Act does not explicitly provide for a complete set of conduct of business rules governing the obligations of a bank to its customers, but only regulates very few points. These include, for example, the provision of information to customers in relation to investor protection schemes. A more important set of rules is to be found in sections 31 and subsections of the Securities Trading Act (Wertpapierhandelsgesetz), which provide for so-called rules of conduct for Investment Services Enterprises (Wertpapierhandelsunternehmen). These rules apply to institutions that qualify as Investment Services Enterprises if they are providing investment services by selling and purchasing securities, as further defined in the Securities Trading Act. These rules of conduct also contain provisions on the obligations of the relevant institution to its customers.
SUPERVISORY REQUIREMENTS
Does the regulatory regime for banking business include regulatory capital requirements? If so, are these based on the Basel Accord and are there variations from the core Basel recommendations?
The German Banking Act provides for certain capital requirements in its sections 10 through 12. Section 10 (Provision of Own Funds) of the Banking Act reflects and incorporates not only the Second Banking Coordination Directive (89/646/EWG), the Own Funds Directive (89/299/EWG) and the Capital Adequacy Directive (93/6/EWG) of the EU, but through the Own Funds Directive also the Basel Accord (Basel I) is reflected. Section 10 of the Banking Act was amended through the Fourth Financial Markets Promotion Act and now refers explicitly to the laws of the EU, which regulate the adequacy of own funds and which have to be taken into account within any ordinance in respect of adequacy of funds of institutions to be enacted by the Ministry of Finance or the BAFin as authorized by the Ministry of Finance.
What effect will Basel II have on banking transactions in your jurisdiction? Are financial institutions already taking account of its future effect?
Basel II is supposed to change the structure of financing obtained by German corporates, especially the German small and medium-sized business (Mittelstand). In the past, as many as 70% of German companies raised financing through credit financings. This contrasts with common means of raising finance in the UK and the US, but will change in the future. Alternative means of financing are gaining importance, such as asset-backed securities structures, leasing, mezzanine financing and financings by means of silent partnerships. Furthermore, Basel II will also lead to more openness and transparency of companies as borrowers in order to remain acceptable to lenders which will demand much more information from their borrowers. This tendency has become apparent already and is, of course, intensified by Basel II.
Does the regime in your jurisdiction include rules and operational and organizational requirements relating to internal controls and operational risk?
The German supervisory regime in Germany includes a variety of rules and operational and organizational requirements relating to internal controls and operational risks. Those instruments are set up mainly through the German Banking Act and the German Securities Trading Act and the relevant ordinances and circulars of BAFin and its preceding authorities issued under those Acts. The Banking Act sets up requirements in relation to own funds/equity and liquidity and its monitoring, and addresses specific organizational obligations of institutions in its section 25a, including, but not limited to, the requirement to set up appropriate regulations to manage, supervise and control risks in general, including appropriate internal control systems. The Securities Trading Act provides for detailed regulations on internal controls in relation to insider surveillance, and rules of conduct for Investment Services Enterprises (Wertpapierhandelsunternehmen), which also comprise various organizational requirements in relation to internal controls. The relevant authorities have also issued by way of circulars certain details in respect of minimum standards for trading and, more recently and only in draft form, for granting loans (Mindestanforderungen an das Betreiben von Handelsgeschäften der Kreditinstitute (1998), Mindestanforderungen an das Kreditgeschäft der Kreditinstitute (draft 2002 - not yet final)). These circulars address internal control mechanisms, risk-control and risk-management.
How will Sarbanes-Oxley affect banking in your jurisdiction?
The Sarbanes-Oxley Act of 2002 has a material impact on German auditors as far as they are addressees of the Act and who are therefore subjected to a second supervisory authority in the US. It is assumed that the Act could also lead to a stricter control of auditors by the German authorities, insofar as the stricter Act could set an international standard and endanger the independent development of national requirements. Furthermore, the Act has a severe impact on German corporations whose shares are traded on US exchanges and German subsidiaries of US corporations. In view of the severe risks and personal liability of chief executives, German board members will reconsider their decision on US listings and the liability risks inherent therein. Germany has already a specific Corporate Governance Kodex, the Act on Transparency and Publicity and the Act on Corporate Control and Transparency. Hence, the Sarbanes-Oxley Act, which puts to a certain extent a stronger emphasis on sanctions than on prevention, should not serve as a guideline and incentive for further legislation in Germany.
Does the regime in your jurisdiction include a requirement for the authorities to approve controllers and major shareholders of regulated banking institutions?
The German Banking Act provides for an obligation for anybody to notify the BAFin and the German Federal Bank who intends to acquire a substantial participation in an institution. A substantial participation is at stake if at least 10% of the capital or voting rights of a third institution are held indirectly or directly in own or third party interest through one or more subsidiaries or entities with a similar relationship or by cooperation with other persons or entities, or if the management of the relevant institution can be significantly influenced. In such notification buyers must provide various information about themselves. Within three months of receipt of the complete notification, the BAFin may prohibit any intended acquisition for reasons further set out in the Banking Act, including the determination by BAFin that the potential acquirer is either not reliable or if other facts become apparent that show the demands against the acquirer set in the interest of reliable and prudent management of the institution would not be met.
INVESTOR PROTECTION
Have there been any recent changes to insolvency legislation in your jurisdiction, or are any such changes proposed? Have regulators made or will they make the regime more or less borrower friendly?
German insolvency law was significantly changed when the old German insolvency law (the so-called Konkursordnung) was replaced by the new German Insolvency Act (Insolvenzordnung - InsO), which came into force on January 1 1999. The new regime is more borrower friendly. Some small amendments have been made to the Insolvency Act since then. One recent change was the implementation of certain articles of the EU directive on the Winding-Up of Credit Institutions (2001/24/EG) dealing with the applicable law in respect of netting and repurchase agreements in the insolvency of a bank. The Insolvency Act now stipulates that the effects of insolvency proceedings on repurchase agreements and netting agreements are governed by the law of the jurisdiction that governs the respective agreements. In addition, a further amendment to the Insolvency Act is under discussion, which contains numerous changes. One goal to be achieved would be the speeding of insolvency procedures as such and the protection of the bankrupt's estate. Proposed amendments include a new authority of the insolvency court to prohibit the holder of the relevant security from realizing movable assets or receivables, to protect any possibilities of reorganization, and also amendments in relation to the possible sale of the 'insolvent' company before the opening of insolvency proceedings (übertragende Sanierung).
Does your jurisdiction operate a deposit protection or guarantee scheme protecting retail depositors from loss in the event of the insolvency of an authorized bank?
Germany operates two protection schemes in order to protect depositors. The most recent scheme is set up by mandatory law as a consequence of the required transformation of the relevant EU directives (94/19/EG and 97/9/EG). The Deposit Protection and Investor Compensation Act (Einlagensicherungs- und Anlegerentschädigungsgesetz) set up certain compensation institutions through the German Bank for Reconstruction (Kreditanstalt für Wiederaufbau - KfW). Of relevance are the EdB (Entschädigungseinrichtung deutscher Banken) and the EdW (Entschädigungseinrichtung der Wertpapierhandelsunternehmen). The protection provided by those institutions is limited to 90% of the relevant deposits or the creditor's claims under the securities transactions, respectively, and a maximum of €20,000.
An older scheme is the deposit protection fund of the German private commercial banks, which covers deposits and depositors if and to the extent that these are not already covered by the compensation schemes referred to above. This scheme comprises institutions that are members of the Association of German Banks (Bundesverband deutscher Banken) and fully secures the deposits of customers of its members up to 30% of the relevant liable equity of each bank for each customer. Such protection includes all deposits held by non-banking institutions, that is, by private individuals, business enterprises and public bodies as far as they concern cash deposits and registered savings certificates. No protection is extended to liabilities of an institution in respect of which it has issued bearer instruments such as bearer bonds or bearer certificates.
German savings banks (Sparkassen) and banking associations (Genossenschaftsbanken) have set up comparable schemes.
Does your jurisdiction have an ombudsman scheme, arbitration scheme or similar scheme for the resolution of disputes between a bank and its retail customers other than through formal legal proceedings?
Apart from general provisions of the German Code of Civil Procedure which set up certain arbitral procedures, all bank associations (that is, the private commercial banks, savings banks and banking associations) offer to customers an ombudsman scheme in which the ombudsman acts as a neutral arbitrator between the relevant bank and its customers. This ombudsman scheme is regulated in a code of procedure set up by the respective associations for those same banks. Those codes of procedure are similar and provide that the ombudsman's verdict is legally binding for the bank if the relevant claim does not exceed €5,000. The use of the relevant ombudsman scheme is voluntary and no precondition for formal legal proceedings.
About the authors
Christina Ungeheuer
Christina Ungeheuer is a partner in the banking and finance group of the Frankfurt office of Baker & McKenzie. Beyond her German legal qualifications, which include a doctorate (Dr jur), she has studied law in Keele/England and is a trained banker (Bankkauffrau). She was admitted to the German bar in 1996 and has since practised law in the firm's Frankfurt office with the exception of a one-year stay in the legal department of a major German bank.
Christina Ungeheuer specializes in banking and financial services, banking supervisory law and project and acquisition finance. She speaks both German and English fluently and also French.
Jörg Kupjetz
Jörg Kupjetz is an associate in the banking and finance group of the Frankfurt office of Baker & McKenzie. Beyond his German legal qualifications, which include a doctorate (Dr jur) he has studied law at the UCLA, USA. He was admitted to the German bar in 2002 and has practised law in the firm's Frankfurt office since January 2003.
Jörg Kupjetz works in the field of banking and financial services, banking supervisory law and acquisition finance. He speaks both German and English fluently.
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