Universal Banks and Investment Companies in Germany Theodor

1 Universal Banks and Investment Companies in Germany Theodor Baums I. Introduction II. Banks as shareholders and trustees 1. Separation between shareholders and investors under German law 2. Contractual vs. corporate governance structure 3. Supervis ory boards and banks as trustees 4. Reputation and performance measurement as substitutes? 5. Publicly held funds and the collective action problem III. Affiliated transactions 1. Scope 2. Conflicts of interests and regulatory provisions IV. Other bu siness interests of the parent bank 1. Underwriting and investment policy 2. Shareholdings of banks and investment policy V. Interests of the parent bank’s management 1. Corporate governance in large banks 2. Investment funds and shares in large banks 3. Regulatory reactions VI. Concluding remarks 2 UNIVERSAL BANKS

AND INVESTMENT COMPANIES IN GERMANY Theodor Baums* I. Introduction Universal banking means that banks are permitted to offer all of the various kinds of financial services. This includes classical banking activities like the credit and deposit business, as well as investment services, placement and brokerage of securities, and even insurance activities, trading in real estate and others. German universal banks also hold stock in nonfinancial firms and offer to vote their clients' shares in other firms. 1 This paper deals with universal banks and their role in the investment business, more specifically, their links with investment companies and their various roles as shareholders and providers of financial services to such companies. Banks and investment companies have, as financial intermediaries, one trait in common: they both transform capital of investors (depositors and shareholders of investment funds, respectively) into funds (loans and equity or debt securities, respectively) that are channeled to other firms. So why should a regulation forbid to combine these transformation tasks in one institution or group, and why should the law not allow banks to establish investment companies and provide all kinds of financial services to them in addition to their banking services? German banking and investment company law have answered these questions in the affirmative. This paper argues that the existing regulation is not a sound and recommendable one. The paper is organized as follows: Sections II - V identify four areas where the combination of banking and investment might either harm the shareholders of the investment funds and/or negatively affect other constituencies such as the shareholders of the banking institution. These sections will at the same time explore whether there are institutional or regulatory provisions in place or market forces at work that adequately protect investors and the other constituencies in question. Concluding remarks follow (VI.). 3 II. Banks as Shareholders and Trustees This section deals with the principal-agent relationship between investors and investment companies and the concurrent roles of banks as shareholders in investment companies and as trustees of the investors under German law. 1. The separation between shareholders and investors under German law One basic structural difference between a mutual fund under the U.S. Investment Company Act of 1940 and an investment company under German law is crucial for understanding of the role of the banks both as shareholders and providers of various kinds of services to investment companies: contrary to a U.S.-style mutual fund,...

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