The message is beginning to get across to German institutional investors about having an independent custodian bank , but only gradually. Major global custodians have been in the market preaching the master custody gospel, though it has been falling on unreceptive rather than deaf ears.

The potential market is huge, but the structure of the market means that custody often follows the asset management business, so that the huge retail mutual funds' custody business usually goes to the bank involved in the KAG, the investment management company, running the business.

With much of the insurance company assets run through Spezialfonds, as are those for corporate pension and other assets, the custody market here usually follows the rule that he who holds the KAG also gets the custody of the assets, as the assets have to be held by a 'depot' bank and this comes as part of the all-in service.

However, the law does not stipulate that the same bank must handle the depot role and in fact the Spezialfonds' sponsors, such as insurers and corporates, control this decision.

US researchers Greenwich Associates found that in the two years the number of institutions using separate banks covered in their survey of 161 organisations with DM228bn under management, only 11% are currently using a separate bank to do their custody work. In 1996, this was 9%. But it did find a notable disparity between insurance companies, who control over half the Spezialfonds investments but only 7% use a separate custodian. For pensions and corporates the proportion has jumped in two years from six to 17%. And another 26% of these institutions are considering this switch in the next three years; only 14% of insurers are. While 19% of the 68 investors with over DM1bn in fund assets are considering the move in this timeframe, nearly 30% of those in the DM500m to DM1bn bracket are looking to make the shift.

This is good news for global custodians that the message of an independent entity collecting and collating the reports from the range of Spezialfonds that investors can have with a number of KAGs is getting across. And the move to increasing investment outside Germany has raised awareness of the benefits of a global player.

Deutsche Bank is one of the main proponents of the new approach, singing very much from the same hymn sheet as the two US global custodians seen as the most active players, Chase Manhattan and State Street.

Heiko Lotze of Deutsche Bank's custody headquarters in Eschborn, just outside Frankfurt, says: There is an increasing realisation on the part of sponsors that custody does materially impact on performance. In addition to administering the investments fully, we offer a range of value-added services that are part of the sponsors services and of their value chain." The market is becoming ready for this, he maintains, with many of the leading companies adopting it. "We have been aggressively following this strategy for 18 months."

As the overseas exposures in portfolios build up, Lotze questions whether "the hausbanks will be able to service the business any longer".

In this strategy Deutsche Bank would not deny that it is following in the footsteps of the two US giants who brought the US approach to the domestic market. Nor has there been very much of a response from the other main German banks and the only main competition to appear has come from Credit Suisse. And there is speculation concerning the intentions of Bank of New York and Citibank, who are believed to be interested in this market.

One market observer points out: "Apart from Deutsche, generally, the other German banks only provide custody for their own funds." But one way to win business from the changes is to act as local custodian for one of the US banks. "In the case of Dresdner, it won the local custody work for State Street, when BfG decided to get out of the market."

At this stage, Chase is reckoned to have done the most in winning mandates in Germany. The bank has been active there since 1994/5, says Richard Warne of Chase in London. "We have been appointed as the depot bank for 100 Spezialfonds by plan sponsors covering $26bn of assets, involving relations with around 20 KAGs." Initially the bank's success was with US multinationals with operations in Germany, but then came a breakthrough with the capturing of the Hoechst account. "Now a number of the KAGs want to appoint us as their depot bank," says Warne.

He attributes Chase's success to its approach, which is to be as German as possible. "We did not tell the Germans the way to do it and we made sure our people understood the de-tailed requirements." Chase has just been given the go-ahead to act as custodian for mutual funds being sold to the general public. "We are the first foreign bank to have been given this."

Of course, these are very much the areas where State Street took a tumble in the custody market, when it had to stop taking on new KAG business because of a breakdown in its systems.

This followed a period when the number of clients grew from five in 1996 to 17 last year. But the systems were not able to cope with the influx of new business within the stringent German regulatory requirements.

State Street reports that it has come a long way since then. A spokesperson in Boston says: "We have just received a final report from regulators some weeks ago and we are in the throes of going through it. It is lengthy, technical and detailed."

The bank, he says, is determined: "To do all that needs to be done to make the regulators feel that we want to be a local bank, and not an American bank doing business in Europe." He adds the report is being taken very seriously. "We are going to do whatever it takes and do whatever the regulators suggest."

At the same time, the bank is hopeful once it gets the all clear it will go back into the marketplace. "I would be very disappointed if we were not marketing for these people by the end of this year," he says.

Lotze, who says the problems State Street had were something that could happen to anyone, adds that the US bank might have some difficulties in getting back into the market in the short term. "For a time, they will have to do damage control and relationship management, but they will find it difficult to get back in the market, in order to rebuild their reputation, which is a good one."

As elsewhere, Deutsche Bank says that it is the more sophisticated invest-ors that make most use of the value-added products, such as securities lending and cash management. "We do a lot of lending for Spezialfonds investors." In fact, the supply of German securities available for lending has become so great that rates have come down.

Cash management is in somewhat the same boat, says Lotze. "If an in-vestor just has a deutschemark account it is hard to make money from cash management, but with 15 to 20 different currencies involved, and if the investment guidelines are not drawn too tightly, then it is possible to make money."

But with the euro's arrival the product scene is going to change dramatically. Deutsche Bank is lining up its products, as are the other custodians, for the new scenario. These are for a marketplace that is now following the trends happening elsewhere. "We see that Germany could be catching up in the next few years - the pace is accelerating," says Lotz. Fennell Betson"

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