The big upheavals and challenges facing Germany’s investment sector will also have a direct impact on its custody business. The introduction of the euro and consequent elimination of exchange-rate risks have resulted in much more diversified portfolios within the Euro zone – the new ‘domestic market’. The trend is still towards portfolios with an increasingly international thrust and this in turn has led to ever louder calls for more global custodians able to meet investors’ ever more exacting requirements with regard to both the custody and administration of their securities.
Given the vast range of investment opportunities now available, it is clear that only global custodians can provide access to between 80 and 100 markets worldwide and hence the kind of network that neither traditional custodians nor even international clearing systems can compete with.
Investors (in most cases pension funds, support funds and insurance providers) are increasingly interested in multi-manager concepts in which a single portfolio is managed by several different asset managers, each of which has a management mandate and is responsible for one particular segment of the fund.

Performance measurement
To keep costs down and keep track of how the portfolio as a whole is performing, more and more institutional investors are now combining their equity and bond portfolios in investment companies that enable them to streamline reporting, while still cooperating with several asset managers at the same time. This development naturally plays straight into the hands of those global custodians that are already present on the German market, for only they can consolidate the various adviser mandates the investor has granted and so measure overall performance – above and beyond the various asset classes – for composition according to the same standards.
Following the events of 11 September and the crisis in Argentina, performance measurement has suddenly become an indispensable aspect of global custody and hence a top priority in the investment process. CFOs want to know how their portfolios are performing at any time so that they can hedge accordingly, if necessary.
When several asset managers are mandated for the same portfolio, only a global custodian can provide the investor with comparable performance data. As performance data is generally obtained using a wide range of methods (eg closing price/daily price, excluding or including tax etc), this is something the traditional method, ie, one performance measurement for each investment company, cannot do.

Changed portents
Far-reaching changes in the investment business have made a dying breed of those service providers that combine asset management with custody.
Investors want cost transparency for every service rendered. The practice of cross-subsidising is therefore on its way out – at least in the investment business. Investors not only want excellent services in every field, but also want to know what each service costs. Investment companies and their parent banks must therefore decide what their future specialisation is going to be.
Deregulation, including that brought about by the fourth Financial Market Promotion Act, and the easing of outsourcing regulations will open up new business opportunities as well as providing much greater scope for players on the German market.
Rising demand for multi-manager concepts means smaller investment companies in particular risk losing business to those players that can offer investors such a platform with multi-adviser structures.

Alternative strategies
Yet this development also opens up new business opportunities for those investment companies that want to become established as purely administrative companies, which take care of all the reporting and red tape required and leave the job of asset management to the advisers the investor has selected. Those investment companies that already have sufficient international expertise will probably concentrate their energies on asset management in future.
Another alternative for those that cover still more of the value chain is to provide a fund supermarket both as a distribution channel and as a certificate administration platform for retail investors. The countless fund supermarkets that have sprung up just recently prove that many investment companies see great potential in sales of their own and other funds.

Changes in the wake of pension reform
All these changes have been accelerated by the reform of Germany’s pension system, which has given business in both retail and institutional funds an enormous boost, not only by creating second-tier pension funds, but also by enhancing the appeal of third-tier investment in mutual funds.
Providers of custody services are likely to do well when it comes to the creation of pension funds – assuming they can offer all the services in demand, including the global custody of retail and institutional mutual funds, fund accounting and performance measurement.
Those that also offer comprehensive administrative services for employee-funded company pension schemes and so cover the whole range of asset management-related services now in demand will certainly be able to gain a competitive edge.
Basle II will make the underlying instruments required to cover the operational risks of the custody business so costly that many national custodians will doubtless wonder whether to remain on this market at all. It looks as though there are hard times ahead for those custodians whose business is concentrated on the German market alone.
Arnulf Manhold is managing director of investor services at J P Morgan in Frankfurt
A version of this article appeared in Börsen-Zeitung earlier this year