Speaking in Brussels in June, former German junior finance minister and World Bank managing director Caio Koch-Weser, admitted that the dream of bringing the financial centre of Europe to the economic centre was still just that. “Germany as a financial services location ‘Finanzstandort Deutschland’ is…still a long way from having realised its potential,” Koch-Weser says.
Things seemed rather different seven years ago, as the European Central Bank-opened for business in Frankfurt. Can the trend be reversed? Must the new coalition government in Berlin stand by, at best fiddling at the edges?
The good news for Germany is that some of the necessary work has been done. Two key pieces of data have recently ticked up:
q Germans have resumed opening private pension policies following their simplification in January 2005 (these Riester personal pensions were launched in January 2002 and were heavily promoted in 2001).
q The main domestic institutional vehicle, the Spezialfonds, which was threatened with decimation by IAS 27 and 39 and CADIII, has been given a reprieve by more flexible legislation in January 2004 , and the necessary regulatory appendices to it (August 2004). This reform also levelled the playing field for non-German fund management ‘advisers’, and took steps to create a domestic hedge fund industry;
Germany’s growing self-confidence abroad (troops in Afghanistan; seeking a permanent UN Security Council seat) is mirrored by a willingness to face facts at home. The Riester reform broke a decade-long conspiracy of silence among politicians about the finances of the state pension system. It also laid to rest several other taboos, in particular the link between trade unions and the setting of private pension benefits, and the exclusion of civil servants (which includes teachers and policemen) from any pension reform process.
Riester prepared the ground for the introduction of additional corporate (Entgeltumwandlung) and personal Rürup deferred compensation pensions, with up contributions up to E40,000 permitted annually.
Other achievements of Schröder’s socialist party (SPD) in the last seven years should also be acknowledged. These include:
q Abolition of corporate capital gains tax, which allowed Deutschland AG to start dismantling its cross-shareholdings;
q A corporate governance codex, and a takeover code, albeit watered down;
q Cuts in top-rate income tax, combined with an amnesty for black money in offshore bank accounts, and a subsequent crack-down on money-laundering and tax evasion.
Further drastic income tax simplification is still needed. The current system rebases with every E36 increase. Before the election, the conservative CDU Party proposed a low-tax academic Professor Kirchhof, to lead the finance ministry. The scent of such reforms this summer caused the German consumer to turn in his slumber. But it also unsettled just enough voters to wipe out the CDU’s lead by polling day. The resulting Grand Coalition, with a Social Democrat Party (SPD) Finance Minister, will certainly not be cutting taxes any time soon. But could it ‘normalise’ them in such a way as to funnel savings to financial services products?
There is no escaping the slide that has taken place in Germany’s relative position in financial services over the last seven years. Koch-Weser’s speech to the Initiative Finanzstandort Deutschland (IFD) in Brussels was rightly tinged with frustration.
Like a ghost at the feast, a month or so before that dinner, Eurostat, the EU statistical office, slipped out a data series which would once have been unthinkable. Net exports of financial services from Germany now mildly undershoot those of Ireland.
Funded pensions may be on the rise, but Germany remains a couple of decades behind the Swiss or the Dutch. The target set by Koch-Weser and his co-signatory to the IFD Report No1, Deutsche Bank chief executive
Ackermann, is not ambitious enough to succeed. A doubling of funded pension assets to E1.2trn by 2015 would leave Germany at the nominal total reached by the UK, with only two-thirds the population, 20 years ago. This will not create pension fund capitalism in Germany.
The IFD Plan has its strong points. The financial centre does tend to gravitate to the economic centre – look at the rise of the US West Coast. Koch-Weser is right that a financial services hub should come to Germany “naturally, because of the size of the German economy”. And the plan puts its finger squarely on two of the structural issues which need change:
q Restructuring company balance sheets away from debt to equity, and particularly away from bank lending;
q Building up fully-funded pensions and other financial provisions to close the funding gap.
However, there are several other points which need to be stated explicitly:
q Germany is switching its financial services model, from the closed-system which underpinned the Wirtschaftswunder, to an open system forced through by globalisation and EU harmonisation. Financial services are very high up on the economic food chain; while it may make sense to move automobile jobs to Eastern Europe.It does not make sense to move financial services jobs to Dublin. Germany needs a plan to actively win back high-end jobs lost to Luxembourg, Dublin, Vienna, Zurich and London;
q Restructuring balance sheets and providing fully funded pensions are, of course connected, because of pension book reserves (PBR). These on-balance sheet pension liabilities let companies off having to issue huge supplies of corporate debt, but at the expense of the pension scheme members. PBRs are holding back Germany’s adoption of the new model. They could be neutralised at a stroke by making them subject to social security taxes;
q The savings tax structure, which favours investment in property (inheritable) over pensions saving (non-inheritable), needs to be reversed and brought in line with international practice. This could be done by introducing personal capital gains tax with an exemption for pension funds;
q Germany’s regulatory environment is still a negative. Government and regulators must explain why domestic fund managers so often go outside Germany to launch products for the domestic market. The IFD says in 2004, 75% of retail fund assets won by German fund managers went to “foreign funds of German provenance”;
q Consolidation in banking: Germany had 2,148 different banks at the end of last year (the UK had around 400). On current trends this will not drop to 500 until 2015, which is too slow. Berlin can do more to help. Deutsche Bank should not be blocked from buying the Postbank;
q Consolidation in insurance: the number of insurance companies is also too high. There were 410 at the end of 2004, down from 480 in 1999. The average asset base is only E1bn. Again some encouragement to consolidate is needed;
q By contrast, the German asset management scene is too concentrated. According to the IFD, the top five domestic firms hold over 80% of the domestic market (in the UK it is 27%).
In his speech, Koch-Weser set a target for wider share ownership. But probably the only way to triple the number of shareholders to 15m by 2015, as he hopes, is to encourage widespread employee share ownership, again through a CGT exemption.
Enthusiasm for EU harmonisation may be the only course of action open to Germany. But it carries the risk that, rather than opening markets for German financial services, it makes them more vulnerable to others, because they move too slowly. According to DWS, in 2004 net mutual fund sales by cross-border groups (including Germans) into Germany exceeded E6bn, while domestic mutual funds suffered some E4bn of net redemptions.
The example of Ireland shows it is neither too late, nor culturally impossible, to make financial services a motor for jobs. The first IFD Report may have missed some key tricks, but the Germans’ natural urge to talk straight means it will eventually be rectified. In other words, don’t write off Germany’s planners yet.
Former Chancellor Gerhard Schröder had his own ‘Thatcher generation’ of managers, who had to get on their bikes.
The ferocious commuting and relocating of the last five years, triggered by the rationalisation in all financial services branches, eg, of fund management within merged insurance companies, was like nothing seen in the UK, even in the early 1980s. University graduates, who had to send out hundreds of CVs and accept whatever job was going, also have changed their view of the world. Together, these existing and future business managers will be a force to be reckoned with.
One might assume that a Grand Coalition will never agree on tax changes. But Germans are genuine admirers of anything they can call a “classical compromise”. And some of the normalisation - read tax-raising - such as social security tax on Pension Book Reserves, and personal Capital Gains Tax with exemptions for pensions and employee share ownership, might actually be easiest explained by a modernising socialist finance minister, within a coalition of Right and Left. The new government certainly needs revenue, and has a sufficient majority to step over factions which would normally block any single party attempting such changes under the proportional system.
Perhaps Germany can turn the rocky road to Finanzplatz Deutschland into an autobahn after all.
Fergus Dunlop is a managing director of SÜDPROJEKT in Munich www.suedprojekt.com
1 Initiative Finanzstandort Deutschland Report No 1 – June 2005. www.finanzstandort.de