Outsourcing has become an important issue for master KAGs but, as Heather McKenzie finds, it works both ways
There’s an air of change in Germany’s securities services market as outsourcing gains momentum. Master KAGs, a unique feature of the German market that enable consolidated management and reporting of investment management accounts with different providers, have begun to seriously consider outsourcing functions to global custodians, or depot banks as they are called in Germany.
In December last year, Société Générale Securities Services (SGSS) completed the acquisition of the fund administration and middle and back office services of Pioneer Investments KAG, a German subsidiary of Pioneer Global Asset Management. The clients of the activities acquired by SGSS include Pioneer Investments and other German fund managers. The related funds under administration were €52bn at 30 September 2007. Pioneer is a subsidiary of Unicredit Group, whose securities services businesses in Italy, Luxembourg and Ireland were acquired by SGSS in October 2006.
“The decision to outsource is a strategic, long-term one and the institution must be sure that the service provider can do the job,” says Dietmar Roessler, head of global fund services at BNP Paribas Securities Services in Frankfurt. “If a service provider doesn’t have a track record in outsourcing, it is very difficult to get into the business unless you buy an existing provider.”
Michelle Grundmann, (pictured right) general manager, Frankfurt at BNY Mellon Asset Servicing, says because KAGs maintain the regulatory responsibility for the data that the depot banks provide, they are keen to enter into partnerships with depot banks in which they have faith and confidence. “To a large extent, the depot banks in Germany perform the same function as the master KAGs and by insourcing, depot banks can create an efficient processing environment by linking the data flows that need to come together.”
KAGs and master KAGs are looking with more interest at the possibility of outsourcing back office administration and fund administration to depot banks and global custodians because the primary systems they have used are more than a decade old, says Grundmann. “Many want to switch to new platforms and are evaluating their administration functions.”
Joerg Ambrosius, managing director of State Street in Germany, agrees that outdated technology has also played a part in the decision to outsource. Systems developer SunGard is migrating customers in Austria and Germany from its V3 fund accounting platform on to GP3. “Users will either have to upgrade to the new system, buy another system or outsource to a full service provider,” Ambrosius says. “I think we’ll see a lot more outsourcing because of this.”
Roessler says German regulatory changes in the early 2000s made it easier for institutional investors to “break the value chain into pieces”. This has led to a greater emphasis on the role of the depot bank. “Many institutional investors are now appointing a single depot bank across all of their asset management activities and this is a wave we have ridden. The depot bank business in Germany is growing very well, particularly on the fund administration and insourcing side,” he says.
Some master KAGs are also looking to insource business from KAGs, says Ambrosius. “We are seeing on the one hand master KAGs looking to insource fund accounting business from the German depot banks and on the other they will insource accounting shops from other master KAGs.” There is now much more open competition between depot banks and master KAGs in the market, he adds.
In January, master KAG Universal-Investment-Gesellschaft announced a €9bn deal with SEB Asset Management under which it will administer the firm’s German securities funds. The back office services Universal has insourced from SEB include fund accounting and reporting. The deal covers about 70 securities funds.
“As a KAG ourselves, we feel we are more deeply involved in the KAG business compared to a global custodian,” says Bernd Vorbeck, speaker of the Universal management board. “Also, we are focused on the national market and understand and have experience of some of the specialities in the German market related to tax, risk management and reporting. From our point of view there is definitely a place for local players in outsourcing.” Universal is also targeting depot banks for outsourced fund administration services - a market much larger than the KAG business. The master KAG’s aim is to increase its insourcing business by €30-50bn over next five years.
Vorbeck says fewer outsourcing deals have been done in the German market than he expected, but a lot of market players are now discussing different outsourcing models. “People have been waiting to see how the initial outsourcing deals have progressed,” he says.
One of the advantages that the global custodian depot banks argue they have over master KAGs is an ability to service an increasingly internationally focused client base. “Large multinationals are asking depot banks whether they are in a position to do custody and report on their subsidiaries around the world,” says Grundmann. “This is an interesting development for the German market, which has many local depot banks. Clients are looking for more control and risk management over their worldwide assets, which is driving an assessment of custody and a desire to consolidate reporting across all of the data and to assess performance globally. This plays into the hands of the larger players.”
Many of the German KAGs have significant unit cost problems - some have old fund accounting systems and others’ business is sub-critical in mass, says Roessler. “With regulatory requirements becoming more stringent and the value of assets contracting, life is more complex for KAGs and there is a greater willingness among them to discuss outsourcing.”
Ambrosius says even though some functions might be outsourced to a master KAG, KAGs still need custody, and master KAGs are not in a position to undertake this easily. “Investment in Germany is becoming more international and the range of asset managers being appointed are far more international than in the past. The practice of only using German-based managers is over.”
The trend to go global is happening at the same time that investors are using advanced products, particularly derivatives and structured products. “Depot banks are not only being asked to do valuations, but are also asked handle some of these products and you need to be able to handle these in the back office.” Efficient systems have become crucial to the whole process, says Ambrosius.
Roessler says there are still around 60 traditional German depot banks operating on old fee structures, which could be affected by the European Commission’s markets in financial instruments directive. “The fee structures are charged on basis points, which can be quite high in some cases and they bite into the performance of the fund. As institutional investors are increasingly more concerned about performance and costs, they have forced depot banks to switch to more modern contracts that have a flat settlement fee. As the old fee structure disappears, some of these depot banks will have financial concerns and may decide to outsource.”
On the valuation front, the subprime crisis has created concerns about asset valuation among pension trustees, says Roessler. “We have seen a significant demand for performance and risk analysis tools, including value-at-risk tools.”
Roessler’s colleague, Gerald Noltsch, general manager of BNP Paribas Securities Services in Germany, says one consequence of the credit crisis is that regulators are demanding more scrutiny of complex structured products. “The outcome of this has been an added workload for the industry to ensure the pricing of these products is accurate. These prices are often given by the banks or brokers that issue the products and reconciling these can become quite cumbersome,” he says.
Outsourcing is also a trend among Germany’s brokers, says Ryanne Cox, director of the financial institutions division at KAS Bank in Germany. “Brokers are increasingly focused on their core trading activities and are more willing to outsource the back office functions, which we provide as part of our broker services activities, which include settlement and reporting.”
Custodians are watching a trend to multinational pension pooling with interest. “There is an increased awareness in the German market that investment vehicles are not tax transparent and there has been discussion of using existing structures to facilitate pooling structures that are domiciled in Germany,” says Roessler.
Ambrosius says he expects to see some large asset pools that are sitting in KAGs to move outside the country because of the lack of a transparent tax vehicle. “There is pressure building up in the market now to get a tax transparent vehicle in place, but there is still a question of whether it will come.”