Regulatory changes – so often the bane of a custody bank’s life – are proving to be a boon for foreign custodians in Germany. A raft of securities industry reforms made over the past few years are opening up what for many years has been a relatively closed market.
Recent reforms have enabled hedge funds to be set up for the first time in Germany. Additionally, price transparency has improved with the breaking down of the value chain into its constituent parts - asset management, KAGs, custody and brokerage. It is also now easier for German investment management firms to outsource back and middle office functions. These changes have chipped away at the dominance of the universal banking model that favoured local custodians and depot banks.
Suzanne Ballauff, head of new business development for JP Morgan Investor Services in Germany, Austria and German-speaking Switzerland, says: “Since JP Morgan entered the German market in 1995, we have seen a continuous opening up of the market to more efficient products and services.”
Now that the value chain has been broken down, Ballauff expects pension funds will seek out the most efficient fund administration platform. “This will reduce the duplication of effort that occurs when both the KAG and custodian have to do fund accounting reporting.”
Mark Kelley, managing director, head of fund services Emea, Citigroup Global Transaction Services, says securities industry reforms have helped Germany’s pension funds to develop and grow. “Tax friendly changes to investment rules are allowing for more aggressive investment strategies by individuals. This means funds are flowing into the institutional funds base.” Germany now has the third largest funds business in Europe, says Kelley.
In December 2004, the German financial regulator, BaFin, granted Citigroup a full licence to offer hedge fund administration services. The licence was given to Citigroup Investment Deutschland KAG, an investment company from which both foreign and German fund managers as well as hedge fund managers can access the German market.
Citigroup can take on the administrative, reporting and risk management requirements on behalf of new funds, removing these barriers to entry and supplying services such as fund administration, custodial banking and prime brokerage services from a single banking platform. Citigroup’s first client under the new licence is Arsago Global Hedge Holding, a Frankfurt-based hedge fund company. It is also acting as a depot bank for Fidelity’s KAG, which Kelley describes as important, given that the investment management company has not previously worked with Citigroup on a fund administration contract.

Kelley says Germany is one of the most important countries for Citigroup, particularly in terms of securities services. “There is great growth opportunity in Germany and we expect it to become more of an opportunity as investment managers and pension funds are finding greater opportunities to get the best return for their investment.”
Germany is also held in high regard by State Street, which in February 2003 completed its acquisition of most of Deutsche Bank’s Global Securities Services business. Under the agreement, State Street paid the German bank an initial sum of around $1.1bn (e846m) and took on 3,200 employees.
Stefan Gmuer, senior vice-president at State Street in Munich says the bank is on track with its plans to have completed integration of the Deutsche Bank GSS business by the end of 2005. Moreover, the bank has managed to retain a high percentage of GSS customers. “We are not only holding on to the GSS business, but are also winning new business. We are very much in growth mode,” he says.
In October last year, State Street won a multibillion euro depot bank mandate from German airline Lufthansa. The deal also included the provision of performance and analytics services.
While Deutsche Bank divested itself of its global custody operations, it has maintained a presence in domestic custody. In December last year it completed the integration of Dresdner Bank’s institutional custody business in Germany, which it acquired in October 2003. More than 100 institutional clients representing assets under custody of around e200bn were transferred over to Deutsche Bank, along with 100 staff.
The transfer of business covered the settlement, custody and administration of mainly German securities and traded derivatives for national and international financial intermediaries. These include banks, global custodians and insurance companies, but none of Dresdner’s private banking clients.
Roger Harrold, head of Deutsche Bank’s domestic custody services, says: “The integration has been a great success. We have kept to the original timetable while maintaining high levels of service both to our existing clients and to those who have been transferred from Dresdner Bank. We now intend to build on that success by extending our enhanced product range within Germany and in other markets, thereby adding further value for our clients.”

As in other European countries, global custodians feel that the provision of outsourcing services will be the key to the German market. BaFin has relaxed outsourcing regulations, making it possible for foreign investment managers without their own KAG in Germany to work with German funds. This has eliminated the final barrier to overseas asset managers entering and operating in the German market.
State Street’s deal with AXA Investment Managers has set a precedent for Germany, says Gmuer. In December 2004, AXA appointed State Street to provide investment operations for e300bn of its assets under management in the UK, France and Germany. Services include middle office functions such as fund accounting, performance measurement, fund administration and investment operation support.
“The middle and back office activities of AXA’s KAG have been outsourced to State Street. Our relationship with AXA has broken a lot of ground in Germany; it is the very first deal of its kind in the country,” says Gmuer. Following the deal, State Street opened an office in Cologne (it already had an office in Frankfurt) and took on 16 local AXA employees.
While Gmuer admits there is a “first mover” advantage for State Street in providing outsourcing services, the bank does not intend to take a “shotgun” approach to its marketing of outsourcing services. “Outsourcing deals are extremely complex. Customers have different levels of sophistication and each deal will have unique features. State Street will turn down business if we don’t think it is the right fit or would distract from our main focus of providing superior services in custody, depot bank and insourcing.”
Citigroup’s Kelley says it is early days for outsourcing in Germany, particularly as the regulatory reforms are bedded-in. “We are getting requests from a number of KAGs to find unique solutions for them. In the next year or so I think the market will develop a number of different structures and it will take some time before a more standardised approach to outsourcing is established.”
JP Morgan’s Ballauff says while there is a large number of local depot banks in Germany, only a handful market their service actively to third parties, with the majority acting as inhouse depot banks for investment managers.
“We are seeing a trend towards global sub-custody product offerings, where some of the smaller banks will keep their depot bank status and do custody for the German market. However, the global network management will be provided by global custodians such as JP Morgan. We are talking to a number of potential clients at the moment and we do see increased consultant activity in the market.”
The market will remain very competitive for global custodians, given both Germany’s large population and its high level of financial assets, she says.

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