“Typisch Deutsch“, groans Peter Opitz, a Frankfurt-based partner at international law firm Freshfields. He sighs resignedly at Germans’ tendency to do themselves down: offered the choice, German business people will trust foreign experts rather than those born, educated and trained in Germany.
Frankfurt may have matured as a financial marketplace, but local bankers have not shaken off their inferiority complex. “What was once an ugly duckling has grown up into a handsome swan, though not necessarily a proud swan,” says Johann-Wilhelm Gaddum, vice-president of the Bundesbank.
As competition grows between Europe’s financial marketplaces, Germany’s moneymen are gripped by the agony of self-doubt. For every banker who celebrates the fact that the big banks have finally shut down their trading rooms in towns like Stuttgart and Düsseldorf, centralizing trading in Frankfurt, another rants that Germany should have conquered its parochialism years ago.
As Finanzplatz Frankfurt slowly begins to tackle its shortcomings, this soul-searching has been formalized with a schedule of regular meetings.
Two years ago the stock exchange started a lobby group to reform financial legislation and gild the image of Finanzplatz – a good deal of the members’ time is spent reminding each other of the problems. Last summer the finance ministry launched its own Finanzplatz talking shop. Even the Bundesbank, which never used to bother with the Finanzplatz, now joins in the debate, although Gaddum tends to take a more constructive line than other bankers.
The challenge Frankfurt faces is straightforward. When the Deutschmark disappears and the Finanzplatz loses the automatic status derived from it, Frankfurt will have to compete for the position of Europe’s leading financial marketplace.
Some theorize that Frankfurt will gain from London because the UK is outside Emu. That may be relevant for fixed-income trading in euro products, but for other businesses it is immaterial.
From the start the Finanzplatz has not enjoyed the full commitment of banks because there is no primary-dealer system for Bund issues. The Bundesbank describes this as a form of freedom for banks, which are not required to act as market-makers or buy at the average price (and, by implication, need not maintain a substantial local trading room). In Gaddum’s words: “One consequence of our liberal German system is that it ties banks only loosely to the Finanzplatz and puts them under very few obligations.”
Whether Frankfurt can cut the mustard as a financial centre depends not just on the currency, but on the infrastructure and the expertise of local financial-services providers.
Frankfurt’s rivals are not only Paris and London but also any other centres capable of providing the appropriate technology, the skilled labour or simply the political support to attract a new venture. The German city of Hanover, for instance, can scarcely claim to be a financial centre on the strength of Norddeutsche Landesbank’s modest trading room, but it has become the home of the German commodities exchange, which opens this month.
There is no shortage of lawyers and accountants in Germany; traditionally these professions had more kudos and were more lucrative than banking.
It was once commonplace, but is now rare, for corporate financiers and derivatives heads to fly in lawyers and accountants from London because local professionals are unable to provide the expertise.
The big accountancy firms all have sizeable affiliates in Germany and long ago learned to offer international accounting standards and US GAAP alongside Germany’s own HGB rules.
When German corporations began to demand those standards around 10 years ago, the big firms imported British and US-trained staff from their partner firms around the world.
When Daimler-Benz decided in 1994 to produce US GAAP accounts – it was the first German blue-chip corporation to do so – it relied almost entirely on KPMG’s German offices. The following year, KPMG generated substantial new business when Deutsche Bank decided to produce accounts under the German HGB system and international accounting standards.
Just-in-time accountancy
It is just as well that accountants have managed to make the transition in time. Their traditional German business is shrinking as clients merge. Since the law changed in February, listed companies have been able to choose whether to publish German HGB accounts or a foreign alternative; they need no longer do both. Many will abandon HGB immediately; at the same time the growing firms prefer US GAAP and IAS; they are standard practice on the new stock-market sector for growth stocks, Neuer Markt.
Law firms are in a more difficult position. Banking clients still make a clear distinction between German firms and international firms, and international affiliations are much looser. Monika Dahlmeyer, head of international funding at DSL Bank, says she uses a leading German firm such as Hengeler Müller Weitzel Wirtz for domestic bond issues that involve only German law, but switches to a foreign firm for Eurobond issues. Corporate financiers make the same distinction.
Cleary, Gottlieb Steen & Hamilton; Jones Day Reavis & Pogue; Clifford Chance and Freshfields operate the largest foreign law firms in Frankfurt. Other major firms, such as Linklaters & Paines and Slaughter & May, set up small Frankfurt offices headed by a single partner but failed to win enough German customers and retreated again.
The international view is that it’s not the lawyers who lack experience of international deals, it’s their clients. “There’s still a shortage of senior bankers with broad experience of sophisticated [corporate-finance] deals,” says Peter Coym, head of Lehman Brothers in Germany.
So German banks and corporations tend to ask law firms to help develop ideas for capital-markets issues, to suggest how new instruments might be applied in the German market and to think up creative solutions to complex cross-border M&A deals.
Opitz of Freshfields describes how when German banks gained permission from the regulator last year to issue asset-backed securities, they asked their international lawyers for insights into that instrument and how it might work for them.
Clearly, law firms which offer experience of similar deals for clients outside Germany speak with more authority than German firms which know the theory but not always the practice.
That is motivating German firms to seek partnerships with international firms. Dehringer Tessin, a medium-size business law firm, recently announced an alliance with Freshfields which will lead to a full merger if it progresses well.
All German law firms recognize the need for foreign partners. Hengeler Müller Weitzel Wirtz, with 55 partners the leading banking law firm in Germany, has a long-standing non-exclusive cooperation with US firm Davis, Polk & Wardwell. Because of the international dimension it offers, Davis, Polk & Wardwell and its peers appear to have achieved an equal footing with local firms, even with German clients. Hengeler Müller Weitzel Wirtz and Davis, Polk & Wardwell made a joint pitch for three important mandates in the German market last year: the IPO of home-loans bank BHW; the merger of Bayerische Vereinsbank with Bayerische Hypo-Bank; and the capital increase for Thyssen.
As the corporate-finance business in Germany explodes and unfamiliar financial instruments are imported by international investment banks, the leading financial lawyers are hopelessly overworked. They have a shortage of staff with sufficient experience to keep up with their clients.
The same is true, bankers say, of the regulator. The German securities market was practically unregulated until 1995, when the Second Financial Markets Promotion Act set up the Federal Supervisory Office for Securities Trading (BAWe). In the autumn of 1997 BAWe announced that it had attained world-class standards. Bankers disagree.
The tension came to a head last October, when Lehman Brothers was the subject of a trading inquiry by BAWe, which bankers say was desperate to enhance its credibility by uncovering and punishing its first case of rule-breaking.
Lehman had issued knock-out warrants on German blue chips, including Bayer shares. But Lehman’s hedging alone appears to have depressed the Bayer share price, pushing the price below the knock-out barrier and losing investors their bonus – even though this was not intentional.
Lehman received a warning from the sanctions committee of the stock exchange on the grounds that any instrument that “acts against the interests of the customer” breaches the rules of local securities trading. Coym protests, however, that Lehman’s only alternative would have been to take a loss itself.
He concludes that the German equity securities market may still be too small to sustain specialist derivatives, and he also wonders whether the regulators appreciate that. “The regulatory environment makes certain products untradable,” he says.
Major banks have long been considering whether trading in Germany makes sense as Emu approaches.
Despite the logical arguments offered by the Finanzplatz lobbyists, few have been convinced that fixed-income trading in euro-zone bonds must be done inside the euro zone. London is still the preferred location because more of the right personnel are there.
Société Générale, Citibank and JP Morgan all abandoned fixed-income trading in Frankfurt last year and some firms, including Morgan Stanley, have never really begun. Lehman Brothers is locating all proprietary trading in London, leaving only German equities trading and DTB trading for customers being handled out of Frankfurt.
Even Deutsche Bank, which is headed by the Finanzplatz’s leading champion, Rolf Breuer, and was therefore expected to choose Frankfurt, seems unable to decide where to locate its trading in euro-denominated bonds. Even among Frankfurt-based traders, there is concern about whether Germany offers an adequate infrastructure.
Back-office blues
Lobbyists who initially focused on shortcomings in trading volume and M&A expertise have recently been forced to switch their attention to that most unfashionable area: back office and settlements.
When Deutsche Telekom went public in 1996, German banks had to negotiate special deals with the trade unions before settlements staff would agree to work on the weekend between the price announcement and the beginning of trading.
Running support services in Germany is expensive, slow and inflexible, because every tiny adjustment has to be negotiated with the trade unions, say the critics.
Regardless of that, the German banks are sticking to their old habits. Dresdner Bank’s basic principle is to centralize all processes which do not involve direct customer contact. So the back-office and settlements operations for its forex business is being moved back to Frankfurt, close to trading and sales and under the nose of management.
Last October Dresdner moved its UK forex settlements to Frankfurt, the move from New York follows this spring. In the autumn forex settlements now done in Singapore, Hong Kong, Tokyo and Sydney will move to Frankfurt too.
Lower costs are not the bank’s motive. The ultimate savings will be negligible – just Dm2 million ($1 million) for the move from New York – and come entirely from technology improvements. Staff costs in Frankfurt are higher than in New York and much higher than in the out-of-the-way locations that some other banks are considering.
Yet bankers are still deeply unhappy about the inflexibility of German back-office personnel. Although high unemployment makes it relatively easy to find rank-and-file staff for back office and settlements, they have to be coaxed into working more flexibly.
Klaus Rohmer, head of forex settlements at Dresdner, expects that his settlements team will soon have to extend their working hours until 10 or 11 in the evening because of the time difference between Frankfurt and New York.
Even though banking staff can legally be required to work their 39-hour week at any time of day or night, the union-dominated works councils have the right to veto shift arrangements they dislike or believe unnecessary. Rohmer is relying on staff goodwill and his own powers of persuasion. Bad vibes between staff and management can be created very easily if staff are pushed too hard, and one-day strikes in German banking are not uncommon.
Testing times
The new arrangements for forex will probably be a test for Dresdner’s securities settlements, which are all still run in individual trading centres: Frankfurt for Dresdner itself, London for Kleinwort Benson and Paris for BIP, Dresdner’s French securities subsidiary. No decision has been made yet on their future.
The same is true of Deutsche Bank. Even though it runs two shifts for its Frankfurt securities settlements, the later shift ends as early as 7pm. So tickets generated by after-hours securities trading in Frankfurt are not booked until the next morning. “It’s not ideal but given the right security arrangements we can live with it,” says Harry Szameitat, chief operating officer in the global-markets division.
The big banks admit that the ideal solution has not yet been found. “The labour laws are not as forthcoming as we would like,” says Szameitat. “Ultimately we produce more expensively than others do.”
German banks probably have no opportunity to make radical changes, because their settlements factories are based in Frankfurt and operating efficiently. Deutsche’s enormous back-office operation in Eschborn, outside Frankfurt, has good throughput rates for commoditized transactions. The market leader is even offering its payments-settlements services to medium-size banks which do not have the economies of scale to justify the cost of their own operation.
It will not be so easy for the Finanzplatz to retain settlements business at banks with smaller local operations. The Frankfurt office of Lehman Brothers, for instance, is small enough not to have the works council which is a legal requirement at bigger firms, so management can lean on individual staff to stay late.
Even so, Lehman is looking for a more efficient solution and is considering moving its entire worldwide settlements – including its German settlements – to a new, purpose-built location. None of the places being considered is in Germany.
Some business may come the other way, however. The Swiss banks are setting up a joint subsidiary in Frankfurt to settle their cross-border payments. They fear that once Emu begins, banks based outside the euro zone will be denied access to intraday liquidity through Target. Their only alternative would be to seek collateral from other banks and that would be inconvenient and expensive.
At present, Rohmer says, Dresdner Bank is focusing on its growing Frankfurt operation and regards a shift to somewhere cheaper as a possibility for five years down the road. “We have introduced job-order cost accounting so that we know exactly how much each transaction costs. If we were to move this work elsewhere we would be able to work out exactly how much it would cost.”
Towards centralization
Deutsche Bank, too is considering the possibility of a radical change one day. The transition will happen in several steps: first the bank will concentrate settlements on a few centres before planning a single centre for its back-office work worldwide. Whether the Eschborn operation survives in the long run depends on whether the law changes, and whether staff mentalities change.
“I don’t think the legal framework is ideal and hopefully the [government] will see that this country is going to lose a lot of jobs unless they permit greater flexibility,” says Deutsche’s Szameitat.
Banking lobbyists are trying to get a change in the law which would oblige some staff to work on German public holidays when the financial markets are open in other EU countries and on Sundays when necessary.
The threat of job cuts is probably the most powerful card the banks can play against the government. Indeed, the government’s package of new legislation, which creates private pension schemes, liberalizes accounting procedures, reforms corporate governance and allows issuers to convert debt into euros, is described as a “programme for jobs”.
But in corporate finance and equity sales, there is little sign that jobs are being created in German banking. Improved infrastructure means fewer staff are needed. Some banks – particularly the local cooperative banks and Sparkassen – are only just beginning to automate payments.
On the contrary, Frankfurt is full of talk about how job cuts in their thousands are approaching. Deutsche’s recent announcement of 5,000 job cuts is thought to be just the beginning. On a smaller scale, NatWest Markets closed its equities, bonds and advisory business in Frankfurt in February with the loss of 38 jobs.
Meanwhile, young German bankers are flocking to London or New York to gain experience in more advanced banking cultures. The institutions have already learned that they do not need to be anchored to Frankfurt to grow their business. Deutsche Börse is increasing its trading volume thanks to remote-access traders based outside Germany. A presence in Frankfurt is irrelevant to DTB trading.
A City address and a foreign accent often seem a distinct advantage in corporate finance.
