‘Made in Germany’ doesn’t yet appeal
Confident of gaining detailed coverage in the German business pages, capital markets broker Exco’s new German managing director Hans Joachim Goehtz met the press on December 10. Over mushroom crepes served at the swanky Frankfurter Hof hotel, Goehtz and the firm’s chief executive Peter Edge explained their strategy to transform Exco into an “investment bank”, providing its bank clients with research and beginning spread trading, repo trading and financial engineering.
New clients would be sought. In an unguarded response to an unexpected question, Edge and Goehtz let slip that, yes, Exco had plans to approach Germany’s cooperative Volksbanken (who tend to rely on DG Bank for capital-markets business) and the Sparkassen (who likewise use their local Landesbank).
Two days later Frankfurt’s Börsen-Zeitung ran the story, mentioning the Sparkassen and Volksbanken in its headline. The bomb had dropped.
By lunchtime, every fixed-income head in German banking had read the story. The outrage was greatest at DG Bank and at the Landesbanken, who saw Exco’s plan as a declaration of war. Yet even the private-sector banks were riled, because they do substantial business with the Volksbanken and Sparkassen too.
This was Friday, however, and Goehtz heard no hint of trouble before leaving for a three-week trekking holiday the following day.
But as his plane took off for New Zealand, fixed-income heads from the Landesbanken and from DG Bank were gathering in Frankfurt for a crisis meeting, the first time they had ever met on a Saturday. Some had already decided how to respond, and were happy to tell the others why. By the end of the meeting, all had reached the same conclusion.
When Exco’s Frankfurt brokers returned to work the following Monday, they discovered that DG Bank and many Landesbanken had stopped dealing with them.
For a brokerage firm, the situation was a nightmare. Half the local market had pulled the plug, and the boss was on walkabout in the antipodes. There was no time to recall Goehtz from New Zealand, so chief operating officer Marcel Wolf flew over from London for the second time in a week to try to repair the damage.
The banks were furious, and Wolf succeeded in meeting only a few of the executives who had attended the Saturday meeting. Others spoke to Wolf by telephone; a few declined even to do that.
With its entire German business on the line, Exco retracted the fateful statement. Goehtz even wrote to his clients promising that Exco would no longer attempt to “acquire” the Volksbanken or Sparkassen as customers. Despite the climbdown, however, several Landesbanken are still refusing to deal with the brokerage firm.
Rivals are gloating at Exco’s expense. “If I did that I’d never get another call [from a bank].” says Klaus Schwantge, head of Finacor’s German operation. “I might as well cut my own phone lines.”
Weeks later, bank traders are still trying to figure out what happened.
Undoubtedly it was an odd error for Goehtz of all brokers to make. As a former head of sales and trading at Deutsche Bank, he has been in the local market for more than 20 years. Presumably he guessed what impact those words would have on his clients. Goehtz says Exco did not intend to alienate anyone; his words were simply misunderstood.
He does believe, however, that there is demand from the Sparkassen and Volksbanken for Exco’s new services: portfolio planning, risk hedging and liquidity management. He is also convinced that brokers in the German market must find a new role, be able to plan and carry out complex, time-consuming transactions and offer advice on market trends.
The banks aren’t so sure. They want brokers to concentrate on price discovery and often use them to compensate for staff reductions in routine trading. But the large banks at least prefer to handle complex trades themselves. Goehtz presumably knew this and he must have guessed that Exco’s plans would be interpreted by the banks as a challenge. Perhaps the big banks overreacted, but then again, they were on red alert. Brokers in Germany have often tried to initiate business with the Sparkassen and Volksbanken and time and again have been repulsed.
Bankers say that Cantor Fitzgerald, the prominent US broker, also tried targeting the Volksbanken and Sparkassen when it burst onto the German scene in September 1996. Cantor denies this. Whatever the history Cantor is now doing business with DG Bank and the Landesbanken. However, brokers are in no doubt of these banks’ views on this subject. Some other banks are even more pugnacious with brokers who try to force changes in the market.
The curious story of Exco’s debacle and the tumultuous arrival of Cantor Fitzgerald are no isolated incidents. They mark the beginning of a real shake-up in German broking.
Both the experienced insider and the feisty newcomer see an opportunity to rattle the old system, where a surfeit of execution-only brokers supply the same prices to a limited number of banks, and rely entirely on the goodwill of those banks for their survival.
At the same time, brokers are fighting dirty, using every opportunity to discredit each other. Euromoney heard dozens of allegations which quickly proved to be baseless or at least distorted.
For the time being, supply and demand is working in the banks’ favour. There are nearly 100 securities brokers operating in the German market, and far fewer banks which are significant players. Moreover, some banks with powerful market share in local securities trading (Deutsche has a massive 30%, Dresdner and Commerzbank at least 10% each) like to describe themselves as “brokers to the market” and take a limited view of independent brokers’ usefulness.
At the same time, brokers’ clients are vanishing. An acquisition and a merger have effectively eliminated BZW and SBC Warburg, while the German securities-trading market is being deprived of major international banks as many decide to concentrate all trading in euro-denominated products in one location: London.
In order to survive, broking firms have been merging, and now a core of around 10 sizeable firms remains. Even that number, however, is far too many for the banks’ liking.
Andreas Gautsch, head of fixed-income trading at Commerzbank, says he has nothing against Cantor Fitzgerald or any other broker, but he simply does not need prices supplied from a dozen different sources. In fact, Gautsch believes passionately that intermediaries will be needed even less as technology advances.
At Deutsche Bank, Wolfgang Matis is even blunter. He uses only two local brokers for fixed-income trading and sees no reason to change as long as those two continue to perform up to standard.
Long-standing brokers in the German market have learned to live with Deutsche’s philosophy and have found clients elsewhere. But Cantor Fitzgerald refuses on principle to accept defeat.
Lee Amaitis, chief executive of Cantor Fitzgerald International, has tried his utmost to cajole the market leader into doing business with his Frankfurt brokerage team.
So far, he has failed. Matis refuses to take calls from Amaitis or from Aynard de Clermont Tonnerre, Cantor’s local managing director.
That could be a deadly blow, since Deutsche is not only the largest player in the German securities market but also makes no secret of its aversion to the US newcomer. While other banks say they do business with Cantor, they do not say how much.
Without Deutsche Bank and without a steady stream of business from other banks, a broker in the German market may well encounter problems supplying timely prices. Amaitis admits that getting started in the morning can be difficult for Cantor’s Frankfurt brokers.
Vanishing clients have hurt Cantor more than any of its rivals. The firm’s main German counterparties are the local affiliates of the big US banks. Over the past year, however, Citibank, JP Morgan and Merrill Lynch have all transferred their German fixed-income trading to London.
That is the reason why Cantor is about to shift its long-term Bund brokerage and its bond options desk back to London, according to Amaitis.
He says he has no plans to move any other business back to London or to stop broking German products. But he acknowledges that he faces powerful animosity from banks and from other brokers in Germany who would love to see him go.
“It’s competitor-driven, ex-employee driven,” Amaitis explains. “We have had tremendous staff turnover in Europe because we are trying to create a different model. The difficult thing for Cantor Fitzgerald is cracking domestic markets.”
It is precisely this attempt to change their home market that local German brokers fear most about Cantor Fitzgerald.
Cantor Fitzgerald arrived in Germany 18 months ago determined to win acceptance for the principle of not revealing the names of counterparties, even though this went against standard German practice (referred to as “name-give-up”).
After struggling against German tradition for a year, Amaitis finally capitulated last September and reluctantly began providing counterparties’ names. (“We picked up some clients because of it,” he acknowledges.) Despite the concession, Amaitis holds fast to no-name-give-up on Bunds. Several German banks insist, however, that they get names on all the transactions they do with Cantor.
Amaitis is playing for time. He points out that no-name-give-up is standard in the French, Dutch and Italian government bond markets and he hopes that as banks centralize their trading in euro-zone bonds in one location, that principle will prevail over German tradition.
Despite its reluctance to offer name-give-up, Cantor does preach a gospel of openness, on the grounds that its prices are displayed on screen for all to see. “Our goal is transparency in the market,” Amaitis says. “If it’s not here in 1998, it’ll be here in 1999.” He believes spreads have grown narrower as a result; the competition retort that Cantor’s local market position is not substantial enough to change anything.
Other brokers also claim that Cantor is using others’ prices on its own screen. Amaitis argues this is a misunderstanding of Cantor’s standard practice: principal brokerage. “Our clients choose to give prices to us to broke to other people. If you are a principal broker you are responsible for the price.”
The US firm also attracted more than the usual hostility from rival brokers by luring away the largest team to defect in the history of German broking (although some bankers say they rather admire Cantor for its nerve).
Previously, the largest defection in German broking had involved a team of five who switched from Exco to Finacor. Then, in the autumn of 1996, Finacor lost 30 brokers at a stroke to Cantor Fitzgerald. The leader of the group was Tonnerre, who had managed Finacor’s Frankfurt operation, and it included almost every one of Finacor’s fixed-income brokers.
Overnight Finacor Frankfurt halved in size and spent all the next year fighting its way back to full strength and towards profit. Schwantge sued Cantor Fitzgerald, lost and does not hide his bitterness and resentment.
But in spite of Cantor’s success in recruiting new brokers, they don’t seem that busy. At 1.40pm on a weekday last month the trading room was not exactly humming with activity.
According to Amaitis, Cantor’s Frankfurt operation was costing it $1 million a month net last year. He admits that volume will have to increase substantially before the 40-broker office turns a profit (although the eight-man equities team is “unexpectedly profitable”).
Cantor is not alone, however: few brokers in Germany make a profit and all are suffering as fees are squeezed.
Traditionally, German brokers have earned money from commission alone. Now, as banks turn the screw, brokers’ conventional revenues are disappearing fast. According to Heinrich Hrase, managing director of derivatives broker Gottex, fees on Deutschmark swaps are down to one-eighth to one-quarter of a basis point for market makers and to one-half of a basis point for market users. That is 50% of the levels of five years ago.
Derivatives broker Intercapital withdrew from bond options, Deutschmark repos and gilt repos some time ago because the fees had sunk so low. “I think the broking industry has been very slow to exit unprofitable business,” says David Gelber, Intercapital’s group managing director. “But in some products the compensation is getting to levels where it is questionable from the economic point of view whether the business is worth it. We have a situation where the top broker earns a lot, the number two earns quite a bit, the number three guy earns a little bit and the rest lose money.”
One long-established German broker describes his confrontation with the head of fixed-income trading at one of the big banks. The banker was told that commissions had sunk so low that no broker could expect to survive on them. While the broker refused to accept any further reduction, the banker dug his heels in too.
For six months the two sides did no more business until the broker was induced to make a compromise. But since then, the broker reports in dismay, the commission paid has sunk still further to the level the banker had proposed in the first place.
German brokers used to get business from banks because of personal contacts between traders and brokers. Now, it’s simply a matter of price.
Nevertheless, the brokers still tend to rely on the argument that they are offering a service rather than a simple product. “We always talk very openly with the banks and we tell them we are constantly reviewing our business strategy. We say to them: “Let us know when we’ve got to change our business,'” says Andreas Schüler, head of Eurobond brokerage at Spütz, the local market leader.
Naturally the firm is loath to admit that there is still room for further price cuts, fearing that banks will apply more pressure. Nor does it want to declare war, especially while banks remain adamant that brokers are still doing very nicely, thank you.
Coping with low fees
When will the crunch come? “When fees are no longer adequate and we reach the pain threshold,” says Schüler. “When we can’t reduce fees any more.” And how will Spütz respond? “We’ll analyze it,” says Schüler. He suggests two possible responses: a sliding scale of fees depending on the depth of advice and the level of service a client receives, and more advisory services in the shape of capital-markets research.
Spütz, which probably gets more business from the big banks than any other broker, believes the day of reckoning is still distant. “I think we can continue the way we are for some time yet,” says Schüler.
“Up to now the shrinking fee levels have been compensated by growing volumes,” says Hrase of Gottex. “We haven’t yet seen the need to tell banks that things can’t go on.” Other brokers are less sanguine.
One obvious way is to begin trading on positions. Every broker who talked to Euromoney hotly denies position-taking, and every one of them accuses various competitors of the practice. Privately, some of them admit that as fees shrink, they are gradually being forced to do trading too.
More openly, the brokers are trying to expand their horizons.
One strategy is for brokers to find a foreign partner and thus gain the ability to broke more products. Carl Kliem, a local German broker, has found a new 40% shareholder in Tullett & Tokyo. Sputz is linked with the leading Dutch market-maker and interdealer broker, van der Moolen. Exco and Finacor’s German operations belong to international brokerage firms.
Meanwhile Cantor, which makes great play of its market expertise in the Italian and French markets, is keeping its eyes open for a German partner too. “It’s not outside the realm of reality that we would talk to a domestic broker,” Amaitis says.
“Brokerages will merge, and the banks will need brokers with connections in France, Germany, and in the Dutch market,” adds Tonnerre, whose firm has offices in London, Milan and Luxembourg as well as Frankfurt. Although major European banks are talking to around 20 brokers now, they will soon be doing business with no more than seven in the euro, Tonnerre believes.
Tonnerre and Amaitis can be encouraged by the fact that even Deutsche Bank, their German bête noire, does business with Cantor in Italy and other European markets.
Moreover, new German banking legislation allows brokers to offer some of the products of an investment bank. Since January, they have been able to take part in issuing syndicates, to sell to the retail market and to trade on their own account. In the weeks since these freedoms were introduced, brokers have been very restrained about the new opportunities. Clearly, any attempt to act like investment banks would bring them into direct conflict with the banks, as Goehtz has discovered.
For the time being, it seems, they are going to talk to the banks openly about their business, rather than seeking confrontation.
Some bankers, at least, appear to be sympathetic. Gautsch of Commerzbank, for instance, believes that in order to survive, brokers will inevitably have to become fully-fledged trading houses. Since the big banks have only limited demand for tiny “investment banks” like Exco, logic will lead brokers to new clients.
Despite their anger over Exco and Cantor, bankers do have some tolerance for brokers’ new ideas. Exco’s attempt to court the Volksbanken and Sparkassen was frowned on because of how it was done, not because it was attempted at all.
“There are no written or unwritten rules,” says Norbert Heeke, head of domestic fixed-income trading at WestLB. “But it’s the first time a broker has rebelled so publicly against the way things are usually done.”
In addition, many Volksbanken and Sparkassen, not just the very largest, are eager to assert their independence from DG Bank or the Landesbanken, and often approach brokers for prices and information.
Heeke estimates that between 25% and 40% of the Sparkassen in WestLB’s home territory of North Rhine Westphalia are dealing directly with brokers, and have been for years.
The banks’ real test
Banks also know that the Volksbanken and Sparkassen represent only the tip of the iceberg. The real test of the banks’ ability to keep their grip on the capital-markets business will come if brokers dare to approach German fund managers, which are all owned by the banks, or even major corporates such as Volkswagen or Siemens, which have substantial trading activities of their own and are jealously guarded by certain big banks.
Swiss-based asset managers and British pension fund managers are two of the other groups brokers claim they do not approach for fear of incurring the wrath of the banks.
In truth brokers do act for all of these clients sometimes, but they do so discreetly and they make sure they find counterparties which have no particular connection to the client. “We might do transactions for corporates like Siemens but we’d make sure we didn’t do them with Deutsche Bank,” says Hrase of Gottex. Another idea of his is to generate transactions between fund managers and corporates without involving banks at all.
Although brokers are convinced that fund managers and corporate treasurers need them, investors tell a different story. Günther Fitzenberger, head of trading at DIT, one of the largest fund providers in Europe, says he requires only six major counterparties in each country. In Germany, these counterparties are all banks. “Getting market and flow data is not enough. We need the detailed information to help us create a full picture of each security and to make buy and sell decisions.”
If brokers can ever hope to deal with investors like Fitzenberger, they will first have to change their products, then gain experience with smaller investors like the Volksbanken and Sparkassen. Perhaps that’s why Goehtz at Exco is still gung-ho about his run-in with the Landesbanken and DG Bank. It established a crucial point. “The banks’ grip on brokerage has weakened, and they know it.”
He even claims that the episode has opened doors. “I think it’s a positive thing. We never had contacts at such a senior level before. I am confident that our relationship with these banks will get better.”
This spring fixed-icome heads at all major German banks are being visited by Goehtz, who hopes to find a new modus vivendi between banks and brokers in the German market.”I’m an ambitious man”, he says. “And I’m not going to let myself be intimidated.
