On January 1 Deutsche Bank gains a new board member. Apart from the fact that he’s colourful, aggressive, and a good mathematician, with swap trading and risk management experience, he’s not much different from the patrician Deutsche bankers he’ll be joining.
But the board of Deutsche Bank have high hopes that hiring Thomas Fischer as their new chief financial officer will prove a vital step in their quest to build a global investment-cum-commercial bank. His presence is even more essential now that Deutsche has bought Bankers Trust, another piece of the jigsaw.
Everyone agrees Fischer is tough, political and smart – the Michael Douglas of the financial markets. But he’s also an accomplished risk manager and in the past three years has proved himself capable of running – and considerably improving – one of Germany’s biggest savings banks, Landesgirokasse Stuttgart.
Growth in banking today, wrote Fischer in his annual chairman’s statement this year, “is hardly possible without taking greater risks. Therefore the ability to diversify and master risks must be perfected – more rapidly than ever before in financial history”. Someone who can master that in Frankfurt, at board level, is exactly what Deutsche Bank desperately needs.
Hiring an outsider would have meant an 18-month delay while the newcomer played himself in. Fischer’s advantage is that he was at Deutsche before – only three years ago. After spells heading risk control, global swaps, then market risk management, he left because his way to the board was blocked. Fischer had been a leading figure on the bank’s risk management committee, and the committee in charge of investment banking strategy.
He left amicably. But it is still unprecedented for a senior Deutsche banker who leaves the firm to be invited back. The way started to clear when former speaker Hilmar Kopper and Ulrich Cartellieri moved from the Vorstand to the supervisory board in May 1997. To fill the gap, first Credit Suisse recruit Josef Ackermann, then long-serving Deutsche banker Jü Krumnow took board responsibility for treasury and market risk management. But Krumnow was already overburdened with credit risk and overall control of risk. Now Krumnow sheds half his duties, keeping risk control and credit risk oversight, and ceding market risk management and treasury to Fischer.
For Fischer it’s like coming home, but at a higher level. “What we’re doing here at Deutsche already reflects Fischer’s approach to a large extent,” says Gunther Schmigalle, head of group market risk management, who used to work alongside Fischer and will now report to him.
Fischer, now 51, was born in Berlin but grew up in Canada and loves all things Canadian. Before banking his background was in industry, at the family-owned wall attachment maker Fischer Dü, and at battery-maker Varta. He’s literate, intelligent and entertaining, and lectures in investment banking at the University of Stuttgart, being famous for his accounts of actual deals. All who know him say he’s a colourful character with sharp quantitative skills.
Fischer makes up in aggression what he lacks in stature. The former university boxer wears elevated, steel-capped shoes and prides himself on his physical fitness. The threat of violence is sometimes thinly veiled: “He likes to talk about the knife he carries and the people he’s beaten up,” says a former colleague. Yet his handshake is “like a dead fish”. He’s “obsessed with security”, says another. When out of Stuttgart he tends to travel with a bodyguard, and his car, even on short trips, is usually shadowed by another.
Insiders see him as a “counterweight to Mitchell” (Edson Mitchell, hired from Merrill Lynch in 1995 to head global markets in London, is the focus of London investment banking) and the newly acquired army of Bankers Trust wholesale and investment bankers in New York and London. Fischer is the risk manager who can finally control these Anglo-Saxon elements, because he speaks their language and understands their game – that’s the theory. Fischer has the advantage of a seat on the Vorstand, Deutsche’s executive board. Mitchell is only a member of the Bereichsvorstand, the divisional executive board.
Officially, Fischer is a counterweight to Josef Ackermann, the board member in charge of the global corporate and institutions (GCI) department, Deutsche’s investment banking operations: “We have to ensure Ackermann has the correct information and can keep his people in control,” says a Deutsche risk manager. But it is the direct interface between Fischer’s risk managers and investment bankers in London, Frankfurt and New York that will be the real battleground. Those risk managers must be confident enough, with enough high-level support, to win arguments against some of the most persuasive risk-takers in the business.
Hands on the purse strings
From November 1 German banks are being charged capital for their market risk, an application 23 months overdue of the EU’s capital-adequacy directive. Allocation and attribution of a capital cost to each business in the bank is vital for assessing its risk-adjusted return. For businesses using complex and illiquid instruments this can be a nightmare, since the mark-to-market value is open to wide interpretation, not to say manipulation. Fischer’s major battles more than three years ago, say former colleagues, were over front office versus back office valuations and the integrity of data on which they were based. Second-guessing highly motivated traders in these cases requires good information and strong character. Fischer’s presence on the board will give the risk managers more clout. He’s also in charge of the treasury department, which allocates and attributes capital internally. In many ways he holds the purse-strings of the bank.
Deutsche’s top management have recognized the need for new blood and new thinking at the top, not only because of the bank’s adventures into investment banking but because of its huge market and credit risk positions around the world. Recent market turbulence and the near-collapse of hedge fund Long-Term Capital Management made them increasingly nervous about other surprises the markets might hold. “Breuer [Deutsche Bank speaker Rolf Breuer] wants to know why he lost something in investment banking. He wants accurate forecasts,” says a former Deutsche Bank interest-rate risk-taker. Volatile earnings are not welcome in a universal banking culture. “Universal banking is all about stability,” says an investment banker working in Germany. “Investment banking is about change.”
Launching the German fight-back
Germany’s universal banks can no longer ignore change or just play at investment banking. The euro will stoke competition in all areas of business and assail their once-captive national market. US investment houses are running rings round them in corporate finance, mergers&acquisitions, and underwriting. And supermarket and direct banking are undermining their retail base.
Deutsche Bank and Dresdner Bank bought British merchant banks earlier this decade as a bridge into investment banking. Deutsche bought Morgan Grenfell in 1989 and Dresdner bought Kleinwort Benson in 1995. Commerzbank flirted with Smith New Court, and Bayerische Vereinsbank with Oppenheimer&Co in an attempt to do the same. But the British merchant banks proved only half a bridge to the Anglo-Saxon culture that dominates global capital markets and investment banking.
So Deutsche opted for expensive add-ons, buying traders and investment bankers in the US mould, hoping they would bring with them enough business to cover the expense. Unfortunately, says the same investment banker, “the sort of people you can buy like that tend to behave like the sort of people you can buy”.
Deutsche’s cost-income ratio in investment banking soared to 80% in the first nine months of this year. Many expensive bankers left as Deutsche Bank in Frankfurt sought to control its costs and risks more firmly, reducing Deutsche Morgan Grenfell to a division within the bank, dubbed global corporate and institutions (GCI).
The sad outcome of this expensive exercise was that top Deutsche Bank management lost its way. It could shackle or alienate these highly paid recruits in a heavy-handed way, but it couldn’t control them effectively in their own language. The adventure begun by legendary speaker Alfred Herrhausen in 1989 was in danger of running into the sand.
Now Deutsche has taken another plunge into the unknown, and again the challenge will be management and integration, although it is interesting that Bankers Trust is a hybrid, more of a creative wholesale bank than a securities and corporate finance house. Advisers have suggested Deutsche should keep the Bankers Trust brand name, while ensuring that BT bankers are seen as “Deutsche bank men”. Is this possible? Does the market see Edson Mitchell as a Deutsche Bank man?
The problem for all German banks is their lack of investment-banking clout at board level, and their difficulties adding such talent. To date their search has been for German speakers which narrows the field to a handful of candidates. Perhaps the ideal person doesn’t exist. “Let’s face it,” says a German headhunter, “most investment bankers are unable to lead. Even a mergers and acquisitions man with a team of 100 isn’t leading something.” In the US, the headhunter observes, “a leader is respected if he has power; in Germany he has to have power and knowledge”. But the right person wouldn’t have to be a native German speaker, he adds: “What he needs is cultural adaptability.” Deutsche’s two Morgan Grenfell board members, John Craven (now retired) and Michael Dobson, didn’t have that quality. The native German speakers picked to manage the London-Frankfurt link likewise seem to lack cultural flexibility. Ronaldo Schmitz will soon retire. Ackermann is not the figurehead that was hoped for.
It’s a similar story at Dresdner Bank. There the focus of investment banking was Hansgeorg Hofmann, a veteran Eurobond originator previously at Lehman Brothers and Merrill Lynch (he left Dresdner after a tax scandal in November 1997). But even Hofmann was more a dealmaker than a master of banking strategy. No high-profile replacement has been found: Gerd Häusler, a former Bundesbanker, has filled the Hofmann post and “at least he knows his limitations”, says a German investment banker. Leonhard Fischer, hired from JP Morgan and now on the Dresdner board, at 36 is regarded as “too young to carry enough weight”.
Dresdner Bank is in danger of appearing yet again an “also-ran” behind Deutsche Bank. “They also have to buy [a US bank],” says a Frankfurt-based corporate financier, “depending on how ambitious they want to be.”
The other big German banks have lowered their horizons. Commerzbank has a policy of add-ons. Its most visible addition is global equity and equity derivatives, headed by Mehmet Dalman. Dalman points out that Commerzbank has chosen to integrate global equities directly with the universal bank so that the two disciplines feed off each other. Commerzbank is learning about equities and equity risk management, while, says Dalman: “I’m learning a commercial banker’s view of credit.” While the bank’s cost/income ratio is around 62%, this start-up is “around 10% higher”, says Dalman, which he regards as “an impressive ratio”. Equally important for Commerzbank is the asset management side, which it classifies as part of investment banking. Commerzbank’s network includes its two German entities, Adig and Commerzinvest, with around Dm100 billion ($60 billion) under management, and Jupiter International Group in the UK, Caisse Centrale de Réescompte in France, Montgomery Asset Management in the US and others managing another Dm80 billion or so. “We’re offering German financial engineering on a global basis,” says Andreas Neuber, assistant vice-president in the asset management department. Commerzbank has gone for a high return on equity rather than expansion. It shut down its derivatives subsidiary, Commerz Financial Products, and it has made no headway in M&A. The popular view is that it will be bought by a Dutch or British bank when the price is right – Credit Suisse tried two years ago and failed.
Westdeutsche Landesbank is also lowering its sights, and integrating West Merchant Bank, London, with Dü
The Landesbank sector is on the defensive. Bankgesellschaft Berlin has had bad results, which frightened Norddeutsche Landesbank out of a mooted merger. Sü Landesbank is caught in an increasingly political merger in Baden-Wü, with L-Bank of Karlsruhe and Thomas Fischer’s bank Landesgirokasse. The decision by Baden-Wü prime minister Erwin Teufel to rotate the chairmanship of the new bank, Landesbank Baden-Wü, every two years, forced Fischer into the arms of Deutsche Bank. It would have been four years until he took over chairmanship.
Deutsche and Dresdner’s biggest native competition may come from Bavaria, where a giant is emerging from the fusion of Bayerische Vereinsbank and Bayerische Hypotheken- und Wechselbank into BHV – Bayerische Hypo-Vereinsbank. The merger got the final go-ahead on September 1. A public row between the two former bank chairmen, which erupted on October 28 and raged for eight days, appears to have strengthened the position of Albrecht Schmidt, former Vereinsbank chairman and now executive chairman of BHV. Schmidt announced on October 28 that he was recommending extra provisions of Dm3.5 billion to cover property loans and joint ventures by the former Hypobank. He implied that there would be “necessary consequences for personnel”. Former Hypo chairman Eberhard Martini, now a member of BHV’s supervisory board, took that as a personal attack and retaliated, saying in a newspaper interview that Schmidt was “consumed by vanity and not fit to run a bank”. It was nearly a week before tempers cooled and full apologies were made, under behind-the-scenes pressure from BHV’s major shareholders Allianz insurance and the state of Bavaria. A supervisory board meeting on November 15 approved the provisions and gave full support to Schmidt.
Schmidt had made an important point: that opaque accounting and smoothing of bank returns with the use of hidden reserves are no longer acceptable in Bavaria. Martini and his risk controllers at Hypobank had allowed a discrepancy to build up between the euphoric property valuations made after German unification, and the price these projects would now fetch on the open market. Rumours that the portfolio was in trouble had forced Hypobank, back in February, to declare a Dm1.5 billion write-down for 1997, which was passed by auditors KPMG and Wollert-Elmendorff (Wedit). But that apparently wasn’t enough. When the new bank BHV took over the books on September 1, Schmidt ordered a check on the valuation. This time the same auditors recommended a further Dm3.5 billion write-down. That put the Dm8 billion invested in joint ventures, mostly in former East Germany, at half its face value, with a total of Dm1 billion written off other property credits.
BHV starts life as a highly conservative bank with conservative ambitions. It wants to be a “bank of the regions” rather than a global bank, seeking to acquire banks with significant local market shares. Organizations such as FGH Bank, the third-biggest Dutch mortgage bank, and Bank Przemyslowo-Handlowy (BPH) in Poland with more than 20% market share in the south, are of particular interest. Its aim is to be a “commercial bank with add-ons in investment banking”, says BHV chief economist Martin Hü
That is reflected in the conservatism the bank has shown in market risk management. In October, German banking supervisors gave 12 banks the go-ahead to use internal market-risk models for capital adequacy purposes, stipulating a multiplier of between three and 10 times for the value-at-risk (VaR) number the models generate. Among the big German banks only Commerzbank and BHV did not obtain this go-ahead. Commerzbank says it has IT problems that should be solved by early next year. BHV didn’t seek approval, since it is still working on its internal Algorithmics-designed Riskwatch model, and in the meantime is adopting the less capital-efficient standardized approach. André Horovitz, head of BHV group risk control, calculates that model approval would reduce the capital charge for market risk by around 50% – depending on the complexity of the portfolio and its correlation effects – provided the multiplier set by the supervisors will be no more than four. But BHV won’t submit its model for approval until September next year.
All German banks found that it took far more work than they expected to prepare their models, especially the collection and reconciliation of business data. “Our two-year project turned into a four-year project, and we just made the deadline,” says Willi Ufer, head of fixed income at DG Bank. “But we didn’t cut corners and go for the quick-and-dirty approach like some other banks.”
The supervisors in Berlin are warning banks to submit their portfolio to extreme stress tests as well as using market-risk models. “Models are tools for normal times,” says Jochen Sanio, deputy president at the Bundesaufsichtsamt fü das Kreditwesen (BAKred) in Berlin. “With high volatility over a long period, they are dead. If managers believe they can sleep well because of models, that would be a problem.”
Bayerische Hypovereinsbank isn’t resting on its laurels. Horovitz, who joined in March, is working on a portfolio approach to credit risk, perhaps more important to BHV than market risk. Using the approach of Oliver Wyman&Co, where Horovitz once worked, “we assign risk capital to businesses based on credit value at risk. And we hope to develop it further into a standard internal model,” he says, anticipating that the regulators will one day approve credit risk models too.
Deutsche’s third way
Deutsche Bank, faced with digesting Bankers Trust and its advanced risk management systems, like many financial institutions is already uncomfortable with the artificial split in its own departments between market risk and credit risk management. “The boundaries are being blurred,” says Schmigalle, head of group market risk management. “Our risk methodology group is looking at credit, market, liquidity and operational risk, to develop a common kernel of methodology and processes. I see a natural tendency for convergence, but it’s a question of timing.”
Deutsche is developing a portfolio approach to credit risk, favouring KMV Corporation methodology, “but it’s a building site”, admits Schmigalle. “All the models on credit risk are a bit iffy. We’re observing trends in the market.”
The bank has many groups looking at risk methodology. Apart from market and credit risk there is a liquidity risk methodology group working in London and Frankfurt and an operational risk group run out of London.
Although most of the complex derivatives books are run out of London, New York has the mortgage derivatives book. But product approval is firmly run out of Frankfurt, and valuation formulas are signed off by Schmigalle’s group. “If there are uncertainties, there is a reserving policy – for which controlling is responsible – that can be quite extreme,” says Schmigalle.
It’s not a clash of cultures between London and Frankfurt, as is so often portrayed, says Schmigalle. Nor is it Edson Mitchell against the rest. “A new GCI culture is emerging.” The real challenge, he says, is how to structure the relationship between the centre (Frankfurt) and the periphery, including asset management.
The periphery will soon include Bankers Trust, unless the BT risk managers are so persuasive that they take over risk management for the whole group. That may have happened at Swiss Bank Corporation (now UBS) between 1992 and 1997 after it bought O’Connor of Chicago, but it’s not Deutsche’s style. More likely a third way will develop, under the firm hand of Thomas Fischer.
