Andreas Brodtmann, Berenberg; Marcus Becker-Melching, BDB; Leonhard von Metzler, Metzler; and Stephan Schueller, Bankhaus LampeGermany’s market continues to provide plenty of opportunities for wealth managers despite the wider macroeconomic challenges to the Eurozone. Maryrose Fison finds industry heads positive, albeit wary of the impact increasing regulation will have on Europe’s largest high net worth market

 

Germany’s private banking market is approaching a cross-roads. On one side is a growing market with the largest pool of high net worth individuals in the whole of Europe.

On the other side is a bombardment of regulatory requirements, growing competition from atypical players and enduring risk-aversion among clients.

According to the CapGemini Merrill Lynch World Wealth Report 2011, the number of individuals in Germany with liquid assets worth more than $1m (€758,079) rose by 7.2% from 862,000 in 2009 to 924,000 in 2009.

HNW populations by country 2010This is twice the size of the UK high net worth market, which grew only 1.4% over the same period, and almost three times the number in France, which has a comparable national population.

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Yet as the population of high net worths grows, so too does the competition. No longer is private banking the sole preserve of centuries-old, independent banks; today financial institutions offering discretionary and advisory services present a variety of business models, creating a patchwork quilt of private banking providers.

Stephan Schueller, general partner and chairman at Bankhaus Lampe, which was founded in 1852, estimates that the market is dominated by 15-to-20 main players.

 

Market distribution

While there remains some debate over the definition of a private bank, the market may be broadly divided into four categories: pure play private banking, private banking undertaken by universal banks, diversified strategies where financial institutions combine a mixture of traits and new entrants.

AUM ranking for independent banks in GermanyPure play providers include traditional private banks such as Metzler, Berenberg and Bankhaus Lampe. Banks such as these tend to be characterised by their focus on wealth management products and services for high net worths. They are known for the close and personal relationships they have with clients and the favourable advisor-to-client ratios they maintain.

Providers offering private banking among an array of universal banking services include Deutsche Bank’s private banking division Sal Oppenheim, HSBC Trinkaus, Unicredit and Commerzbank. Deutsche is known to be the largest, although it does not break-out its German private wealth figures from its global AUM. Commerzbank is estimated to have about €24bn with Unicredit known to have €28bn in total financial assets, although AUM figures are not disclosed.

Under this model, banking clients are allocated to a private banking division when they amass wealth above a certain threshold. The private banking services offer the universal bank a reliable commission income combined with a capital light model.

Financial institutions which combine both traditional and universal banking characteristics include BHF Bank, which has been private since 1854 and has strong investment banking and corporate banking businesses as well as private banking revenues.

More recently, an additional category has begun enter to the fray albeit on a low level. This bracket includes savings banks and cooperatives, which have in the last three years begun to offer private banking divisions to help retain clients whose wealth surpasses average retail savings levels.

 

Regulation rears its head

Since the onset of the financial crisis, a number of measures have been taken at the national and European level to stave off the likelihood of further market ripples.

The offshoot of this has been what many in Germany consider a broad-brush approach towards regulation, forcing private banks which have traditionally steered clear of providing credit, loans and structured products to adhere to tough, frequently changing regulatory requirements.

Today, the key regulations that German private banks face are Basel III and the Markets in Financial Instruments Directive, MiFID.

There has also been the high profile tax agreement between Germany and Switzerland last year. The inflow of assets from German citizens moving their assets from Switzerland back to Germany will have been minor, but no doubt it gave German banks a top-up.

It also remains to be seen how much of the sting from the Foreign Account Tax Compliance Act (FATCA) has been removed following last month’s agreement between the US and Germany, France, Italy, Spain and the UK.

 

Basel III

Pull quote on Basel IIIThe Basel III accords were agreed in 2010 and require that banks raise their capital ratios to close to 10% over the next decade.

More recently, in January this year, the Danish Presidency of the Council of the European Union published a compromise proposal on the EU’s Capital Requirement Directive, CRD IV, which is expected to replace previous CRDs and be used to implement Basel III.

Marcus Becker-Melching, managing director of political affairs and corporate finance at the Bundesverband Deutsche Banken (The Association of German Banks), told Private Banker International that the compromise proposals were largely appropriate but expressed regret that the leverage risk concept had been contained.

"We are extremely concerned about the changes to the capital buffers," Becker-Melching says.

"The capital conservation buffer is no longer set at 2.5% but placed completely at the discretion of member states. Member states may now, without giving any reason, require all banks located in their jurisdiction to hold both the capital conservation and the counter-cyclical buffers in full from 2013.

"Should these changes be retained, the objective of the Single Rule Book will be totally undermined. There will be nothing to prevent capital requirements diverging widely across member states after 2013."

Leonhard von Metzler, director at the private banking business department at Metzler, says Basel III has had less of a direct impact on Metzler because the bank does not do the kind of balance sheet driven business which requires a lot of regulatory capital such as offering credit or loans.

"At our bank, we are not doing any commercial credit or loan business," von Metzler says.

"We had limited credit and loan business until the early eighties but today we work as an advisory oriented investment bank – without taking many risks – as well as an asset manager. So we are less affected by the regulatory capital requirements than a full service bank. Furthermore we have regulatory capital in terms of core tier 1 of more than 20%."

 

MiFID II

MiFID I came into effect on 1 November 2007 and replaced the existing Investment Services Directive, ISD.

Since 2007, it has been subject to a number of revisions. MiFID II, which remains in the draft phase, remains one of the top issues for German private banks largely because of the onerous requirements it places on product information, disclosure and agreement protocols and the cost-impact this has on private banks’ bottom lines.

Currently, investment advice as a service is provided at a specific point in time in Germany. Inducements from third parties are allowed if these are transparent and not considered detrimental to clients and fee-based advice remains a niche product.

Under the MiFID II draft proposals, there would be a differentiation between "independent" and "dependent" advice, a ban on inducements for independent advice and increase requirements for a range of products and further information to be provided to customers explaining which service was being provided.

Becker-Melching said that it is "extremely important to be able to offer both fee-based and inducement-based advice" and added that "calling fee-based advice "independent" is a value judgement and discriminatory".

The key point that private banks who were interviewed for this article made, was that the level of product disclosure protocols was costly and also limiting.

Professor Schueller of Bankhaus Lampe says: "We see huge additional costs coming to the market as a result of increased regulation for private banks.

"The biggest influence on private banking costs is adhering to customer protection rules and guidelines. We have regulations in Germany which go beyond MiFID and are in more detail.

"Those are partly German law and partly strong recommendations by BaFin [The German financial regulator]."

"For example, in Germany we have to offer the clients so-called "product information sheets" for every product we recommend.

"Furthermore, if talking of advisory mandates we have to write detailed advisory protocols. They must be confirmed and signed by the clients, before there is any buying- or selling-action possible.

"These protocols must be kept by us for a minimum seven years. The bureaucracy is tremendous."

 

Counting the cost

Asked to estimate crudely how much the cost of applying these laws and regulations was to a private bank, Schueller said a very approximate calculation would increase the costs by 5% although he stressed this was a rough estimate.

Andreas Brodtmann, one of three managing partners at Berenberg, whose history traces back to 1590, said the number of additional information protocols was also restricting the banks’ ability to act quickly on fast-changing market opportunities.

"If we are talking to a client over the phone and advise him to buy 1000 shares, we can only go ahead after having received a written confirmation that he really intends to do it," Brodtmann says.

"The spoken word does not count any longer. You receive it by fax, you receive it by letter, but you cannot proceed with the transaction immediately and go ahead without having it written.

"[Otherwise] you risk that the client says, ‘This purchase was not my intention, please cancel the transaction’."

Von Metzler forecasts that the increased volume of compliance protocols would precipitate at wealth managers a shift away from advisory business towards discretionary services.

"If you try to do advisory business with new wealth management clients you need to fill in certain documents and protocols and that is quite a burden for us," he adds.

"We have always focussed more strongly on discretionary business than on advisory business. So those rules finally have driven us exclusively in this direction."

 

Client retention

Quote on fragmentation of German marketAs significant further consolidation within the private banking market looks unlikely in the short-to-medium term, organic growth in clients remains a key growth route for providers.

But the challenge here is in persuading clients to exit safe haven investments in favour of portfolios that offer more growth opportunities.

Brodtmann says a defining feature of many high net worths post-financial crisis is their risk aversion and continued uncertainty over the likelihood of a currency crisis has compounded this.

"There is a frustration among private banking clients about what the markets are giving them," he says.

"If you have negative equity market returns and your bond income is low at the same time, you cannot fulfil client expectations. You try the utmost by diversifying into other asset classes such as real estate, commodities, private equity, art or classic cars. But many of them were more correlated than we all thought is possible.

"Furthermore, German investors are really scared of currency devaluation and inflation. Having experienced currency reforms at least twice in the country’s last century history, it is a fear which is deep inside."

In spite of the DAX falling around 15% last year, Brodtmann is optimistic the German markets are picking up and is confident the 20% increase in equity values seen so far this year on the Frankfurt Stock Exchange will continue growing "with double-digit returns this year with the exception of black swans [unexpected events]".

 

Positive outlook

GDP growth rates in 2010, 2011 estimateWhile the market continues to face challenges on the regulatory front and frustration from clients about poor capital markets generally, the German private banking market presents a positive overall picture.

Schueller estimates the total assets under management of the German private banking market will grow by between 5 and 7% per annum.

"Capital markets are assumed to develop positively and clients from foreign countries, especially from the emerging markets are going to invest money in Germany. Despite that, German wealth is growing at a rate of 5%," he says.

There have also been a number of high profile transactions within the private banking space in recent years reflecting the rapid evolution of banks in response to changing socio-economic conditions and banking requirements.

In October last year, Precision Capital acquired KBL epb, the German subsidiary of Merck Finck, after its planned acquisition of Hinduja failed.

In September 2011, LGT decided to exit the German market after the acquisition of BHF failed on regulatory grounds and BHF was sold to Dutch group ABN AMRO. The same month, WestLB International was sold to Dekabank due to a strategic refocus of West LB.

In 2009, Sal Oppenheim came under pressure during the financial crisis and was sold to Deutsche Bank and a few months earlier, Reuschel was sold to Conrad Hinrich Donner Bank following Commerzbank’s announcement that it planned to focus on its core business.

Generally, the private bank operators interviewed by Private Banker Internationalwere conservative about the likelihood of further transactions in the next two to three years, pointing to the well-known complexity associated with transactions of this kind.

"If you see the character of the five independent private banks, what makes it so specific is that they have mainly more than 100 years of their own style and very own culture. It is really a tough job to manage or merge such private banking cultures," Schueller says.

"Thus, for the time being, I cannot see any mergers and acquisitions processes."

Becker-Melching echoes these sentiments, adding: "Further market-driven M&A activity is unlikely.

"Consolidation within the savings bank and cooperative bank sectors continues to move forward slowly. There will be no significant cross-sectoral consolidation in the foreseeable future."

"Generally, consolidation of the German market will continue to proceed at a rather slow pace, however, there is no ruling out critical escalations due to the sovereign debt crisis or capital requirements, which may then lead to a faster pace of consolidation."