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Monday, 23 October 2017

Precision on a smaller scale

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  • Precision on a smaller scale
  • The sun rises early morning behind the skyline of Frankfurt
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  • Traders are pictured at their desks at the Frankfurt stock exchange.

Removed from the fierce competition among the global financial centres, Frankfurt’s raison d’etre is to serve the German real economy, currently the brightest beacon of hope for European growth. Most global banks have a presence there, yet the city retains a village-like charm.

(To view the digital version of this report, please click here.)

London has traditionally enjoyed a level of political support that Frankfurt, situated remotely from the politicians in Berlin, can only envy, said Gertrud Traud, chief economist at Helaba, a Frankfurt-based bank. Now London finds itself in an increasingly similar situation to Germany.

“Politicians are now in the driving seat,” said Thomas Schluter, spokesperson of the Association of German Banks. The haircut that banks voluntarily took on their Greek exposures perfectly demonstrates the new climate in global banking, with banks forced to acquiesce to politicians.

Geographical proximity is not the only explanation. The UK economy is dependent on financial services as its pre-eminent sector, responsible for more than 11% of UK tax income, according to PwC. But if the UK is globally synonymous with investment banking, Germany’s association with manufacturing is even stronger, and it is that industry the German government is most concerned with protecting. Its financial services industry, by contrast, provides only about 4% of the German tax take.

German banks are mainly there to serve the real economy, which is in turn driven by its manufacturing sector and particularly the Mittelstand. Fulfilling this function makes the sector extremely decentralised. Even within Germany, Frankfurt does not have the stranglehold that London has in the UK. 

“Much of Germany’s financial infrastructure is actually outside Frankfurt,” said Prof Jan Pieter Krahnen, head of Center for Financial Studies at Goethe-University Frankfurt. “The savings banks are the biggest segment by far, and they are present everywhere in the country. Although they look like a collection of small banks, they are highly co-ordinated with lots of common services. They are, in effect, one entity and together they are bigger than Deutsche Bank.”

Similarly, the 1,500 co-operative banks are found across Germany, and constitute the second-largest banking body, only slightly smaller than the private banking sector. Deutsche Bank comes in third.

Changing focus

The focus on domestic business banking also means Frankfurt is dominated by traditional loans business, with capital markets constituting a much smaller segment of banks’ activities. But this is starting to change, said Oliver Wagner, managing director of the Association of Foreign Banks in Germany.

“We are seeing changes in behaviour, away from lending and increasingly into capital markets,” he said, with more and more Mittelstand companies issuing own bonds instead of using loans. Banks now advise their business clients at structuring corporate bonds and help them to place them in the market nationally and internationally. 

This might be a small advantage for foreign banks, which have expertise in this area, Wagner said, but is unlikely to change market competition between Frankfurt and other German financial centres noticeably. Mittelstand and other German businesses would continue to prefer to bank locally due to the federal structure of the German economy, he said. Even when companies list on the Deutsche Borse, many opt to simultaneously list on local exchanges, where they have better access to local retail investors.

The economic fallout of the crisis has arguably increased the relative strength of Frankfurt within Germany: regional banks have suffered more than those in the financial capital, because they tend to be less diversified. But there are vibrant financial centres outside Frankfurt, in Munich, Dusseldorf and Hamburg, each with its own strong national ties. Munich has a concentration of Italian and Swiss banks, serving businesses that trade between the two via the shared border. Hamburg has strong Scandinavian ties, as well as some Iranian banks and Dusseldorf is home to a number of Japanese banks, which serve Japanese manufacturers that originally settled there.

“To some extent Frankfurt is competing with the likes of London and New York, in terms of trading on the stock exchange and investment banking,” said Josef Schiessl, managing director of Frankfurt Main Finance, a lobby group that speaks on behalf of Frankfurt’s financial sector.

The city does, however, serve its own niche – “Frankfurt is the spiritual home of important instruments, like Pfandbriefe,” said Schiessl.

Good things, small packages

During the crisis Frankfurt’s smaller scale has been advantageous. “We have been more stable than other financial centres during the crisis,” said Schiessl.

According to a study by Helaba Financial Centre by Ulrike Bischoff, the number of financial institutions in Frankfurt declined by 5% during the crisis. The shrinkage among foreign banks was 4%, leaving about 200 foreign banks from 40 different countries still in operation. 

Germany’s economic strength and low unemployment is a boon for banks, which have healthy customers on their balance sheets, though some worry there could soon be a labour shortage. 

The financial crisis had highlighted the advantages of Frankfurt’s conservatism, said Bischoff. Its universal banks have proven exceedingly stress resistant in the crisis, and “Frankfurt has a good chance to emerge as a relative winner from the adjustment process in the financial world triggered by the crisis”. 

Where some financial centres have in past decades benefited from deregulation, they will feel the pain now that the pendulum has swung back the other way, said Traud, with the changing regulatory climate less pronounced.

Yet Frankfurt faces the same regulatory challenges others are wrestling with, and the risk of regulatory arbitrage is increasing in Frankfurt given its lack of political support, said Schiessl.

“Frankfurt has a good chance to emerge as a relative winner from the adjustment process in the financial world triggered by the crisis”

Many cited the financial transactions tax as a serious threat to business, a measure championed by German Finance Minister Wolfgang Schaeuble, particularly if the measure were not universally applied – within Europe and globally. Germany’s willingness to press ahead with reforms on its own if others do not agree were demonstrated by its short-selling ban in May 2010. 

Some people believe Germany is unlikely to act unilaterally in this instance, although there is broad agreement that unilateral implementation, without major economies like the UK on board, would still be disastrous. Even with implementation across Europe, German banks question the motives behind such a measure. “A financial transaction tax would not prevent a future crisis, it will simply hurt,” said Schluter. “We already have plenty of tax.” 

Neither would the pain fall on those on whom it is presumably intended: the banks. “This would very likely be passed on to consumers,” said Krahnen, meaning higher banking charges for German retail bank customers.  

What Frankfurt fears most is regulatory arbitrage. “We have given up on global regulation,” said Wagner. “But we must see regulation implemented at a European, not a national level.”

From an income tax perspective Frankfurt operates from a position of relative parity to competitors in the UK and elsewhere. Tax on income above €0.5m was raised to 47% from 43% recently, which means it has no significant competitive issues. This distinguishes it from France, for example, which faces anxious months ahead in light of an election where the subject of draconian income taxes has played a significant role. 

Embracing the future

As home of the European Systemic Risk Board, Frankfurt is the venue for some important regulatory discussions. These discussions should contribute to making finance safer, in turn benefiting Frankfurt. “We can all see there is much more dialogue than there was before the crisis, between politicians, central banks, regulators and the industry,” said Schiessl. 

Yet there is a question about the future size of the Frankfurt financial community. New players will settle, with representative offices from the Arab and Asian regions already in the process of opening, said Bischoff. “Some foreign banks in Frankfurt are reporting the expansion of their business activities,” she added. According to her study, 85% of institutions surveyed maintain one German office, in Frankfurt. Three-quarters of them were are also represented in London, and more than half additionally in Paris, but Eastern European banks were most likely to have their Western European operation established solely in Frankfurt. 

Others think overall that the industry is set to decline, if only modestly, mostly as a product of further consolidation that must occur among German banks. “The banking sector everywhere is currently seeing banks reducing their balance sheets, and business lines,” said Traud, though she predicted the decline will be small in Germany.

Listings lure China

Deutsche Borse’s trading system, Xetra, hosts about 250 participants in 18 countries, with more than 4,500 authorised traders connected. According to Deutsche Borse there are 31 Chinese companies listed on Xetra, with the next IPO, Haikui Seafood, scheduled for May 15. “Haikui Seafood will be the 10th Chinese IPO in the highly EU-regulated Prime Standard,” said Andreas Brevern, a spokesperson for Deutsche Borse.

“Germany is a desired location for Chinese companies because a listing in Frankfurt improves their reputation,” said Brevern. With China establishing itself as a manufacturing superpower, it is natural it should look to Germany’s top-tier global brands, such as Daimler, Volkswagen, BMW, and Allianz – all listed in Frankfurt – and list themselves on the same venue.  

At the centre of Europe, and the home of the ECB, and by extension the euro, Germany also enjoys strong and numerous economic ties with China, said Brevern. 

A Frankfurt listing is also fast – typically between four and six months – and low cost, said Brevern. A study by Professors Christoph Kaserer and Dirk Schiereck, at Technische Universitat Munchen and Technische Universitat Darmstadt, respectively, analysed listing costs across a number of exchanges.

The research studied levels of IPO underpricing, that among its peers, including Euronext, NYSE, LSE, Nasdaq and HKEX, Deutsche Borse offered, on average, the closest price to fair value to issuers, with an underpricing of just 3.77%, with Euronext next at 5.19% and the LSE having 9.34%.

The initial flotation costs were competitive on Deutsche Borse, at 7.4%, second only to Euronext for the main market, with 7%, with the LSE coming in at 8.6%. But Deutsche Borse’s ongoing listing fees were consistent across companies of all market caps, and the most attractive on offer among peer exchanges for companies over €250m. 

A similar pattern emerged for the alternative markets listings, with its Entry Standard market competitive against Alternext and AIM, for Euronext and the LSE respectively, as well as to non-European competition.

In terms of liquidity, IPOs on Deutsche Borse’s main market on average saw trading volumes of more than double what was seen on Euronext 10 days after listing. Deutsche Borse saw 13,251 trades against Euronext’s 5,890, although London was higher at 17,719. But Deutsche Boerse was far ahead of its European competition for the alternative market IPOs. 

The exchange has been active in reinforcing its appeal among Chinese issuers, opening offices in Beijing, Shanghai and Hong Kong, launching its website in Mandarin and hosting seminars for companies considering an overseas listing. 

“Especially for Chinese SMEs it is very difficult to list on the domestic venues because the pipeline is clogged for years to come,” said Brevern. “The large, formerly state-owned companies are usually first in line.”

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