It may not be saying much, but custody has never been so exciting as it is in Germany at the moment. For one thing, the master KAG concept is putting global custodians on the map as nothing has before. And, of course, there is matter of State Street digesting the custody business of Deutsche, as well as who will be the next global custodian to enter the German arena.
First, the classic master KAG scenario involves an institutional investor opting to consolidate its different Spezialfonds into one mega Spezialfonds – all with a single KAG, known as the master KAG, which runs the fund as a series of segments often with one external asset manager on an advisory basis for each segment. Increasingly these are non-domestic firms.
Usually, sitting in front of this arrangement is the global custodian, acting as the interface between the client and the managers and the KAG, handling all the different reporting streams in a standardised format.
One of the most notable mandates to have come on the market has been that of the E8bn VBL, pension scheme for state employees based in Karlsruhe, which adopted the master KAG structure and appointed BNP Paribas as its global custodian for part of its assets.
Commenting on the move, VBL’s managing director Richard Peters says to work within a master KAG structure requires up-to-date and accurate information. A global custodian can provide the necessary flow of information from the managers on a daily basis. He adds that this makes everything very transparent.
Happy at the high profile VBL win, Dietmar Rössler who is responsible for institutional clients for BNP Paribas in Frankfurt says the master KAG is one of the factors driving their business forward in Germany. He sees the master KAG as a very helpful development in the bank’s success in winning E11bn in new assets in over 110 Spezialfonds owned by pension fund and other clients, but it is not the only one. “We have developed a product that has very German features, with all the account management team being German speaking, and German language-based internet reporting. What surprises many clients is that we provide performance measurement, performance attribution and risk analysis online and in German.
“Now nearly every institutional investor is looking at the master KAG, though not necessarily deciding to go that route in the end. But it does raise the issue of having a global custodian,” Rössler says. The interest in core satellite strategies is growing, and investors want custodians to help in the running of a battery of specialist managers on a controlled basis.
At JP Morgan, which has done well in garnering new assets in recent years, Arnulf Manhold, the group’s global custody chief in Frankfurt, says the bank saw that major clients were very interested in the master KAG concept, as it provided such wide opportunities on the asset management side. “Investors like the standardisation that comes from having everything handled at one source,” he says.
“There is a natural connect that whenever an investor appoints a master KAG, at the same time, or indeed, as we have experienced appoints a global custodian first and then the master KAG.”
But JP Morgan which has had its own KAG operations in Germany for the better part of 15 years decided to take the bold step of separating its asset management from its Depotbank business, and opting to run the KAG purely as a funds administration business to take advantage of the opportunities its sees arising in the master KAG marketplace. The asset management business is being run separately through a newly established operation.
The new administration arm JPMorgan Fund Services sees more opportunities coming its way in this format. “We think we can create synergies by having two different offerings,” says Manhold.
“Now all asset managers are potentially third party clients.”
Manhold sees opportunities to act as the insourcer for their administration function. Already, the group is reported to have entered an agreement with another KAG to provide their administration services.
At State Street, a different view is taken. Giving his personal perspective, Stephan Gmuer, senior vice president says: “We do not want to get into competition with our underlying clients. But where people, talk about doing it all under one roof, it sounds good on the surface, but the German market is crying out to get away from this concept, the incestuous, cross-subsidised approach of universal banks.”
But an increasing number of KAGs that the bank works with are developing master KAG services. Thomas Bergenroth, who is senior vice president at State Street in Munich says: “If we wear our global spectacles, the administrative part of the investment process, is closer to the custody world than it is to the asset management. We want to move into the world of the KAG back office outsourcing sector. KAGs are happy to talk to us as a neutral source as we do not have a retail activity, nor an investment banking capability.”
State Street aims to act as a global custodian in the relationship between the institutional investor and the master KAG, and as a separate activity, undertake the backoffice outsourcing for KAGs. “We are happy to take out the administration work from the asset manager shop and offer them solutions,” says Bergenroth. “There we see the business migrating.”
Multinational clients are well aware of the benefits of such a division, it is the more local client who does not see the need to break up the value chain, adds Gmuer. Certainly, the whole KAG Depotbank structure is coming under pressure.
One thing the consolidation results in is consolidation of assets, points out JP Morgan’s Manhold. “This will make securities lending more interesting and attractive.”
At BNP Paribas, Rössler points to greater client interest in the additional services custodians need to provide to make the fees they get for custody palatable. Clients are very interested in the transaction cost analysis that is offered, he says. “This is something that is quite new to the German marketplace. The Myners debate in the UK, made German investors aware of the issues and are looking for this information.” He believes the group is one of the first to introduce commission recapture to the market.
The realignment in the marketplace as a result of the Deutsche State Street custody merger, is working in BNP’s favour, he claims “It creates an environment where clients are nervous and unsure about the new set up.”
Such a scenario would be hotly disputed by State Street, where the mood is upbeat to say the least. “We are very positive. Client retention is one of the key corporate goals,” says State Street’s Gmuer. “All major clients are being talked to in detail about the conversion plans. We have very close contact with Deutsche Asset Management as one of these.” The whole transition is scheduled to be completed mid 2005.
The feedback from clients has been positive. “The argument that really convinces clients is that we are the world’s largest global custodian,” he says. “So what has changed for clients in terms of the day-to-day people or approach? Not much!”
The operation, which is structured as a GMBH, headquartered in Munich, has assets in Germany of E214bn approximately, involving some 400 to 450 clients, he says. “We already outsource the DeAM’s subsidiaries, and we have a substantial portion of third-party clients on the books.” Everything is as on course as it could be, Gmuer declares. “We have a small team of professionals focused solely on the integration in daily contact with the account managers and reporting back. So we get the temperature of our clients on a daily basis almost.”
But in addition to the conversion, State Street is also open for new business, Gmuer points out “We have won at least half a dozen blue chip names. In particular the development of pensions trusts as groups takes the pension liabilities off corporate balance sheets. We have done very well in the pension sector.” The group now works with some 40 KAGs, with five new relationships in the last few months, Gmuer claims.
The aim is to combine the best of both with a new systems platform, particular beneficial in the mutual funds administration affecting the Publikum funds at the retail end. “Our Spezialfonds systems were state of the art,” he adds. State Street will have over 20% market share in fund administration ultimately involving the migration of over 1,000 funds.
Other global custodians are said to be poised to enter the market. At BNP Paribas, Rössler is not too concerned as he says it took the group some three years to start winning business there – a year and half setting up the organisation and a similar period out in the marketplace talking to potential clients. “To deliver this capability took a significant investment,” he points out.
ABN Amro Mellon has won new business in Germany, while the Bank of New York is reckoned to be well down the road to enter along with its partner ING. And Citi is strongly rumoured as another candidate.
But the feeling is that they will need to tie up with someone local, as otherwise the costs will be exhorbitant. This could come via buying into the market or create a strategic alliance or by operating a joint venture. But undoubtedly spurred by the Deutsche exit from the custody business, there will be other local players considering the same course of action.
One intriguing question that is thrown up by the development of the master KAG concentrating on administration only is whether they and the global custodians will be tussling for business in the years ahead.

Topics