FRANKFURT, Germany - Hoechst AG has become the first German company to select a global custodian for its pension fund investments in stocks and bonds.
Chase Manhattan Bank will provide custody services for nearly 4 billion deutsche marks ($2.86 billion) in Hoechst pension fund investments in stocks and bonds. The balance of the 7 billion mark ($5 billion) fund is invested in property and home loans to employees, which are administered internally.
The unprecedented move is expected to open the 257 billion mark ($184 billion) retirement plan market to foreign-based bank custodians and money managers. It also threatens to shake up existing money management fee structures.
Hoechst's change is "a seminal event," said Len Brennan, managing director for Frank Russell Co. in Europe, the Middle East and Africa. Mr. Brennan said the move should make it easier for German pension funds to invest overseas, as they hire banks with international safekeeping capability and the money management industry moves toward "clean fees."
Indeed, other German corporations and insurance companies are considering separate custody of their assets. For example, Rainer Fabian, a member of Ludwigshafen-based BASF AG's pension board, said hiring an independent custodian is under review for its 5 billion mark ($3.6 billion) in Spezialfond assets.
Patrik Roeder, head of asset management at Frankfurt-based Hoechst, said the chemical and pharmaceutical giant wants to provide more protection for plan participants by having a custodian independent of its money managers.
Also, the company wants online access to real-time data and better breakdown of costs between asset management, custody and brokerage, he said.
If others follow Hoechst, they could upset the cozy relationships between German companies and the universal banks - led by Deutsche Bank, Dresdner Bank and Commerzbank.
Most German companies still use the book-reserve system, carrying their pension liabilities on their balance sheets backed by corporate assets rather than segregated funds - in effect providing a cheap source of financing to the corporation but failing to diversify investment risk. However, large companies increasingly are turning to setting aside reserves to cover a portion of their pension obligations.
They typically turn to banks to manage corporate retirement assets in a variety of Spezialfonds, tax-favored commingled investment vehicles for institutional investors. The banks charge low fees for asset management - often 10 to 15 basis points for a 100 million deutsche mark portfolio - but some pension experts say money management even has been given away.
Banks make their money on providing ancillary services, such as custody and brokerage through bank affiliates.
In particular, some sources say banks rake in hefty profits from brokerage activities, by churning accounts, charging excessive fees or not obtaining best execution on trades.
Because money management fees are rolled into one figure, it's impossible for German corporate executives to determine how much they have been charged for different services.
Jane Welsh, a senior consultant at Watson Wyatt Worldwide, Reigate, England, estimates hidden costs account for about half of the fees for a $100 million domestic balanced portfolio.
Some experts think the amount of hidden fees is far more dramatic. Russell's Mr. Brennan estimates asset management fees may amount to only 10 basis points, while the total cost actually ranges between 60 and 110 basis points.
Mr. Roeder said one of the key issues for Hoechst executives is to get greater transparency of fees. One likely outcome is that Hoechst will have to pay greater fees to money managers - but less for brokerage services, he said. He plans to meet with Hoechst's nine external managers to renegotiate fee structures.
While Mr. Roeder declined to disclose the names of Hoechst's managers, they are believed to include the three biggest German banks, plus State Street Global Advisors and J.P. Morgan Investment Management.
Chase will provide custody services for more than 3 billion marks of Hoechst's pension assets invested in externally managed Spezialfonds, plus nearly 1 billion marks run in an internally managed bond portfolio.
About half of the fund is managed externally, including all of Hoechst's 20% equity allocation and most of its 38% bond investments. Property investments and home loans to employees, comprising 42% of assets, are handled internally.
Greater protection cited
Another key issue is to provide greater protection for Hoechst employees and retirees, Mr. Roeder said. He said Hoechst executives no longer are comfortable with having investment managers double as their own custodians.
What's more, the current system does not provide up-to-date information on investments, but only monthly reports. Hoechst officials have to assemble data from a variety of sources to get a complete picture of fund investments.
With Chase as custodian, Hoechst executives will get, at the push of a button, a consolidated update on fund investments. Chase also offers trade-date and accrual accounting, performance measurement and brokerage performance services.
Trade-date accounting reflects fund balances from the time trades are made; usual German accounting only reflects balances after transactions are settled, which can distort actual investment holdings.
Having "up-to-date information is crucial," Mr. Roeder said.
The implications of funds using separate custodians are vast for German money managers. But no one expects the process to change overnight, as German corporations maintain close ties to their banks.
In fact, Germany's bond culture and the large equity stakes that German banks hold in major corporations - which often involve holding board seats on corporations' supervisory boards - suggest German companies will move to separate custody only gradually.
Still, Hoechst's selection of Chase has been turning heads.
"I think this (Hoechst's move) will probably be seen as a start of unbundling the (investment management) system and different services involved with a Spezialfond," said Gunther Skzrypek, managing director of J.P. Morgan Investment Management, Frankfurt.
Sources said the Big Three banks stand to lose out if unbundling moves ahead. But there are many smaller German managers who are good at investment management that would be happy to outsource custody, noted David Mark, vice president, State Street Bank GmbH, Munich.
Mr. Skzrypek said the move also may benefit foreign-based money managers, as German investors are becoming increasingly sophisticated.
Robin Amacher, managing director of Frank Russell A.G., Zurich, added: "There still is a lot of relationship banking going on in Germany....but the market is becoming more and more competitive."
Hoechst's contract with Chase, however, still has to be signed. Mr. Roeder said the contract will go into effect at year end. Both Chase and State Street are expected to imminently win regulatory permission to offer custodial services to German clients, after rounds of delicate negotiations with German authorities.
Chase, meanwhile, has to invest lots of time, money and resources into beefing up its custody capability. German clients, for example, insist upon sizable local operations, explained Adrian Mearns, director at Chase Investment Bank Ltd., London. The bank already has 150 people in Frankfurt and will add to that number as needed, he said.
Meanwhile, Chase will have to establish electronic links with Hoechst's money managers - a time-consuming process because such technological hookups are not in place.
But many are optimistic the German market is starting to change. As Frank Russell's Mr. Amacher observed: "There is considerable change taking place in the marketplace, and this is only the beginning of what we will see over the next few years."