Euroweek Germany capital markets report: Frankfurt as the financial centre of the eurozone

Euroweek, Germany Capital Markets report, April 2013

Frankfurt’s skyline is very much the image of a modern financial centre: the functional innovation of Foster & Partner’s Commerzbank Tower, the stocky Messeturm, the glass twin towers of the Deutsche Bank headquarters. So it looks the part, but does it deliver? Does Frankfurt warrant mention among the world’s leading financial hubs? And is it fair to call Frankfurt Finanzplatz the key financial centre of the Eurozone?

First, the case for.

Frankfurt’s first boast is location: locally, the centre of the Rhein-Main economic region, and taking a wider view, a logical centre for European finance in particular. “It has been a financial centre for centuries, being at the cross-roads of north-south and east-west trade,” Lutz Raettig, president and chairman of the board at Frankfurt Main Finance (FMF), tells Euroweek. “Hence, we did not need to build it.”

According to FMF, Frankfurt hosts 34,000 businesses with a gross domestic product of more than Eu50 billion between them. It has individual wealth, too: a gross domestic product per wage earner of over Eu84,000, FMF says. And if we accept that Frankfurt is the clear financial centre for Germany itself, then the scale of German exports within the total Eurozone clearly speaks to Frankfurt’s importance as a financial hub. German exports were Eu88.6 billion in January 2013, and have been as high as Eu98.8 billion in March 2012, according to the German Federal Statistical Office; by comparison, France, the next most significant safe haven Eurozone economy, had exports of Eu36.735 billion in January 2013, according to Trading Economics, citing data from the Ministry of the Economy.

The attached chart compiled my Markit Economic Research shows Germany’s dominance still more starkly. By combining final 2012 numbers in most markets with estimates in others, it indicates that Germany accounted for 31.4% of euro area exports of goods and services in 2012, totalling Eu1.36 trillion, well over twice as much as France, and more than the Netherlands, Italy and Spain combined. So if Frankfurt is the financial hub for this engine room of Europe, then that’s a very sound foundation.

Second, the institutions. Absolutely central to any claim of Frankfurt to be a financial centre is the presence of the European Central Bank, which was established here in 1998. On top of that, there is the Bundesbank, the Committee of European Insurance and Occupational Pension Supervisors, and of course Deutsche Borse Group (whose headquarters in the distinctive Cube building is strictly speaking in Eschborn, but that’s very much within Frankfurt’s periphery).

These institutions, vital domestically, are worth looking at in greater detail from a regional perspective. The ECB is obviously the single key institution in dealing with the Eurozone crisis. As Raettig says, the presence of the ECB in Frankfurt has been “beneficial all through. From the human to the cultural all the way to the economic aspects. The population is growing and is drawing talent from all over Europe. Frankfurt was always an open city, but thanks to the ECB it became probably the most European of cities.”

As for the Bundesbank, few have better stated its importance than Jacques Delors mischievously did during his presidency of the European Commission: “Not all Germans believe in God, but they all believe in the Bundesbank.”

And Deutsche Borse Group is considerably more than a Frankfurt stock market these days. Granted, its planned merger with NYSE Euronext was nixed by the European Commission in February 2012, ending an alliance that would have created one of the world’s greatest global exchange groups, but nevertheless the group has considerable reach. In June 2011 it became the sole owner of Eurex, the group’s clearing house and a derivatives exchange that boasts participants from 700 locations worldwide and 1.5 billion contracts traded per year.  It is the majority owner of Tradegate Exchange, the European retail platform for equities, bonds, funds and ETFs. It runs the XTF business for exchange-traded funds, in which it is the European market leader, with a market share of 38%, according to Deutsche Borse Group. And it owns Clearstream, the settlement and custody arm, which calls itself the leading European supplier of post-trading services, with over 300,000 domestically and internationally traded bonds, equities and investment funds deposited with it, relationships with 2,500 customers in over 100 countries, and settlement of more than 250,000 transactions per day.

“We are home to the nuts and bolts of financial centres,” says Raettig: “Payment systems (such as SEPA), clearing and settlement systems, and the trading platforms at Deutsche Borse, to name but a few.” On top of that is “the deep capital pool that makes Frankfurt a leading European market for debt instruments, not least for the European Stability Mechanism,” he adds.

Third, there’s the argument that if leadership of the Eurozone through crisis has effectively moved to Germany in the last two years because of Germany’s economic strength and stability, then it must follow that Frankfurt is the logical financial centre for the region.

Hubertus Vath, acting managing director of Frankfurt Main Finance, recently spelled out this argument. “The ‘Made in Germany’ hallmark stands for quality workmanship, reliability and stability,” he said in a recent address. “And this applies to the services of the German financial sector just as much as for machines and cars.” Frankfurt, he said then, hosts 260 banks and around 200 branches of foreign banks (though in written responses to Euroweek FMF now refers to more than 200 banks, with over 74,000 employees, and 156 out of 206 foreign banks that are active in Germany). “It finances the main driver of the economy – exports – as well as the expansion and internationalisation of Germany’s economy with its mainstay of medium-sized companies.”

To Vath, Germany’s resilience in the financial crisis is instrumental to the argument for Frankfurt’s financial centre. “There was never a credit squeeze here, despite all the prophecies of doom. The bedrock that made Frankfurt strong has proved itself yet again: the close link between the financial and the real economy.”

Raettig makes a similar point. “Frankfurt has been stable throughout the crisis,” he says. “We did not participate in the excesses before, nor did we see the big layoffs. We believe that makes Frankfurt the natural centre for regulation in the post-crisis era.”

Vath’s argument – that in Germany, a greater portion of financial market activity is based on assets and activities in the real economy – is a powerful one, if difficult to prove. One can perhaps link it to the popularity of German treasury bonds as safe havens for investors, which they have consistently been throughout the crisis: as other articles in this guide explain, German funding costs are as low as 1.5% for 10-year bonds, and on two-year securities ended up with a negative nominal rate for a spell in 2012. And for those making the stability argument, it’s useful to be able to point to the presence of the European Systemic Risk Board, which exists within the ECB, and the Institute of Risk Management and Regulation, which was set up in Frankfurt in 2009. These days Frankfurt touts itself as a centre of excellence for risk management, which is a canny thing to try to forge a leadership position in.

“Frankfurt is a synonym for prudence,” says Raettig. “We have unique experience in risk management and regulation. We are not only home to two central banks but, thanks to the Bundesbank, train more nationalities of central bankers than any other financial centre in the world. “

Another theme is the Frankfurt Rhine-Main knowledge region, which refers chiefly to the universities in Frankfurt and the consequent number of well-trained employees available. Another is the technology and infrastructure available in Frankfurt, and this can be compelling: Vath has said that 85% of German data traffic, and 35% of all European data traffic, pass through the Frankfurt internet exchange point, the DE-CIX.

Next, the case against.

Is Frankfurt even the key centre of Germany, let alone Euroland? Certainly not by population: it is only the fifth largest city in the country, although it has the highest economic power of them all. Other cities have sought to build financial centres too, such as Finanzplatz Dusseldorf, to which HSBC is committed.

We can probably let that argument go – a city doesn’t need a huge population to be a financial centre, though most happen to have one – but it is certainly fair to compare Frankfurt to other global hubs and see how it stacks up.

What do the independent adjudicators say? The Xinhua-Dow Jones International Financial Centers Development Index ranks Frankfurt seventh, behind London (2^nd) and, crucially, Paris (5^th). Within that are a number of underlying rankings: the most relevant is ‘financial market’, which includes capital market, forex, banking and insurance; in that respect Frankfurt is ranked 6^th, again behind London and Paris, with the commentary saying it showed weakness in forex and insurance.

The Global Financial Centres Index, published twice a year by Z/Yen Group, ranked Frankfurt just 13^th in its 2012 ranking in September, though it had jumped to 10^th in a more recent interim ranking; this approach has London at the top and Paris far further down. Digging deeper once again into the underlying calculations, Frankfurt ranked seventh worldwide for banking, sixth for government and regulatory, and ninth for wealth management, but was outside the top 10 in asset management, insurance and professional services.

It’s worth noting that the Z-Yen survey publishers are a London-based think tank and the report is sponsored from Qatar, but nevertheless, the September 2012 report does not make appetising reading for the Eurozone: “A number of questionnaire respondents feel that finance is such a global industry that it is now more essential than ever to have a globally linked trading hub in each main time zone. The opinion is that within the European time zone, London is currently the only realistic option as Frankfurt and Paris are not sufficiently competitive.”

Increasingly, though, there is a sense that Frankfurt’s future as a financial centre is all about London. Admittedly, there is scarcely a credible comparison today between the two as global financial centres: in the Z/Yen Group, London ranked top in every sub-index category bar banking (where it was second to New York), leading the world in asset management, government and regulatory, insurance, professional services and wealth management. According to the World Federation of Exchanges, London ranked fourth in domestic equity capital market capitalization at the end of 2012 (US$3.34 trillion), Deutsche Borse ninth ($1.49 trillion).  And stocks are the most favourable comparison between the two: in foreign exchange, London is commonly thought to handle around one third of worldwide transactions while Frankfurt is nowhere. According to CityUK, London hosts the largest insurance industry in Europe, with net premium income of GBP187 billion in 2011; accounts for around half of all European investment banking activity, one third of private equity fundraising, and 85% of hedge fund assets; hosts an interest rate derivatives market responsible for 46% of global turnover; and hosts leadership European positions from legal services to accounting, maritime services and Islamic finance. It’s not just about the population: Frankfurt just isn’t London.

And yet. Ask any economist about Frankfurt’s future as a financial centre, and one of the first things they will mention is London. “The development in Frankfurt depends mainly on developments in London, in my view,” says Stefan Bielmeier, chief economist at DZ Bank. “It’s really dependent on whether the UK stays in the euro area. Frankfurt should develop its current role in the future but I don’t expect large steps.” Put the same question to Torsten Windels, chief economist at Nord/LB and, after noting the crucial importance of the ECB’s presence, the answer is similar: “If there are further steps for the UK to go out of the European Union, this is a very strong threat for London, and a chance for Frankfurt. But if there is no significant difference in the framework in Europe, then the division of work between Frankfurt and London will be more or less the same.” And Janet Henry, chief European economist at HSBC, adds: “Any initiative that diminishes the attraction of London as a financial centre (because the UK is not in the Eurozone) is more likely to increase the attraction of Frankfurt. But it is also possible that some EU policies on the financial sector reduce the attractiveness of all of the EU financial sectors relative to say New York or Geneva.”

For its part, FMF treads a careful line on commenting on the UK. “According to polls a rising part of the population in the UK is in favour of leaving the EU,” says Raettig. “Even though we believe it would be a great loss for both the UK and Europe we have to take the possibility of the UK leaving the EU into account. We see that many decision makers understand that Frankfurt is where the trade and investment flows are and will reconsider decisions on where to be and what to do in favour of Frankfurt. We nevertheless do not want the UK to leave.”

Henry’s point on EU policy is an interesting one: that EU policies on banking integration, and on capital requirements, will impact any European financial centre and curb its opportunity. Gernot Griebling, in macro research at LBBW, says: “Generally I would expect the growth of the financial industry will be curbed and grow much slower due to regulatory developments, especially the capital requirements in the Basel 3 liquidity rules. The financial industry will not be a growth engine as we were accustomed to from the 90s and the beginning of the new century.” Though, as he notes: “This is valid for other countries, not only for Germany; it is also a subject for the UK.”

Another question is just how much Frankfurt wants to be the financial leader of Europe. Economists in other chapters in this guide have spoken of the discomfort Germans feel at any idea of taking Eurozone leadership, and there is a sense that this is perhaps not a national priority in terms of financial markets either. “Frankfurt has strong banks,” says one economist. “But when it comes to ideas of low taxes and bank-friendly regulation, this is not where German politicians would want to fight at the forefront. This is London’s position, essentially. It’s just not likely that Germany in its current mindset will become the Mecca of the bankers of the world.”

Then there’s the Eurozone crisis issue. Clearly, this has damaged Frankfurt’s standing versus non-European financial centres, dampening the economy, trade, and financial markets activity. However it is hard to argue that it has damaged Frankfurt relative to, say, Paris, which if anything appears to have suffered a greater reputational knock with the recent change of government towards one perceived to be less-bank friendly than its predecessor.

Chiefly, the Eurozone question raises questions about the health of the banking sector in Germany, with some, including Commerzbank, having taken state aid. Another chapter looks in detail at the impact on German banks if the euro were to collapse and a return to legacy currencies took place; on page xx, one economist argues that the entire tier one capital of the German banking system would be wiped out, which helps to explain just why Germany has been so keen to do everything it can to preserve the euro in its existing form. It’s so monstrous a prospect that FMF isn’t even considering it. “The political will to support the euro has been underestimated to the peril of speculators,” says Raettig. “There is no need for a plan B.”

But is that true? As Elke Konig, head of BaFin, Germany’s financial regulator, noted last year: “The German banking system is comparatively robust, but it cannot completely seal itself off from developments around it.”

That said, being the financial centre of the eurozone’s key safe haven is clearly preferable to being the financial centre of a troubled peripheral country, or even a strong but downgraded nation, so from that perspective one can argue Frankfurt’s standing has improved in local terms. That argument is supported by the capital flows, and reduction in funding costs, Germany has enjoyed since the crisis began. To put it another way: if Frankfurt isn’t the eurozone’s key financial centre, it’s hard to argue any other city that is.