Roger Kubarych: I was reading Rudy’s bio, which I’ve probably seen a couple of times before, and I realized that it looked rather similar to mine. Rudy started out at a central bank—I started out at a central bank. He left—I left. He worked in the stock exchange business a good long time—I never was a chairman of the Stock Exchange, but I did work for the Stock Exchange for a while. We’ve both been in the private sector, essentially working at the leading edge of some interesting changes occurring at the intersection of the financial markets and business. These changes have been noticeable in the United States for some years now, and are happening in an increasingly interesting way in Germany.
I read two different titles for you, Rudy: “Executive Vice President, Deutsches Actieninstitut,” and then in English “German Institute for Share Promotion.” Does the English translation express well what you are really doing? I thought it was an organization that is trying to mobilize the chief financial officers in Germany to essentially create “Germany’s Big Bang.”
Rudy, thanks for joining us here today. Please, start us off with a few minutes of your own views on what’s important in this whole area of business and finance in Germany, then we’ll go after a few points of comparison between the U.S. experience and the German experience. The conversation will be very informal and I hope that everybody here will have an opportunity to get some points on the table and provide your own views as well as ask questions. We are not going to run a press conference, but offer an opportunity for all of us to discuss various issues.
So Rudy, without any further introduction, you are on.
Rudiger von Rosen: Thank you for the free breakfast, and thank you all for the time you’ll spend here. In a way, I find it difficult to speak today knowing that the Yankees are the champions of the century. In comparison with this historic event, Germany is so insignificant, located somewhere on the other side of the Atlantic.
First of all, I wouldn’t talk of “big bang”. This sounds a bit like revolution, and the Germans have always had a problem with revolutions. So although we, Germans, do everything step by step, in the field of equity trading and finance we have witnessed a lot of changes in Germany. There have been mergers and takeovers in all sectors of the economy on a scale we have never had before.
In the middle somewhere, as a service institution, is of course the Stock Exchange. The Stock Exchange, perhaps under pressure from the electronic communication markets—these former proprietary trading systems—has been forced to act. As you know, Eurex, the German futures market formed just 10 years ago, is now the largest derivatives market in the world after its recent merger with the Swiss derivatives market. The discussed alliance with CBOT will make it even bigger.
Similarly, our Stock Exchange electronic trading system is expanding and currently it is accepted by Vienna, and Helsinki; we are in discussion with Prague and many other markets as well. We founded a new Stock Exchange trading in interesting East European stocks, which may enter soon the area of bonds too. Recently Deutsche BÃ¶rse Clearing and Cedel, the European clearing house, merged to form again the largest clearing system. So all these different services, trading facilities, clearing opportunities strengthen Deutsche BÃ¶rse’s global position.
We’ll have to find out whether the planned cooperation with London followed by agreements with seven other exchanges in Europe will work. However, this planned alliance pushes the Stock Exchange even further into new areas. I mention this only because it is outside the promotion field of the government. We’ve never had in Germany as positive a climate for venture capital as we have today. If you look at the number of patents filed in Europe, and specifically in Germany, you will realize that we’ve never had so many before. Hundreds of venture capital firms are entering the market through the new market segment of Deutsche BÃ¶rse “Neuer Markt,” the equivalent of Nouveau MarchÃ© in Paris, France’s alternative investment market.
Astonishingly enough, within the two and a half years since Neuer Markt was founded in March 1997, it has reached, in relative terms, the European market capitalization in this high-tech market segment. There is no other area which has grown as fast as this one, and looking at the numbers for 1999, we expect roughly 150 new Initial Public Offerings (IPOs) at the Stock Exchange. This figure is for Germany only, and keep in mind where we started from.
In the field of financial services there is a lot going on.
As you are well aware, for a year we’ve had a new government. No other German government has lost so much public support in such a short period. I cannot say whether the SchrÃ¶der government will be able to deal the three main problems Germany faces now: unemployment, an expensive pension system in dire need of reform, and extremely high taxation. The former government didn’t have solutions to these problems and arguably made crucial mistakes regarding the tax and social security systems. Our pension system has to be organized along the model of what in the United States is called 401K, introducing pension plans in Germany. I believe, we will move in this direction: we have already prepared all the necessary plans, similar to the personal equity plans in the U.K. and other countries.
Tax reform has been a hot topic for some time now, and it is becoming even hotter than ever because pressure from powerful interest groups is forcing our government to revoke some of the changes in the tax system introduced only a year ago, right after elections. What it amounts to is reverting to the previous style of taxation.
However, tax reform is inevitable, because it is driven by a powerful force—the euro. It doesn’t really matter whether the euro/dollar exchange rate is $1.20, as it was at the beginning of the year, or $1.07 or $1.02. It is a powerful market force that will make tax reform in Germany unavoidable.
Institutional investors have been very active buying euro stocks and rebuilding their portfolios. Research by Lehman Brothers in the last months shows that the largest winner of these developments accelerated by the advent of the euro will be Germany, because there are the largest European companies and German stocks have been up until now slightly underrepresented in institutional portfolios. So I think, in general, despite the negative pressures on the government from interest groups such as trade unions, the conditions for change are well present in Germany.
One word about this Deutsches Actieninstitut. It does, of course, more than share promotion. We are not just a lobby association. Thirty-eight chief financial officers of such large companies as Daimler Chrysler and Deutsche Bank are on our board supporting the idea that we have to do more for equities in Germany. If you take again these last years, equities have been largely promoted, even on TV. And it works: there was over-subscription by 5 times for Deutsche Telecom’s IPO of DM20 billion, which for our country is a lot. This year, just within a month, more than DM30 billion was raised for equities at the market. One of the smaller companies in the very hot Neuer Markt had over-subscriptions by 70-100 times, which, I admit, is not very healthy, but it contributes to a climate where people have to get engaged. And people are becoming increasingly aware of the market and the opportunities it offers. They are discussing more and more the subject of equities, perhaps not to the same extent as they are discussing soccer results, but still there has been a remarkable shift in public understanding of the opportunities offered by a vibrant stock market.
Roger Kubarych: Thank you. These are tremendous strides in the technical side of Germany’s equity infrastructure and it really does qualify as a “big bang.” You may recall the origination of the term. To put it in a historical perspective, the term “big bang” was used first here in the United States back in the 70s to describe the movement toward negotiated commissions for brokers, instead of fixed commissions, basically introducing competition into Wall Street. It led, as you might have expected, to a tremendous pressure on profit margins and a huge wave of consolidation.
Then London’s big bang occurred. It was also the opening up and moving from fixed to negotiated commissions, but it also changed the nature of what institutions could do: they did not have the Glass Steagall Act in England, but they actually had other regulations with a restrictive effect on the stock market. The big bang in London eliminated them. It had a tremendous impact on the structure of the financial services industry.
The big bang in Germany is a little different. It isn’t about brokerage commissions or universal banking. They already exist. It is about equity culture: the infusion of equity culture in society and giving it a more prominent role.
Sometimes it is easy to forget all of the building blocks necessary for a healthy equity culture. Let me remind you of just four of them.
Then I’ll ask Rudy to comment on how Germany measures up.
To have an equity culture you really have to have management focused on enhancing shareholder value. You have to align the interest of management with the interest of shareholders, which does not exist in most countries. In most countries, management’s interest and shareholders’ interest diverge. It is only coincidental if it doesn’t diverge. The U.S. equity culture over a period of time has led to a lot of convergence, and one of the symbols is paying top managers in stocks and stock options. So this is the first building block. The question to Rudy is: Is this happening in Germany?
The second building block comes in the nature of what you would call the oversight of business, the second guessing, the Monday morning quarterbacking. In the opposite of an equity culture—a banking culture—oversight is done primarily by creditors, usually banks. In Germany, business oversight was in the hands of very big, very smart, very powerful banks.
In an equity culture business practices oversight function is performed by the market place, anonymously, in a dispersed way. Who does it? Equity analysts do it with every report they write. In Germany, are the equity analysts going to be objective in their analyses, if they work for these big financial institutions that still have substantial shareholdings in the very companies analysts are supposed to research? Are these analysts going to able to ever issue a sell report when they know that their own employer is a major shareholder?
The third building block, and part of the oversight function, is the investigative journalist. What keeps companies in the United States honest is in part the existence of hard driving investigative journalists who are not suppressed by employers with equity stakes in the very companies they are trying to dig up dirt on. Is that also going to happen in the newly emerging German equity culture?
Another factor of great importance to the Americanization of finance is an aggressive buy-side. Rudy mentioned the 401K plans. Even before we had the 401K, there were defined benefit pension funds, the kind that accounted for several trillion dollars worth of equity ownership. For example, they include the IBM pension fund, the Kodak pension fund, AT&T fund and so on. There are also the state and local pension funds. They matter because they too have an important oversight function in the Monday morning quarterbacking of large U.S. businesses. We welcome heartily Germany’s equity culture, but there is the question whether these building blocks are really in place, because just having a great stock-trading mechanism isn’t enough. What is your reaction to my building blocks, Rudy?
RÃ¼diger von Rosen: Two remarks. First of all, I am not in the construction business.
Roger Kubarych: You can change the metaphor, if you wish. You can go back to sports metaphors. It’s okay with me.
RÃ¼diger von Rosen: What is really the outcome of the Big Bang in London? There are no more British investment houses today. We see this quite clearly: the Barings, the Morgan Grenfells are gone, taken over largely by continental European banks. Second, I have to go back slightly into history, because this subject of equity culture fascinates me personally. In the early 20s, in Germany there were quite a few American investment banks in Germany. Subsequently they all left the country and focused on building up an equity culture here in the United States. But while in Germany, in their founders’ years—in the last 2-3 decades of the last century—they brought industry to the market. At the time in Germany there were three times as many stock market listed companies as today. There was no electronic trading, but there were 29 different exchanges in the German Reich. This was equity culture per se.
Today, all the newcomers to the stock exchange offer their employees stock option programs. Our institute helped the government to create the legal framework for these programs, we also prepared the legal texts for buy-back programs, and within a year, in terms of buy-backs we have reached, in relative terms, U.S. standards. Most of the big companies have already announced that they are moving at least partly into this market. The benefits of stock option programs are generally understood. You have a much better chance to get the best employees and keep them if you offer stock options.
Shareholder value was at one point hotly discussed by the trade unions, the churches, etc. It is not discussed today—its importance is overwhelmingly accepted.
All the necessary laws were implemented in 1998, and astonishingly enough, by practically unanimous vote, despite the differences between the Social Democrats and the Christian Democrats. All the financial promotion laws were voted in parliament almost unanimously. Surprisingly, the Greens have been extremely supportive in this respect. They understand the need to use more modern instruments in business. They seem to have learned better than the big parties that if you would like to reach the low unemployment level of the United States, you have to cultivate acceptance of stock market culture in companies’ management as well as in outside investors, specifically the private investors.
On the question of the power of the banks: this is a long story. We have difficulties to really understand it. However, please keep in mind that within the European banking system, Deutsche Bank’s market share is quite modest. All three big banks are much smaller in total than the savings banks in Germany. In Holland, Switzerland, etc., the three largest banks cover 50%, 70% of the market. In Germany they cover only 30%. The hot high-flying IPOs, the ones that really bring fire into the market, are not brought by Deutsche Bank. They are brought by the cooperative banks, and by the private banks, such as Sal. Oppenheim, Flemings, Goldman. Foreign banks play an extremely important role in Germany—in the futures and options market they account for more than 50% of the business, and in the cash market, between 35% and 40%. The question about German banks’ influence has to be put in the proper perspective.
Despite some resistance, a couple of weeks ago we organized a large forum on the topic of Internet-facilitated general assemblies. We believe that we have to enhance the influence of shareholders by giving them an easier access to the levers of control over the strategy of the company they invest in. In addition, wider shareholder participation in the general assemblies would diminish the influence of banks in the management of the firm.
Roger Kubarych: Thank you, you’ve taken the question mark off the Big Bang and everybody wants to get in the discussion now.
Q: I missed among Roger’s building blocks one that I think is very important. This is the issue of disclosure rules which have been traditionally lacking not only in Germany but in most European exchanges. I’d like you to comment on that.
RÃ¼diger von Rosen: The need of transparency is no longer disputed in Germany, and in Europe, in general. When I started my stock exchange career in 1987 this was the reason to hire me: the decision-makers at the time said they needed someone who was more outspoken and perhaps might be successful in bringing more openness into the markets. When I proposed a law on insider information, there was such an outcry, that I thought they would fire me. Today, such a law has been implemented, and we have a supervisory authority on this issue.
Today, even without a specific law, Deutsche BÃ¶rse requires that all new IPO companies to be listed on the Neuer Markt segment comply with the U.S. auditing standards (GAAP). Also, Deutsche BÃ¶rse asks these companies that they accept the takeover code, and next year we will have a new takeover law and a European Takeover Directive (ETD). The law and the ETD will apply to all markets, not only to the Neuer Markt. In addition, we are working on an issue on which I am not sure we’ll get overall support—a code for best practices in corporate governance in the areas of management, supervisory board and general assembly. For instance, mutual fund subsidiaries of the big institutions are becoming more independent and are demanding with growing insistence that companies’ managements take into account shareholder value when makings strategic management decisions. And this is something no longer criticized. We have been discussing these issues, and you may find interesting to know that certain requirements which have been law in Germany for quite a while now are being included in the code of best practice in other European countries.
The need to understand that shareholders are the owners of the company was a hard-learned lesson for most of the German companies. And I have my doubts whether American companies have today as many people on their boards of management as German companies. Disclosure is discussed, it is not at all any longer criticized, and it is accepted as a necessity. Managements really understand that they have to orient themselves to the public, that they have to accept the ad hoc publicity rules requiring that all relevant news should be brought to the market as fast as possible, and I think it is working quite well now.
Q: To follow up on this, one of Roger’s building blocks was the role of the securities analyst. The securities analyst, of course earns his living by asking questions and obtaining information. I have been following for many years the euro insider trading block. What concerns me is can you really expect to have a vigorous research analyst function if the information once obtained is to be made immediately public? Is the ad hoc publicity requirement discouraging a vigorous research function?
RÃ¼diger von Rosen: I don’t think so. We’ve been discussing the issue of whether one-on-one meetings may lead to a conflict of interest for the company as well as for the analyst, by not providing the same information level for those who are not present at the meeting. In Germany, where this ad-hoc publicity law was introduced in 1994, companies had to learn to handle it. In the United States where such requirements have been present for a long time there is more understanding on the issue. In Germany, companies at first found the new rules somewhat confusing—there is no catalogue listing exactly what information is to be made public immediately. For the past five years our institute has been trying to facilitate the application of this law by organizing seminars that bring together legal experts and company executives for a discussion of the problem of insider trading and ad hoc publicity.
I think I might mention also that we just founded a German rating agency called Euro Rating AG, not to be dependent only on Moody’s and the rest of the international rating agencies, because we believe that German market has specifics not yet taken into account.
Q: I have a question regarding the so called corporate culture. Even among the other countries in Euroland there are quite significant differences in corporate culture. Do you find that the differences between the European countries may cause difficulties for the financial services industry?
RÃ¼diger von Rosen: First, you must realize that today the majority of financial laws are hammered out in Brussels and not any longer in the member countries. All countries in the European Union have lost sovereignty in this field. All financial controls—subsidies and subventions, grants, etc.—are managed in Brussels. Everything that has been decided in Brussels has to become national law, a process that takes on the average one to three years.. European law is always above national law. By removing currency risks the euro is forcing investors to look for cross-border investment opportunities rather than staying within their own country market. Investment decisions are increasingly characterized by industry focus instead of country orientation.
This really takes place daily and has many implications. It is speeding up reforms that have been long overdue. One example is the European Stock Companies Act that has been on the discussion table for more than 30 years. If a realty company, for example, decides to move its headquarters from Germany to Holland, currently, because of different regulations in each country, the firm will have to first liquidate all its assets in Germany and start practically from ground zero in Holland. The European Stock Companies Act is supposed to change this and align regulations in the different countries. However, it has been facing stiff opposition from the German trade unions, as well as the Christian Democrats and the Social Democrats. They are blocking it because they feel that they will be losing control. I don’t know when we will get this new regulation but is essential for all European mergers, for example.
Q: How about the democratization of risk taking: the participation of literally millions of people in the stock market. About 45 % of all Americans are directly exposed to the stock market, and only 15% are members of the unions. This ratio has enormous political implications as well as impact on business. Do you think risk-taking democratization is coming to Germany? Could Germany continue to have an equity capitalization that is only 34 to 40% of GDP, when in the United States it is about 120 - 140% of GDP?
RÃ¼diger von Rosen: My figures are 52% for Germany and 175% for the United States, but the relative proportion is the same. Membership in trade unions will have to be discounted as a force in business because, for example, in Egermetal, the most powerful trade union in Germany, 30% of the workers are retired. Where is the influence of this trade union then? In addition, quite a number of the union members are unemployed. Much more important is to build up employee stock programs that make employees direct beneficiaries of increased productivity and better management practices.
Q: What proportion of your Institute’s 38 members have employee stock option plans?
RÃ¼diger von Rosen: All of them. Again in the United States more people participate in employee stock programs but this has something to do with our social security system as well. One of the difficulties of the unification of Germany was that West Germany took over all liabilities of East Germany’s social security system. Imagine what would happen if California bought Mexico and had to provide pensions, without any additional payment, for three million retired Mexicans. And this is exactly what happened in Germany. With a legal act of the government, all retired East Germans were brought into Germany’s social security system.
More than 90% of the East German women were working compared to 60% in West Germany at the time. In East Germany women used to work longer years than in West Germany and eventually they ended up with larger retirement pensions than the West Germans. This raises a lot of eye brows and not only eyebrows.
This is why our social security is so expensive.
Q: I have never been able to understand the one-to-one conversion between the Ostmark and the Westmark. Where was the value there?
RÃ¼diger von Rosen: In February 1990, at the Forum in Davos, I prepared a draft for a then very famous East German—the Mayor of Dresden. My proposal was an exchange Westmark to Ostmarkt of 1:4.. The proposed ratio was simply the median of the then market price of 1:8, 1:9, and the one-to-one conversion that the East Germans expected. Such an exchange rate would have worked much better. My former boss Carl Otto PÃ¶hl resigned because he disagreed with the government on the conversion ratio.
Helmut Kohl, who was then Chancellor, is a historian and a very proud German. At the time, some of his advisors insisted that East Germany was just a small place, only 17 million people, and who else but West Germany could solve all the problems. And these same advisors are voting left wing now. Unbelievable.
Roger Kubarych: Rudy, thanks for coming. We learned a lot. You are fantastic with your breadth of knowledge and good humor, and I encourage everybody to visit www.dai.de and you can follow the work of this very interesting organization as Germany changes in ways that many of us never thought possible just 10 years ago. Thank you, Rudy.