The evolution of prime brokerage in Germany

Since the introduction of the 2004 German Investment Act, there has been debate on the potential growth of the local hedge fund market, and on possible 'local' prime brokerage solutions. However, as well as domestic hedge funds, the legislation deals also with another important area: the regulation and distribution of 'foreign' (non-German) hedge funds. Furthermore, the related Investment Tax Act enables local investors to obtain favourable tax treatment on investments in foreign funds, including hedge funds.

It can be said that the new German Investment Act and Investment Tax Act have explicitly launched a German hedge funds market, in two main ways:

? By introducing the concept of German hedge funds.
? By enabling foreign hedge funds to access the German market in an efficient way.

Much of the debate has focused on the first topic, including local hedge funds' structure, their potential growth, and their appeal to local investors. However, the second area may well prove more important for this market's evolution.

In fact, to date few local hedge funds have been set up. This can be attributed to the higher set-up and running costs, greater operational complexity and lesser flexibility of German structures over offshore ones. In addition, offshore solutions are well tested, and accepted by most of the traditional investors. Finally, a good pool of expertise exists among service providers.

In this light, German structures are still at a relative disadvantage versus offshore entities - which is to be expected when a new, untested solution is compared with a mature one. However, on top of this, the level playing field between German and foreign funds introduced by the new regulations has further slowed the uptake of German structures. In particular, the regulations do not seem to give German funds a clear advantage over foreign funds in the important areas of fund marketing and distribution, and investors' tax treatment. It may be worth noting that, as the extra cost and complexity of a German structure is less marked for listed and OTC derivativesbased strategies, local vehicles have been relatively more common for these - but they do not require a prime broker.

Finally, the recent strength of the equity market may also have contributed to dampening the growth of the local hedge fund market. In the past few years traditional long-only funds may have attracted more interest than hedge funds. However, if the market volatility persists, as has been the case recently, the interest in hedged strategies may well increase.

Currently, apart from a few local structures, quite a number of hedge fund managers have targeted this market through foreign vehicles. Even when a European domicile is chosen, the choice often falls on Ireland or Luxembourg, both regarded as established hedge fund domiciles. As a result, the new German hedge fund market has not produced a clear trend in prime brokerage model solutions. A multitude of solutions have been adopted, from German to offshore vehicles to EEAdomiciled vehicles as well as German and foreign managed account platforms. I believe that the evolution of this market will be investor-led. Since the launch of the Investment Act, interest from local investors in hedge fund products has been modest compared with the German investment market as a whole. Once this increases, I am sure a clear trend will emerge among the various structures available to tap into this market, and a clearer 'local' prime brokerage trend will become evident. 

By Antonello Russo  Antonello Russo is director of Global Prime Services at Deutsche Bank. This article has been written by Mr. Russo in a  ersonal capacity, and Deutsche Bank AG accepts no liability for its contents

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